EMU External Account Reviewed

The euro area reported its current and financial accounts for the month of June.  Combined they make up the balance of payments.

Traditionally, under the gold standard, the current account would be balanced by capital flows and the transfer of gold claims.  

In the modern era, some economists emphasize the basic balance in explaining (and forecasting) currency fluctuations.  The basic balance is the current account plus long-term capital flows.   The assumption is that short-term capital flows are noisy, influenced by cyclical factors, while long-term capital flows are thought to be the true signal, reflecting underlying productivity.

Yet, it often seems that the long-run is a series of short-run disruptions, and that in any kind of time frame relevant for investors and speculators, cyclical considerations are significant. Moreover, currencies deviate in terms of both direction and magnitude for extended periods.  It is there are a number of other balances that currencies ought to bring into equilibrium.  It also some times the causation arrow is reversed, and the currency movement causes a change in behavior by various participants.

Nevertheless, the euro zone balance of payments is interesting.   The data is from June, which was just after the euro peaked, failing for on the second attempt to move above $1.40.    Given the 13.1 bln current account surplus and 8 bln euros of direct investment inflows (as a proxy for long-term capital flows), the basic balance approach would seem to be consistent with an appreciating currency.

There are three key elements to the current account:  trade (goods and services), investment income and government transfers.  The euro area recorded a surplus on the first two elements of about 25.2 bln euros. The euro area governments made 12.2 bln in euros in net transfers to produce the 13.1 bln current account surplus. 

This is a decline from the nearly 20 bln euro surplus in May.  Keep in mind these represent seasonally adjusted numbers.  On a not-seasonally adjusted basis, the euro area current account surplus rose almost 21 bln euros from a little less than 9.5 bln in May.

Over the past 12 months the euro area has recorded  226.7 bln euro current account surplus, which is about 2.4% of its GDP.  For the 12-month period that ended June 2013, the current account surplus was 2.1% of GDP. The trade surplus rose by 20%, but this was offset in part by the 20% decline in the income balance, and a small increase in the net transfers.

The capital account surplus was 14 bln euro in June.  Three quarters of this derived from direct investment inflows.  Traditionally, as we saw when reviewing the basic balance approach, direct investment is considered long-term investment.  However, this is not always the case.  Consider that the bulk of the 8 bln euro direct investment recorded in June reflected inter-company loans.  These are not necessarily a long-term commitment that comes to mind when one considers direct investment.  

The euro area imported a net 6 bln euros of portfolio capital.  This was a function of a net inflow into the equity markets of 51 bln euros.  There was a net outflow of 45 bln euro in the debt markets.  This was a function of euro area agents purchases 31 bln euros of foreign bonds, while foreigners sold 20 bln euros of the region's bonds and notes.  

It is clear that portfolio and direct investment accounts have deteriorated in recent months. Couple this with the shift in speculative positioning, as reflected in the futures market, and one can appreciate why the euro has been moving lower.