The FINANCIAL — Imagine a farmer. He produces some of what he needs himself, while he buys his other necessities in the market.
The FINANCIAL — Imagine a farmer. He produces some of what he needs himself, while he buys his other necessities in the market.
To pay for his purchases, he sells some of his crop in the same market. However, the value of what he buys is much higher than the value of he sells.
This farmer is Georgia. In 2011, the pile of stuff that Georgia imported was more than three times as large as everything that the country exported. This means that for every dollar that Georgians earned by selling goods to people in other countries, they spent three dollars on buying products, from abroad. What this is means is that the country as a whole does not produce enough goods to maintain its current levels of consumption, government spending, and investment.
If the market suddenly ceased to exist, our farmer would not be able to sustain himself in a barter system, because he needs more than he can contribute. The same is true for Georgia: it consumes more than it produces.
The technical term for how much you export and how much you import is the trade balance. If your trade balance is negative, meaning you import more than you export, you are said to be running a trade deficit, while in the opposite case you are running trade surplus. It is mathematically impossible for every country to run trade surpluses or trade deficits at the same time, unless you export to the moon: trade surpluses need to go somewhere, and trade deficit need to come from somewhere.
How does our farmer pay for his goods if he makes less money selling his stuff than he needs to buy other things? The easiest option for him is borrowing: he can borrow money from another farmer to buy the extra things that he needs.
In countries with large trade surpluses, such as China and Germany, people usually save more than they spend. Their financial institutions then end up with a huge glut of money, that they want to put somewhere. Often, this cash ends up funding the countries that use debt to fund their trade deficit. In these countries, people spend more than they earn, which is why they have a low savings rate.
Georgia has in fact been doing the same thing: the government and its population have been borrowing from abroad for years. Georgia’s Gross External Debt, a very crude measure of how much Georgians borrow from abroad, put together by the National Bank of Georgia, has gone up significantly. At the end of 2006, it was less than $4B, rising to more than $11B at the end of this year’s first quarter. This includes not just government debt but all debt outstanding to organizations and individuals outside of Georgia. In fact Georgia’s central government debt as a percentage of GDP has also been rising quite rapidly, from 22.7% in 2007, to 36.7% in 2010, according to World Bank Data, although it has since been on the decline, and is now at 26%, according to my own calculations based on GeoStat (National Statistics Office of Georgia) data.
In classical economic theory, when a country has a free-floating currency – which means it is not fixed by anyone, but determined by market forces – the currency serves as the adjustment mechanism. If a country exports more than it imports, its currency will appreciate (increase in value), because foreigners need that currency to buy the country’s products. Because the increase in the value of the currency will make its products more expensive, demand for that country’s exports will go down. Since the currency is now worth more, foreign products will become cheaper relative to domestically-produced products, and imports will increase. Voila, our trade surplus disappears. The theory predicts the opposite for a trade deficit.
Of course economic theory doesn’t always work in practice. But in this case, some if its predictions are quite accurate. The United States Dollar, as predicted by the theory, because the US has a trade deficit, has in fact depreciated a lot. However, there is is still a trade deficit and a current account deficit, because the dollar has not depreciated enough. This is partly caused by continued demand for dollars by foreigners, because it is perceived as a safe haven currency in bad economic times.
In Georgia the theory doesn’t work as well as one would expect, because the Lari is managed by the National Bank of Georgia. Although the currency is floating, the National Bank has a target range, and if it gets outside of that range, the Bank will intervene in the currency market. Most trade is also conducted in United States Dollar, which limits the Lari adjustment mechanism.
What is the problem, I hear you ask? In fact, there is a lot of controversy within the economics profession about whether persistent trade deficits (or current account deficits, which include investment income and cash transfers) are a bad thing. One problem is that a trade deficit is usually coupled with a current account deficit, which means that people in a country make less money than they spend. The only option that is left is to borrow the money, which can lead to an unsustainable build-up in debt, a bubble that will eventually lead to a bust. We have seen many emerging market countries that have gone through these debt crises, and during the last few years, even developed countries have started to face these problems.
A country can live beyond its means for awhile, by borrowing the money. Georgia’s indebtedness levels are still quite low compared to other countries, so the trade deficit issue is not very urgent. However, the country cannot continue to live beyond its means indefinitely. Eventually it will have to either stop spending so much on imports, or develop viable export industries.
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