Unit 7-Balance of Payments and Trade

The Balance of Payments

• Measure of money inflows and outflows between the United Sates and the rest of the world.
• A system of accounting used for international trade
• Inflows are referred to a credits
• Outflows are referred to as debits

The Balance of Payment is divided into three accounts

1. Current Account
2. Capital/Financial Account
3. Official Reserves Account

Double-entry Bookkeeping

• Every transaction in the balance of payments is recorded twice in accordance with standard accounting practice

Current Account

• Balance of Trade or Net Exports
• Exports of Goods/services - imports of Goods/services
• Exports create a credit to the balance of payments
• Imports create a debit to the balance of payments
• Net foreign income
• Income earned by U.S. owned foreign assets- Income paid to foreign-held U.S. assets
• Ex. Interest payments on U.S. owned Brazilian bonds - Interest payments on German-owned U.S. treasury bonds
• Net Transfers (tend to be unilateral)
• Foreign aid --> a debit to the current account
• Ex. Mexican migrant workers send money to family in Mexico

Capital/Financial Account

• The balance of capital ownership
• Includes the purchase of both real and financial assets
• Direct investment in the United States is a credit to the capital account
• The Toyota Factory in San Antonio
• Direct investments by U.S. firms/individuals in a foreign country are debits to the capital account
• The Intel factory in San Jose, Costa Rica
• Purchase of foreign financial assets represents a debit to the capital account
• Warren Buffet buys stock in Petrochina
• Purchase of domestic financial assets by foreigners represents a credit to the capital account
• The United Arab Emirates sovereign wealth fund purchases a large stake in the NASDAQ

Relationship between Current and Capital Account

• The current account and the Capital Account should zero each other out.
• That is...the current account has a negative balance (deficit), then the capital account should then have a positive balance (surplus).
• Ex.The constant net inflow of foreign financial capital to the united States (capital account surplus) is what enables us to import more than we export (current account deficit).

Official Reserves

• The foreign currency holdings of the United States Federal reserve System
• When there is a balance of payment  surplus the FED accumulates foreign currency and debits the balance of payments
• When there is a balance of payment  deficit the FED accumulates foreign currency and credits the balance of payments

Active vs. Passive Official Reserves

• The U.S. is passive in its use of official reserves.  It does not seek to manipulate the dollar exchange rate.
• The peoples Republic of China is active in its use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate with the U.S.

Balance of Trade 

• Goods and Services Exports - Goods and Services Imports
• Trade Deficit- when the balance of trade is negative (more imports then exports)
• Trade Surplus- when the balance of trade is positive (more exports then imports)

Current Account

• Balance on Trade + Net Investment + Net Transfer

Capital Account

• Foreign purchases of your country's assets + your country's purchases of assets abroad

Official Reserve

• Current Account + Capital Account

Balance on Goods and Services

• Goods Imports + service imports
• Goods exports + goods imports