A statistical statement summarizing the transactions of a given economy with the economies of the rest of the world is referred to as a balance of payments. There are three types of accounts under the balance of payments namely: the current account, the capital account and the financial account. The current account comprises of transactions between residents of the country and non-residents in goods and services, the capital account comprises transactions in capital that directly impact the country’s assets and liabilities and the financial account comprises the net financial assets acquired and disposed the net financial liabilities incurred.
The European Union has been recording a growing trade surplus with itself and a trade surplus with the rest of the world. It experienced a trade surplus in its current account amounting to about 1.2% of its GDP. 12 of its members had a goods surplus while 23 members had a services surplus in relation to the rest of the world. The European Union generally records a capital account deficit as it transfers its financial assets to the rest of the world and the countries that contributed to the large capital account deficit are the United Kingdom and Ireland. The financial account also recorded a surplus with 19 members regarded as net lenders and 9members regarded as net borrowers to the world. As such the balance of payments account of the European Union indicates that the union is in a position of economic growth marked by surpluses in its current and financial accounts.
After the 2007-2008 financial and economic crisis, the European Union launched and put in place new policies and proposals to boost its economic recovery (Balance of Payments Statistics-Statistics Explained 2019). This trend of E.U. experiencing trade surpluses with a favorable balance of payments is expected to continue into the future given the measures European Union has put in place. The E.U. has put up trade policies that include: trade agreements with other countries who are not part of the E.U. to open up new markets which will lead to increased trade opportunities for the E.U. companies, trade regulations that protect E.U. producers from unhealthy and unfair competition, E.U. countries are members of both the World Trade Organization (W.T.O), which puts up international trade rules, and European Commission which negotiates on its behalf. The main aim of these trade policies is to encourage sustainable development.
The European Union also made trade agreements with non E.U. countries aimed at ensuring better opportunities for trade, reducing barriers to trade and ensuring investment (European Parliament, Making the most of globalization: EU trade policy explained, 2019).Additionally, the E.U. has also put in place rules that protect their companies against unfair trade practices such as dumping and subsidies that make prices of European products artificially higher than that of non E.U. products.
It is paramount to mention that these measures have helped establish and solidify the E.U. as an important block globally in the world trade. Therefore, the recent observed trends of growing trade deficits and favorable balance of payments for the E.U. should be expected to continue into the future.
The United States on the other hand, has been able to safely run persistent external deficits for a long period of time and this has to do with its currency holding the status of being the world’s reserve currency. The dollar provides the rest of the world with liquidity and it is globally used as a safe storage of assets. Therefore, the United States holds a special place in the global economy.
When the US imports good and invests in other countries, it pays in dollars. The other countries in turn purchase US’ exports and invest in the US with some the dollars received and keep the rest. If the other countries were to use all the dollars they received then the US would have no trade deficit. As long as growth in the US is slower than that of the rest of the countries in the world, the demand for its currency increases. It will have to either borrow more and more to finance its purchases or sell more of its assets (Guilford, Purtill 2018).Therefore, there is a tradeoff between running external deficits and being a reserve currency. The US must therefore always run persistent external deficits to ensure that the global financial system and trade has enough supply of dollars or give up its currency’s position of being a reserve currency to avoid running an external deficit. The running of a persistent external deficit by the US can therefore be termed as being structural in nature.
Recent trends have shown that the external deficits of the United States are rising gradually. However, the external deficits of the United States and debts as a percentage of the GDP cannot rise forever. The more the deficits and debts keep growing, the harder it is for the United States’ economy to adjust these deficits and payment account in the long run. An adjustment would inevitably bring about an economic recession or a crisis in the long run. Given the tradeoff between running external deficits and being the world’s reserve currency, if the US wanted to reduce its deficits to zero then it would have to give up its position of having its currency as the world’s reserve currency. This would in turn plunge the nation into an economic crisis and even depression.
As the external deficits of the United States accumulates, the interest payments it has to make on its debts also increases. As a result, the cost of borrowing by the government of United States increases. The increased interest rates and increased debts will up the government’s net payments of interest. Taxes in the US will also have to increase so as to cater for the increase in the government’s net payments of interest. The increase in taxes as a percentage of GDP means that the citizens of US have to pay more taxes from which there is zero direct benefit gained (Capretta 2018). Though in the current period, an increased deficit would bring about economic growth in the US, in the long run, high levels of deficits must be addressed and adjusted at all costs. The price to be paid for running large deficits currently will be felt at much later period and will plunge the country into a crisis.
Though the growing trade deficits of the U.S. may not have any crisis effects on its current economy and instead the economy is under an expansionary period, an impending crisis may be looming. If the trend does indeed continue then adjustments will not be made without inviting a crisis or even an economic recession in the U.S.
European Parliament, Making the most of globalisation: EU trade policy explained. (2019, March 6). Making the most of globalisation: EU trade policy explained | News | European Parliament. Europa.Eu. https://www.europarl.europa.eu/news/en/headlines/economy/20190528STO53303/making-the-most-of-globalisation-eu-trade-policy-explained
Gwynn Guilford, Corinne Purtill. (2018, May 2). The US can eliminate its trade deficit or have the world’s dominant currency—not both. Quartz. https://qz.com/1266044/why-does-the-us-run-a-trade-deficit-to-maintain-the-dollars-privileged-position/
Capretta, J. C. (2018, June 28) Long-Term Deficits Will Weaken the Economy and Invite a Crisis. (2018, June 28). RealClearPolicy – Opinion, News, Analysis, Video and Polls. https://www.realclearpolicy.com/articles/2018/06/28/long-term_deficits_will_weaken_the_economy_and_invite_a_crisis.html
Balance of payment statistics – Statistics Explained. (2019, May). European Commission | Choose your language | Choisir une langue | Wählen Sie eine Sprache. https://ec.europa.eu/eurostat/statistics-explained/index.php/Balance_of_payment_statistics