Balance of Payments Phil Bryson Global Trade and Finance

Part I Balance of Payments Accounting

Records of transactions among nations have not always been kept. Are they very recent? Records of transactions among nations have not always been kept. Are they very recent? Balance of Payments Accounting

General use of BP accounting is more recent, but in 1381 Richard Aylesbury, an Englishman, had not only collected such statistics, but was developing analysis as to why the accounts behaved as the did. Balance of Payments Accounting

It is not clear that they are really necessary! Balance of Payments Accounting

For example, who keeps track of California’s balance of payments transactions with other US states? For example, who keeps track of California’s balance of payments transactions with other US states? Balance of Payments Accounting

What kind of records should be kept? What do you want to find out? The nature of the record changes by what we are trying to find out. Balance of Payments Accounting

What kind of things do governments wish to know? What is the international demand for our currency doing to its value? Do we have enough currency reserves, or capacity to pay for our trade? Does our trade promote full employment? And so on. Balance of Payments Accounting

What kinds of transactions represent the basic focus of balance of payments accounting? What kinds of transactions represent the basic focus of balance of payments accounting? All transactions between the citizens of a nation and those of other nations are recorded in the balance of payments for a given period of time. All transactions between the citizens of a nation and those of other nations are recorded in the balance of payments for a given period of time.

Recording International Payments How is information recorded in balance of payments accounting? How is information recorded in balance of payments accounting? The basic technique is standard, double-entry accounting, The basic technique is standard, double-entry accounting, a flow of funds statement that shows changes in assets, liabilities and net worth over time. a flow of funds statement that shows changes in assets, liabilities and net worth over time.

Recording International Payments The balance of payments statement is to inform government authorities of the international position of the country to assist them with monetary-fiscal questions as well as trade and payments policies. The balance of payments statement is to inform government authorities of the international position of the country to assist them with monetary-fiscal questions as well as trade and payments policies.

Debits, Credits, and International Payments What is the meaning of a debit in a balance of payments account? What is a credit? What is the meaning of a debit in a balance of payments account? What is a credit? A debit records a transaction increasing assets or reducing liabilities. A debit records a transaction increasing assets or reducing liabilities.

Debits, Credits, and International Payments A debit results from some kind of transaction requiring an immediate out-payment. A debit results from some kind of transaction requiring an immediate out-payment. A debit arises from the purchase of goods, claims, or reserve assets and represents an inflow of value. A debit arises from the purchase of goods, claims, or reserve assets and represents an inflow of value.

Debits, Credits, and International Payments A credit records a transaction reducing assets or increasing liabilities. A credit records a transaction reducing assets or increasing liabilities. It results from some kind of transaction requiring an immediate in-payment. It results from some kind of transaction requiring an immediate in-payment. A credit arises from the sale of goods, claims, or reserve assets and represents an outflow of value. A credit arises from the sale of goods, claims, or reserve assets and represents an outflow of value.

Sources and Uses of Funds How does a country derive foreign currencies it needs to conduct its international business? How does a country derive foreign currencies it needs to conduct its international business? The sources of funds, the supply of foreign exchange, are The sources of funds, the supply of foreign exchange, are exports, exports, investment income, investment income,

Sources and Uses of Funds The sources of funds, the supply of foreign exchange, are The sources of funds, the supply of foreign exchange, are transfer payments received, transfer payments received, and long-term and short-term borrowing. and long-term and short-term borrowing.

Sources and Uses of Funds Credit entries reflect the sources, debit entries indicate the uses of foreign exchange. Credit entries reflect the sources, debit entries indicate the uses of foreign exchange.

Part II The Balance of Payments Accounts

BALANCE OF PAYMENTS ACCOUNTS These accounts are to summarize payments a country receives from other nations and payments it must make to other nations. They consist of the following five categories: 1. MERCHANDISE OR TRADE BALANCE: (Exports minus imports )

BALANCE OF PAYMENTS ACCOUNTS 2. GOODS AND SERVICES BALANCE: (Just add services) 3. NET UNILATERAL TRANSFERS (Gifts)  U.S. government transfers to foreigners  (E.g., Foreign aid or wheat from U.S. stockpiles)  Private remittances of wages earned abroad, and  Lots of other transfers.

BALANCE OF PAYMENTS ACCOUNTS To here, we are looking at the CURRENT ACCOUNT BALANCE (Net flows of goods, services and gifts). Again: 1. MERCHANDISE OR TRADE BALANCE: 2. GOODS AND SERVICES* BALANCE: 3. NET UNILATERAL TRANSFERS

Balance of Payments There is also a set of asset flows referred to as the CAPITAL ACCOUNT BALANCE 4. NET CHANGES IN FOREIGN HOLDINGS OF U.S. ASSETS Flows of financial assets and similar claims, or Foreign direct and other investments in the U.S., or “Private capital flows.” (Note that we are talking direct and portfolio investments here).

Balance of Payments 5. NET OFFICIAL INTERNATIONAL RESERVE TRANSACTION Foreign official holdings of U.S. assets, Foreign official holdings of U.S. assets, U.S. holdings of official reserve (gold and foreign exchange) assets U.S. holdings of official reserve (gold and foreign exchange) assets or, “Official asset flows.”

All Together Now 1. MERCHANDISE OR TRADE BALANCE: 2. GOODS AND SERVICES* BALANCE: 3. NET UNILATERAL TRANSFERS NET CHANGES IN FOREIGN HOLDINGS OF U.S. ASSETS 5. NET OFFICIAL INTERNATIONAL RESERVE TRANSACTION

Balance of Payments THE BALANCE OF PAYMENTS IS, THEREFORE, THE SUM OF THE CURRENT AND CAPITAL ACCOUNT BALANCES. THE BALANCE OF PAYMENTS IS, THEREFORE, THE SUM OF THE CURRENT AND CAPITAL ACCOUNT BALANCES.

Services in the Balance of Payments Note: *Services include travel and tourism, trade transportation, insurance, education, financial, technical, telecommunications and other business and professional services. In addition there are royalties, payments for capital services besides interest, such as dividends, payments for foreign labor, etc.

Overall Surpluses and Deficits What is an overall balance of payments surplus? What is an overall deficit? What is an overall balance of payments surplus? What is an overall deficit? A surplus is when the sum of the current account plus the private capital account is counterbalanced by an accumulation of official net assets, so official reserve assets increase. A surplus is when the sum of the current account plus the private capital account is counterbalanced by an accumulation of official net assets, so official reserve assets increase.

Overall Surpluses and Deficits What is an overall balance of payments surplus? What is an overall deficit? What is an overall balance of payments surplus? What is an overall deficit? If it is in deficit, the sum is counterbalanced by an accumulation of official net liabilities, so the country sees its official reserve assets decline. If it is in deficit, the sum is counterbalanced by an accumulation of official net liabilities, so the country sees its official reserve assets decline.

What Drives Large U.S. Current Account Deficits ? What Drives Large U.S. Current Account Deficits ? See Coughlin & Pollard and the readings suggested in King, if interested. They are very short and reassuring. See Coughlin & Pollard and the readings suggested in King, if interested. They are very short and reassuring.

The U.S. currently has a huge current account deficit. Why do we have it? Is it sustainable?

The current account balance is the difference between domestic saving and domestic investment. If domestic saving falls, the US must borrow from abroad to finance domestic investment… The current account balance is the difference between domestic saving and domestic investment. If domestic saving falls, the US must borrow from abroad to finance domestic investment… US foreign indebtedness is not necessarily bad if foreign funds are used towards investment. (p. 231) US foreign indebtedness is not necessarily bad if foreign funds are used towards investment. (p. 231)

Repayment of the debt is potentially a problem if foreign funds are used to purchase consumption goods since future generations will bear the burden of debt. Repayment of the debt is potentially a problem if foreign funds are used to purchase consumption goods since future generations will bear the burden of debt.

Poole presents evidence that the rising current account deficit is associated with rising domestic investment, and a significant share of foreign investment in the US is equity investment which does not have to be repaid. He concludes that the US does not have a current account disorder.” (p. 231)

Poole reminds us that a “capital and financial account surplus is identical to a “current account deficit” because their dollar values are identical by the rules of accounting. (p. 236)

If a foreign firm builds a production facility in the US, the capital and financial account surplus increases, which, in turn, means that the U.S. current account deficit would increase. (p. 236) If a foreign firm builds a production facility in the US, the capital and financial account surplus increases, which, in turn, means that the U.S. current account deficit would increase. (p. 236) The rising current account deficit in recent years has been accompanied by a rising rate of U.S. domestic investment. (p. 237) The rising current account deficit in recent years has been accompanied by a rising rate of U.S. domestic investment. (p. 237)