The current account aggregates net trade of goods and services, foreigners’ earnings on investments in the UK, earnings on UK investments abroad, and cross-border transfers of money, goods and services. Here’s the equation:
In 2012, the current account deficit rose to £55 billion, or about 3.7% of GDP—the biggest it’s been since 1989. Some posit that’s a bad sign—that since foreign investment isn’t high enough to offset the current account shortfall, capital’s draining out of the UK, and crisis thus looms.
Here’s the problem with that logic: It assumes the UK economy is a fixed pie—that there’s only a limited amount of capital, and if more leaves than comes in, then the entire country will be worse off. But that’s not quite true.
Imagine I’m a country—the Sovereign Nation of Elisabeth. I have trade relationships with three nearby countries, Landlordia, Malldonia and Supermarketland, and I have a huge deficit with each. I buy lots of goods and services from them, but I don’t sell them a darned thing—and yet my country isn’t bankrupt. Why? Because I have other sources of income, like my job, which more than offsets my outflows. In essence, I create personal wealth (at least what little I can considering California’s high taxes and cost of living).
And that’s how it is for the UK and other advanced economies with current account deficits. The UK may send more money out than it gets from abroad, but it also creates quite a bit of wealth domestically. Inventors get ideas, create products and start companies that grow into huge businesses—that creates wealth. People invest, and asset values grow—that creates wealth. The private sector’s net return on investment has ranged from 11% to 15% for over 15 years. Through year-end 2012, the FTSE 100 had returned 959% since 1981 (7.65% annualized). Private non-financials firms have accumulated about £750 billion in cash. Household wealth has steadily grown over time and is nearly £4 trillion today. All of this domestic growth is more than enough to offset the amount of capital flowing out.
Simply put: The UK has its share of risks these days, but the current account deficit likely isn’t one of them.