<p>The close connection between trade balances and international flows of savings and investments leads to a macroeconomic analysis. This approach views trade balances—and their associated flows of financial capital—in the context of the overall levels of savings and financial investment in the economy.</p>
<h2>Understanding the Determinants of the Trade and Current Account Balance</h2>
<p>The <strong>national saving and investment identity</strong> provides a useful way to understand the determinants of the trade and current account balance. In a nation’s <strong>financial capital market</strong>, the quantity of financial capital supplied at any given time must equal the quantity of financial capital demanded for purposes of making investments. What is on the supply and demand sides of financial capital? See the following Clear It Up feature for the answer to this question.</p>
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<h3 data-type="title">What comprises the supply and demand of financial capital?</h3>
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<p>A country’s national savings is the total of its domestic savings by household and companies (private savings) as well as the government (public savings). If a country is running a trade deficit, it means money from abroad is entering the country and is considered part of the supply of financial capital.</p>
<p>The demand for financial capital (money) represents groups that are borrowing the money. Businesses need to borrow to finance their investments in factories, materials, and personnel. When the federal government runs a budget deficit, it is also borrowing money from investors by selling Treasury bonds. So both business investment and the federal government can demand (or borrow) the supply of savings.</p>
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<p>There are two main sources for the supply of financial capital in the U.S. economy: saving by individuals and firms, called S, and the inflow of financial capital from foreign investors, which is equal to the trade deficit (M – X), or imports minus exports. There are also two main sources of demand for financial capital in the U.S. economy: private sector investment, I, and government borrowing, where the government needs to borrow when government spending, G, is higher than the taxes collected, T. This national savings and investment identity can be expressed in algebraic terms:</p>
<p>\(\begin{array}{rcl}\text{Supply of financial capital}&amp; \text{=}&amp; \text{Demand for financial capital}\\ \text{S + (M – X)}&amp; \text{=}&amp; \text{I + (G – T)}\end{array}\)</p>
<p>Again, in this equation, S is private savings, T is taxes, G is government spending, M is imports, X is exports, and I is investment. This relationship is true as a matter of definition because, for the macro economy, the quantity supplied of financial capital must be equal to the quantity demanded.</p>
<p>However, certain components of the national savings and investment identity can switch between the supply side and the demand side. Some countries, like the United States in most years since the 1970s, have budget deficits, which mean the government is spending more than it collects in taxes, and so the government needs to borrow funds. In this case, the government term would be G – T &gt; 0, showing that spending is larger than taxes, and the government would be a demander of financial capital on the right-hand side of the equation (that is, a borrower), not a supplier of financial capital on the right-hand side. However, if the government runs a budget surplus so that the taxes exceed spending, as the U.S. government did from 1998 to 2001, then the government in that year was contributing to the supply of financial capital (T – G &gt; 0), and would appear on the left (saving) side of the national savings and investment identity.</p>
<p>Similarly, if a national economy runs a trade surplus, the trade sector will involve an outflow of financial capital to other countries. A trade surplus means that the domestic financial capital is in surplus within a country and can be invested in other countries.</p>
<p>The fundamental notion that total quantity of <strong>financial capital</strong> demanded equals total quantity of financial capital supplied must always remain true. Domestic savings will always appear as part of the supply of financial capital and domestic investment will always appear as part of the demand for financial capital. However, the government and trade balance elements of the equation can move back and forth as either suppliers or demanders of financial capital, depending on whether government budgets and the trade balance are in surplus or deficit.</p>

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Understanding the Determinants of the Trade and Current Account Balance

Economics studies social behavior guiding the allocation of scarce resources to meet the unlimited needs and desires of the individual members of a given society, and for the production of goods and services, growth of production and welfare over time, and a great variety of other complex issues of vital concern to society. 

Economics

Discover the factors that influence trade and current account balances, explore historical and international trade balances in context, and learn about the pros and cons of trade deficits and surpluses.


Understanding the Determinants of the Trade and Current Account Balance

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