Rethinking market regulation: a proposal to integrate the national accounts and expose foreign exchange risks This paper contends that the System of National Accounts (SNA) and Balance of Payments (BOP) are not ‘fit for purpose’. Their usefulness is eroded because there are major differences in reporting between stocks and flows: stocks are reported net, flows are reported gross; stocks are valued at end-period exchange rates, flows are valued at transaction date exchange rates; there is inadequate reporting of domestic ‘buffer’ stocks such as property, land, labour and environmental resources; the accounts are obfuscated by financial innovation; legal entities are hidden in complex ownership structures; and domestic sectoral balances are not confirmed with the foreign sector. Instead, the SNA, BOP and International Investment Position (IIP) rely heavily on market pricing and ‘balancing transactions’ between the current, capital and financial account. The market risk from these ‘balancing transactions’ would be better revealed if the stocks were reported gross and reconciled with the flows: a form of ‘trade confirmation’ that would reveal gaps and discrepancies between accounts from different countries. A ‘trade confirmation’ would report stock changes on the transaction date. The design could be adapted from database technologies where a ‘two-phase commit’ gives an indication of the quality of the data. The publication of ‘data mappings’ would allow researchers to mix-and-match data from different sources. These proposals become more feasible after the introduction of the Product Identifier (PI) and Legal Entity Identifier (LEI). Better integration of the SNA and BOP would allow researchers to study new questions and identify foreign exchange risk in specific sectors. ‘Data mappings’ would make it easier for economists to validate previous research findings, bring them up-to-date with new data and test new theories. In
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Rethinking market regulation: a proposal to integrate the national
accounts and expose foreign exchange risks
This paper contends that the System of National Accounts (SNA) and Balance of Payments (BOP) are
not ‘fit for purpose’. Their usefulness is eroded because there are major differences in reporting
between stocks and flows: stocks are reported net, flows are reported gross; stocks are valued at
end-period exchange rates, flows are valued at transaction date exchange rates; there is inadequate
reporting of domestic ‘buffer’ stocks such as property, land, labour and environmental resources;
the accounts are obfuscated by financial innovation; legal entities are hidden in complex ownership
structures; and domestic sectoral balances are not confirmed with the foreign sector.
Instead, the SNA, BOP and International Investment Position (IIP) rely heavily on market pricing and
‘balancing transactions’ between the current, capital and financial account. The market risk from
these ‘balancing transactions’ would be better revealed if the stocks were reported gross and
reconciled with the flows: a form of ‘trade confirmation’ that would reveal gaps and discrepancies
between accounts from different countries.
A ‘trade confirmation’ would report stock changes on the transaction date. The design could be
adapted from database technologies where a ‘two-phase commit’ gives an indication of the quality
of the data. The publication of ‘data mappings’ would allow researchers to mix-and-match data from
different sources. These proposals become more feasible after the introduction of the Product
Identifier (PI) and Legal Entity Identifier (LEI).
Better integration of the SNA and BOP would allow researchers to study new questions and identify
foreign exchange risk in specific sectors. ‘Data mappings’ would make it easier for economists to
validate previous research findings, bring them up-to-date with new data and test new theories. In
turn, better data and more robust research would improve the measurement and prediction of key
indicators such as Gross Domestic Product (GDP) and the sustainability of the external position.
The difficulties presented with co-ordinating a ‘two-phase commit’ are illustrated with a brief
literature review and some contemporary examples: TARGET2 balances within the European
payments system; the challenges posed by external positions; trade imbalances; and gross domestic
product measurement errors. There is a possibility that greater transparency will accelerate the re-
balancing of trade and investment flows. Given the slow nature of large data projects, the risks from
Adapted from (Office for National Statistics, 2012b, p. 2)
Where compensation includes pensions; operating surplus includes rental income; mixed income
includes the income of the self-employed; and net taxes are taxes on production and products less
any subsidies
All three approaches to GDP are, therefore, subject to errors in the measurement of ‘balancing
transactions’. If final consumption is estimated from consumption taxes, and exports and imports
from trade statistics, then the investment figure in GDP(E) is a residual and subject to the
measurement error in ‘balancing transactions’. Similarly, GDP(I) can be inflated or deflated by
inaccurate measurement of the gross operating surplus, and GDP(P) relies on accurate measurement
of output. Table 4.1 shows that GDP measurements would be more accurate if financial and capital
account transactions were known with more certainty.
The impact of the capital and financial account on gross capital formation can be quite variable.
Consider some contemporary examples in the UK: the privatisation of the Post Office, and the sale of
a central London property to a foreign investor. Under privatisation, services provided by the Post
Office are recategorised without affecting the overall number. However, privatisation affects the
balane sheet: private borrowing rises and government borrowing falls. The Post Office can sell
capital assets to a foreign entity and lease them back, which reduces private borrowing but has a
negative impact on the current account since investment income flows abroad.
The re-categorisation of compensation from public to private sector can have significant effects on
taxation if employment is relocated abroad. Ceteris paribus, the effects of privatisation depend on
the interplay between taxes and investment income flows. The worst case for GDP is that fewer
domestic taxes are paid, and investment income flows to foreign rather than domestic investors. On
the other hand, if the privatised firm pays more taxes, or the government sells a loss-making service,
privatisation implies a boost to GDP. Either way, the government has swapped uncertain changes to
tax and investment flows for a certain reduction in total debt servicing costs. Taken together, this
swap suggests more volatility in GDP.
For the swap to be neutral, the government would need to reduce spending if taxes from the
privatized Post Office fell, or if investment income flowed offshore. Higher volatility in GDP also
comes at a cost to government.
The sale of a UK property to a non-resident investor also impacts GDP. The first thing to note is that
‘despite their obvious importance, even stocks of residential dwellings are not publicly available for
more than a handful of countries’ (Various, 2008, p. 404). In other words, the balance sheet is
incomplete, and the initial sale only impacts GDP if there are secondary effects: higher domestic
consumption, or even an increase in investment income if the resident invest in foreign assets.
The other impact is from the actual use to which the property is put. If the property is rented out,
and the non-resident transfer the rent abroad, there is a decline in GDP; if the proceeds are spent in
the UK on property there are secondary effect on GDP; and so on. In both cases, a ‘two-phase
commit’ between residents and non-residents would shed some light on the effects of privatization
and property sales.
Building on crypto-currency design
The hidden exchange of currency and commodities, such as crypto-currencies, makes a ‘two-phase
commit’ difficult because the legal entities are anonymised. Large denomination bank-notes (and
gold) are also difficult to trace, although more difficult to move across borders than crypto-
currencies. For the US, an estimated half of the growth in currency issue since 1988 was due to
foreign holdings, with about three-quarters of currency held as the highest denomination $100 bill
(Judson & Judson, 2012, p. 8). When Euro cash was introduced in 2002, a EUR 500 denomination
note was issued; Japan has issued a YEN 10,000 note since 1958; and the highest denomination note
from among the G5 is the CHF 1,000, first issued in 1907 and amounting to 60% of the value of Swiss
notes in circulation in 2013 (Swiss National Bank, 2013b).
Yet these foreign holdings of domestic bank-notes are an exchange risk for central banks, if non-
residents decide to exchange their bank-notes en masse. According to the IFS, the Bank of Japan has
the greatest exposure in proportion to foreign assets, followed by the Federal Reserve and Bank of
England:
Figure 4.4
Sources: IFS, WM Rates, bank-notes as percentage of GDP
In fact, the public ledger adopted by crypto-currencies could be easily adapted to be both
anonymous and to have a ‘two-way commit’: the public ledger already records the ‘what’ (the
product is a crypto-currency) and the ‘when’ (a ledger). The LEI could be anonymized but still
contain met-data that identifies then accounting sector and country.
Moving towards integration
The current SNA and BOP would need to adopt a single, international, product and legal entity
identifiers (PI or LEI) as a first step towards integration. This represents a massive co-ordination
problem. At present, each country publishes their own set of national accounts, usually via the
central bank or a statistical body like the Office for National Statistics (ONS) in the UK. National
datasets are collated by supranational and international bodies, like the IMF, UN and the
Organisation for Economic Co-operation and Development (OECD): the OECD being the successor to
the organisation which ran the US-financed Marshall Plan after World War II. The flow of data is then
from national to supranational and international bodies.
The historical data series have major gaps. Flow of funds data for Europe, for example, are not
available before 2002 (Duc, 2009, p. 5) and ’reliable high frequency time series exist [only] for a
fraction of the world economies’ (Kinsella, 2011b, p. 12). Given the scale of the co-ordination
problem this is hardly surprising, despite advances in communications, data processing and data
storage and data technology. In 2009 the Bank of England reported that ‘in the UK, much work
needs to be done to fill the data gaps identified from the financial crisis. One issue is the
development of a flow of funds model for the UK’ (Murphy, Westwood, & Murphy, 2009, p. 23).
Much of the UK data are judged to be ‘poor quality’ with ‘six significant asset classes for which (there
are not) unique data on sectoral holdings, of which quoted and unquoted equity and short and long-
term debt are the most important’ (Barwell & Burrows, 2011, p. 7). Reports from the European
Central Bank, Bank of Japan, IMF and Bank of England (Duc, 2009; IMF Staff, 2009; Konno, 2010;
Murphy et al., 2010) call for improvements to the quality, timeliness and coverage of regulatory
data, in particular the need to keep up with financial innovation, notably structured credit and credit
risk products, and to better monitor the ‘interconnectedness of systemically important financial
institutions’. The top three data issues identified by the IMF were ‘aggregate leverage and maturity
mismatches… the financial linkages of systemically important global financial institutions and… cross-
border activities of nonbank financial institutions‘ (IMF Staff, 2009, p. 11). Economists who work
with the flow-of-funds data also express dissatisfaction, particularly working with countries outside
the US (Zezza, 2012).
Errors, omissions and revaluations are an intrinsic part of the reports. Table 4.8 shows that the net
errors and omissions (NEO) for the UK BOP, in 2010, were about three times the changes in the
capital account and official reserves, and around 18 per cent of the current account deficit:
Table 4.8
UK Balance of Payments (2010 Figures) £ billions
Current account (71.60)
Goods (exports) 410.22
Goods (imports) (563.15)
Balance on goods (152.93)
Services (credit) 238.75
Services (debit) (169.14)
Balance on goods and services (83.32)
Income (credit) 255.42
Income (debit) (212.94)
Balance on goods, services and income (40.84)
Current transfers (credit) 21.95
Current transfers (debit) (52.72)
Capital account 5.01
Capital account (credit) 9.41
Capital account (debit) (4.40)
Total, current and capital account (66.60)
Financial account 63.57
Direct investment (abroad) (10.67)
Direct investment (United Kingdom) 46.95
Portfolio investment assets (130.88)
Equity securities (12.59)
Debt securities (118.28)
Portfolio investment liabilities 143.94
Equity securities 3.60
Debt securities 140.35
Financial derivatives 44.94
Financial derivatives assets
Financial derivatives liabilities 44.94
Other investment assets (359.94)
Monetary authorities
General government (1.56)
Banks (212.18)
Other sectors (146.20)
Other investment liabilities 329.22
Monetary authorities
General government 1.21
Banks 96.65
Other sectors 231.35
Total, current, capital and financial account (3.03)
Net errors and omissions 13.04
Reserves and related items (10.01)
Reserve assets (10.01)
Conversion rates: GBP to USD 0.65
The final part of this paper considers the impact of a ‘two-phase commit’ and alternative mappings
on three examples: TARGET balances; cash and crypo-currencies; and the trade balance.
Recommendations
This paper proposes a public transaction ledger to reconcile international trade. The key trades that
are missing from the SNA and BOP are currency and foreign exchange: rather, the financial system
puts blind faith in trade reconciliation via ‘the market’. Yet the list of potential market failures is
growing: current account imbalances, reserve accumulation and unsustainable external positions.
These external positions include tipping points at the sectoral level (households, firms, banks and
governments) as well as at the aggregate level. Gaps in the balance sheet around derivatives,
property, land and labour exacerbate the difficulty of creating a public ledger.
The PI and the LEI enable two of the three salient features of a public ledger: ‘what’ and ‘who’.
Design patterns from database and internet technologies offer ways to deal with the key issues of
anonymity and localization. The TARGET settlement system for Eurozone countries is a very rigid
interpretation of a public ledger, with no ‘balancing transactions’ due to foreign currency
fluctuations. At the other extreme, crypto-currencies are a very loose interpretation, with a single
product (the crypto-currency), a single country and currency (the world), and a single sector.
This Chapter proposes adopting other technology patterns, in particular the publication of ‘data
mappings’ between national, supranational and international regulators. These ‘data mappings’
could show the relationships between datasets across time as well as countries, making it easier for
economists to validate previous research findings, bring them up-to-date with new data and test
new theories. With less reliance on ‘balancing transactions’ economists will have a better chance of
measuring gross domestic product and evaluating polices. Economics might become a more modest
discipline, where economists specialise by sector, country and historical period.
There are some risks from the rapid re-balancing of trade and financial flows. Gourinchas and Rey
have estimated that to return the US trade balance to equilibrium with financial account requires an
‘implausible depreciation of 75 per cent’ in one year or ’a depreciation of 18 per cent per year’ over
five years (Gourinchas & Rey, 2007, p. 32). Bulk public data collection also raises major issues about
privacy rights and government power (New York Times, 2014): these issues do not exist with
anonymous public ledgers, such as the cryptocurrency pattern. Given the slow nature of large data
projects, and the risks from market manipulation, leverage and unsustainable positions, the
alternative is stark: we can continue to put our faith in private capital, financial and currency
markets.
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