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The book I'm reading shows that $$ S= I +CA$$ where $S$ is savings, $I$ is investment, and $CA$ is the current accounts surplus.

The book then states "any domestic savings not absorbed by domestic investment must be shipped outside the country in the form of goods and services." I can understand how this works from an accounting equation point of view, but intuitively it doesn't seem to make sense. It seems odd that saved money would end up in the form of exports.

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    $\begingroup$ I think it is more appopriate to say that any excess savings are invested abroad. $\endgroup$ – london Jul 19 at 21:57
  • $\begingroup$ I agree with that, but I guess I'm just kinda confused about how $NX$ fits into that. If net factor payments and everything else are 0 except for $NX$, for example, then $CA=NX$. But it doesn't seem clear how more savings has anything to do with a trade surplus. $\endgroup$ – Vasting Jul 19 at 21:59
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    $\begingroup$ In that case, assume that countries with excess savings may produce more goods and services than they can absorb domestically, thus,they export the excess production. Hence the trade surplus. $\endgroup$ – london Jul 19 at 22:22
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    $\begingroup$ @Vasting assume you are Toyota. You produce a car in Japan and sell it in the US. The US-dollars you obtain in result of this transaction represent Japanese net foreign investment. $\endgroup$ – Grada Gukovic Jul 21 at 4:01
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This is accountancy and double-entry bookkeeping, but intuitively there are two ideas underlying this:

  1. The net difference between domestic investments and domestic savings has to be financed from abroad (or leads to financing foreigners if domestic savings exceed domestic investments) and this is reflected in the financial or capital accounts of the balance of payments. Put more simply, if you want to build new buildings or buy new machinery or just put stuff into warehouses to sell next year, and your domestic economy is not saving enough to pay for this, then you need to get the extra stuff (probably represented in money terms, but really it is goods and services) from foreigners, creating new liabilities to them.

  2. The financial or capital accounts should be balanced by the current account of the balance of payments (note the accounting use of the word balance). The net stuff you need for the excess investment over savings needs to bought from abroad (or if savings exceed investment then this needs to represent net stuff sold abroad).

There is a subtle difference between the balance of trade and the current account balance, with the difference representing income flows on existing international investments, but this is often relatively small and in accountancy terms is taken into account in the calculation of domestic savings.

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  • $\begingroup$ I can see that if $S$ < $I$, then we would need to get the extra stuff from foreigners. Am I safe to assume that the "extra stuff" would be capital goods used for investment? And what exactly do you mean by "creating new liabilities" - are the goods not paid for immediately? $\endgroup$ – Vasting Jul 22 at 12:33
  • $\begingroup$ As you say, intuitively the extra stuff might be imagined to be capital goods, but in reality it is a net figure of all trade in goods and services. It could for example be pieces of metal which get transformed domestically into machinery. There are two ways of paying: send stuff the other way (but we know not enough has been sent), or increasing international liabilities / reducing international assets (corresponding to direct, portfolio or other investment) $\endgroup$ – Henry Jul 22 at 14:55
  • $\begingroup$ This might seem very naive, but when you mention that we know not enough has been sent the other way, aren't way paying for everything that we import (regardless of how much we export) using cash? And if we don't have enough cash we raise debt - is that what you mean by international liabilities? $\endgroup$ – Vasting Jul 22 at 15:15
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    $\begingroup$ @Vasting If you borrow from foreigners then clearly you have new liabilities to them. If you pay them cash with your money, then they will presumably spend them in the future, so that is also an increase in your liabilities. If you pay them cash with their money then that is a reduction in your international assets (not quite the same legally as an increase in your international liabilities, but pretty close in economic terms). And really this is net - you export to them and import from them, paying in cash or borrowing in monetary terms rather than using barter, and most of it cancels out $\endgroup$ – Henry Jul 22 at 17:04
  • $\begingroup$ Ah, that makes sense. So if I understand correctly, if we pay another nation with cash, then we essentially owe them goods in that much later. Is there a reason why the other nation will presumably spend them in the future? $\endgroup$ – Vasting Jul 22 at 20:06

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