Balance Of Payments Crises

Phil Pilkington takes an issue with Sergio Cesaratto on the usage of the phrase “balance-of-payments crisis” on problems of the Euro Area.

Phil’s argument is that typically nations facing balance of payments problems need foreign currency and it manifests itself as a depreciation of the domestic currency but in the Euro Area this isn’t the case (because the exchange rates are fixed irrevocably between the Euro Area nations by the national central banks and the ECB). So the usage of the phrase “balance-of-payments crisis” is an abuse of language.

Now, to be short my argument that there is nothing wrong with the usage is because of the definition of what “balance-of-payments” actually is. Here is why:

A balance of payments transaction is a transaction between residents and non-residents. It is not relevant in which currency the transaction really is. So if you were a U.S. resident and if I as an Indian pay you $1 in New York in person, it is still a balance of payments transaction from the viewpoint of the United States. (of course if I own a firm in the United States which pays you then it is not a balance of payments transaction because the firm would be a resident).

In this way it becomes clear that some Euro Area nations have a balance of payments financing problem and since it reached a crisis level, the problem can be classified as a balance of payments crisis even though there is no exchange rate which has collapsed.

The nations which were/are in troubled had difficulties because they had huge current account deficits and as a result became indebted to the rest of the Euro Area. This became unsustainable and turned into a crisis. And both borrowers and lenders are to be blamed.

Since these nations had huge indebtedness to the rest of the Euro Area, they had troubles borrowing and refinancing their debts with foreigners and still have.

So I do not know why someone can take an issue with the phrase “balance-of-payments crisis”.

Except for the huge depreciation of the domestic currency, the Euro Area economic dynamics resembles a typical balance-of-payments crisis in all other ways. There is deflation of domestic demand, financial instability, high unemployment, increase in poverty and decrease in happiness and standard of living etc. There is international help in both cases.

Once again. A BoP transaction is between residents and non-residents. (See 2008 SNA, and BPM6 on this). A BoP crisis hence is a crisis in which borrowing and refinancing existing debt from non-residents has become difficult and is at crisis levels.  Whatever a country such as Portugal does at the moment, some units will be left indebted to the rest of the world/Euro Area. This is because liabilities are greater than financial assets and the difference is the net indebtedness to foreigners. Whatever new debts are created are equal in value to newly created financial assets. So the arithmetic dictates foreigners should be relied upon. The one qualification is that Portugal significantly improves its net exports but that is the same as saying its balance of payments is improving.

So anyone saying it is not a “balance-of-payments crisis” is fooling himself/herself.

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