A Simple Illustration of Global Macroeconomics

What happens when Philippines sells a COMMODITY to US?

A trade between countries whether goods or services constitute what economists call a current account.  The transaction above generates a positive current account balance as the Philippines receives a dollar while a negative current account balance as the US pays a dollar.

The same effect will be in the US should the process be reversed.

What happens when Philippines sells an ASSET to US?

An investment in the Philippine economy by another country forms part to what economists call capital account. The transaction above generates a positive capital account balance as the Philippines receives a dollar while a negative current account balance as the US invests a dollar in the Philippine economy.

The same effect will be in the US should the process be reversed.

Sum CURRENT ACCOUNT and CAPITAL ACCOUNT then you will have what economists call BALANCE OF PAYMENTS.

What will happen if US will always import more than it exports? Assuming that US has no capability to print money, what do you think will happen to the US economy? It will run out of cash!

The situation I cited above would be a nightmare for any country but this is exactly what is happening in Greece. Greece’s current account [1] was consistently at negative territory. Also worth noting is its budget deficit (government spending exceeds government revenue) and declining GDP.

Euro is a currency used by 22 countries: Andorra, Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Kosovo, Luxembourg, Malta, Monaco, Montenegro, the Netherlands, Portugal, San Marino, Slovakia, Slovenia and Spain and the Vatican.

As a member of the Euro, only the ECB has the sole authority to set monetary policies and print money. The only option that a country has if they ran out of money is to borrow money or what we often see as government bond issuance. However, in the case of Greece, few investors are willing to lend them money as evidenced by their high interest rates.

Notes:
1.   Capital account was not given much importance since it is not a clear indicator as current account. A surplus or positive capital account means that money is flowing into the country which could also mean that the country is borrowing or selling assets. The same as in negative capital account which might mean that money is flowing out of the country or increase ownership on foreign assets.
2.   http://www.imf.org/external/pubs/ft/weo/2012/01/pdf/text.pdf
3.   Long-term interest rates, http://www.ecb.int/stats/money/long/html/index.en.html#fn3

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s