David Waring

In our last lesson we looked at the second category of what moves the forex market with a look at capital flows. In today’s lesson we are going to continue our free forex trading course with a look at how trader flows are measured, through something which is known as the current account.

While the concept that we are going to be covering here is fairly involved, I am covering this not because I feel we need to know all the details, but because having a general understanding of how the flows of money in and out of a country are measured, is important to help understand how the value of currency is affected by those flows. Now that we have an understanding of both trade and capital flows we are going to learn how each is measured starting with the current account.

The basic formula for calculating the current account for a country, is exports - imports of goods and services (also referred to as the balance of trade) + Net Factor Income from Abroad (basically interest and dividends) + net transfer payments (like aid given to foreign countries).

In general for the countries whose currencies we are focused on, the balance of trade portion of the formula is the main component we are concerned with and very little if anything will ever be heard about the other two components.

When thinking about a countries imports and exports (balance of trade), you will often hear a country described as having either a current account surplus or a current account deficit. A current account surplus basically means that a country is exporting more than they are importing which, as we learned in our lesson on trade flows, should strengthen the value of the currency all else being equal. A current account deficit basically means that a country is importing more than it is exporting which should weaken the value of its currency all else being equal.

If you remember from our lesson on trade flows I gave the example there of a US company needing to import 1 Million Dollars worth of steel from a Canadian steel producer. Just to give a simple example lets say for a second that this was the only transaction that both the United States and Canada did with foreign countries. If this were the case then the United states would have a current account deficit of 1 Million Dollars and Canada would have a current account surplus of 1 Million dollars.

Now obviously there are millions of transactions just like this one which go on between countries all over the world. The current account measures these transactions so we as traders can have an idea of whether the value of a countries currency should be increasing or decreasing based on the trade flows of that country, all else being equal.

As of this lesson China has the largest current account surplus at $363 Billion and the United States had the largest current account deficit at $747 Billion. It is because of this that many argue China's currency is too weak and the US Dollar is too strong, two imbalances which have started to right themselves over the last year.

Here is a graph of the current accounts of some of the major countries whose currencies we are focused on, so you can have an idea of whether those countries are more import or export oriented. As we will learn this is something which is going to be important when analyzing economic data relating to those currencies.

Japan: A Surplus of $201 Billion
Germany: A Surplus of $185 Billion
Switzerland: A Surplus of $67 Billion
Canada: A Surplus of $28 Billion
New Zealand: A deficit of $10 Billion
France: A deficit of $35 Billion
Australia: A Deficit of $50 Billion
Italy: A Deficit of $58 Billion
United Kingdom: A Deficit of $111 Billion

That's our lesson for today. In our next lesson we will look at how the capital flows side of the equation is measured so we hope to see you in that lesson. As always if you have any questions or comments please leave them in the comments section below, and good luck with your trading.

ivanhoe

Dave,
Do you have any Web sites you like to use to monitor this data?

David Waring

Hi Ivanhoe,

Glad to hear from you.

I like the global calendar over at Dailyfx.com as it gives the time and expected release for all the major data points from around the wold as well as a link where you can go to read analysis of the data and pull historical numbers.

You can find the free global calendar at the top of the Dailyfx site.

Best Regards,
Dave

__________________
My Free Courses: Forex Course - Stock Course - Futures Course - Basics of Trading - Subprime Crisis - Prorealtime Charts

Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.

tim

This one seems confusing because if China is exporting more than the US, then China's currency should be worth more than the US currency? This is true for the other countries compared to the US as well, like Canada, but the American dollar is stronger then the other countries. How does the US keep the dollar up?

thanks,
tim

tim

Oh I see, It has got to do with the capital account and many other things probably coming up in the next videos. Is that what happened from this crisis in October, 2008... The American stock markets fell hard, and people in other countries bought stocks in the US, and pushed up the US currency? People were predicting that the US dollar would fall because of the Fed bailout? But the US dollar has rallied.

David Waring

Hey Tim,

Glad to hear from you and welcome to the community. These are very good questions which I think show you are grasping the material well.

While the US Dollar has been rallying recently, up until a few months ago we were in a multi year selloff that took the US Dollar to its weakest levels against most currencies of the the world in many years if not ever. So, while the capital account certainly plays a role, in the last few years it has not been enough to offset the money flowing out of the country due to imports, which I think most agree is one of the major fundamental reasons we have seen such a large US Dollar Selloff.

You are also correct that many people thought that the US Bailout would cause the US Dollar to weaken further, and the reason why is because this is going to increase the debt of the US immensely which can create a variety of problems from potential inflation to other countries becoming wary of continuing to lend money to the United States.

Contrary to this however the US Dollar has rallied very strongly which has been in my opinion a result of the following factors:

1. The crisis is global and while people are concerned about the US they are more concerned about many other countries and therefore see the US as the safest place to park money, at least in the short term. So instead of people shunning US debt as a result of the crisis as many though they would people have actually started pooring more money into US Government debt and seeing it as one of the only truely safe places to store their money. This is what is referred to as "safe haven flows" which you may have heard of.

2. The deleveraging process which is currently going on basically means that all these huge institutions in the US who have money invested in different markets both here and overseas are selling out of those investments in mass and parking their money in US Government debt instead. This has caused a huge pickup in the demand for dollars.

Those are the two main points in my mind and wether or not they continue, and for how long is going to be the topic of great debate and will most likely determine the future direction of the US Dollar. If you are interested in learning more on this in addition to continuing the free forex course I recommend checking out Simit Patel's blog who talks a lot about it.

Best Regards,
Dave

__________________
My Free Courses: Forex Course - Stock Course - Futures Course - Basics of Trading - Subprime Crisis - Prorealtime Charts

Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.

DANOSANJOSE

Just found a useful site which provides fairly up-to-date current accounts for all countries - https://www.cia.gov/library/publicat.../2187rank.html

David Waring

Thanks for the resource DANOSANJOSE much appreciated.

Best Regards,
Dave