International finance

The Balance-of- Payments Accounts Chapter 1

Learning Objectives  Explain what is meant by a country’s “balance-of-payments” statement and how it is constructed.  Analyze the difference between alternative accounting balances within the balance-of-payments.  Describe the recent balance-of- payments experience of the U.S.  Define the international investment position of a country.

 Balance of payments accounts are a way of keeping track of all economic transactions between the home country and the rest of the world over a specific time period (usually one year). Balance-of-Payments

Recent Growth of Trade and Capital Movements - The value of trade in goods and services has increased from $582 billion in 1973 to $15.8 trillion in International transactions of the monetary sort have also grown very rapidly over the last few decades.

Credit and Debits in Balance- of-Payments Accounting  Credit items reflect transactions that give rise to payments flowing into the home country.  Debit items reflect transactions that give rise to payments flowing out of the home country.

exports foreign investment inflows interest payments on earlier investments Credit items

Debit items imports foreign investment outflows Interest payments to foreigners

The IMF gro ups items in to four cate gories Category III: Short-term nonoffici al financial flows, Category I: Current account; Category IV: Changes in reserve assets of official mo netary authorities (c entral banks). Category II: Direct investment and other long-term financial flows; Credit and Debits in Balance-of- Payments Accounting

Category I: Current account Credit items include exports of goods and services, interest and dividends from investments abroad, wages earned abroad, and gifts from abroad. Debit items include imports of goods and services, interest and dividends paid to investors abroad, wages paid to foreigners, and gifts sent abroad

Category II: Direct investment and other long-term financial flows  Credit entries: anything that causes a net increase in the holdings of assets in the home country by the foreign country.  Debit entries: anything that causes a net increase in the holdings of assets in a foreign country by the home country.

Credit items: any increase in foreign holdings of such assets in the home country. These are mainly private flows, with maturities under one year. Debit items: any increase in home country holdings of such assets in the foreign country. Category III: Short-term nonofficial financial flows

Category IV: Changes in reserve assets of official monetary authorities (central banks)  Credit items: whenever the foreign country central bank acquires home country assets (such as bank accounts).  Debit items: whenever the home country central bank acquires foreign country assets.

Sample Entries in the Balance-of-Payments Accounts  In general, balance-of-payments accounting relies on double-entry bookkeeping.  This means that any transaction must be added as a credit and a debit.  This implies that the sum of all credits must equal the sum of all debits, and the total BOP is always in balance.

#1: Exporters in the U.S. send $6,000 of goods to Canada, receiving a short- term bank deposit of $6,000 from Canada.  Credit: Category I: Export of goods +$6,000  Debit: Category III: Increase in short-term private assets abroad -$6,000

#2: Consumers in the U.S. buy $10,000 of goods from Canada, paying with a short-term bank deposit of $10,000.  Debit: Category I: Imports of goods - $10,000  Credit: Category III: Increase in foreign short-term assets in the U.S. +$10,000

#3: U.S. residents send $5,000 to Mexico as gifts.  Credit: Category I: Exports of +$5,000  Debit: Category I: unilateral transfer of - $5,000

#4: An American firm provides $2,000 of shipping services to a Canadian company, which pays by transferring money into its U.S. account.  Credit: Category I: export of services +$2,000  Debit: Category III: Decrease in short-term private assets in the U.S.: -$2,000

#5: A Canadian company sends $8,000 in dividends to bank accounts of American stockholders.  Credit: Category I: investment receipts from abroad +$8,000  Debit: Category III: Decrease in short-term private assets in the U.S.: -$8,000

#6: An American buys a long-term bond from a Mexican company for $2,000; transfers payment from her U.S. bank account.  Debit: Category II: increase in long-term asset abroad -$2,000  Credit: Category III: Increase in short-term private assets in the U.S.: +$2,000

#7: Canadian banks wish to reduce holdings of dollars in U.S. banks by selling $800 to the Federal Reserve.  Debit: Category III: Decrease in short-term private assets in the U.S.: -$800  Credit: Category IV: Increase in foreign short-term official assets in the U.S.: +$800

Assembling a BOP Summary Statement DebitsCredits #1Increase in short-term private assets abroad -$6,000Exports of goods+$6,000 #2Imports of goods-$10,000Increase in foreign short- term private assets in US +$10,000 #3Unilateral transfers-$5,000Exports of goods+$5,000 #4Decrease in foreign short- term assets in U.S -$2,000Exports of services+$2,000 #5Decrease in foreign short- term assets in U.S -$8,000Investment income from abroad +$8,000 #6Increase in long-term assets abroad -$2,000Increase in foreign short- term private assets in US +$2,000 #7Decrease in short-term private assets in the U.S.: -$800Increase in foreign short- term official assets +$800 -$33,800+$33,

BOP Summary Category IExports of Goods+$11,000 Imports of goods-$10,000 Merchandise trade balance+$1,000 Exports of services+$2,000 Imports of services-$0 Balance of goods and services+$3,000 Factor income receipts from abroad+$8,000 Factor income payments abroad$0 Balance on goods, services, and investment income+$11,000 Unilateral transfers received+$0 Unilateral transfers made-$5,000 CURRENT ACCOUNT BALANCE+$6,

BOP Summary (cont’d) Category IINet increase in foreign long-term assets in U.S.+$0 Net increase in long-term assets abroad-$2,000 BASIC BALANCE+$4,000 IIINet increase in foreign short-term private assets in U.S. +$1,200 Net increase in short-term private assets abroad-$6,000 OFFICIAL RESERVE TRANSACTIONS BALANCE-$800 IVNet increase in foreign short-term official assets in U.S. +$800 Net increase in official assets abroad-$0 TOTAL$

Statistical Discrepancy  The current account balance may not exactly equal the financial account balance due to incomplete or imperfect data, illegal activities, and mismatches on the timing of data collection.  To account for these, a category called “statistical discrepancy” is included in the BOP.

U.S. International Transactions, 2007 (billions of $) Exports of Goods+$1,148.5 Imports of goods-$1,967.9 Merchandise trade balance Exports of services+$497.2 Imports of services-$378.1 Balance of goods and services Factor income receipts from abroad+$817.8 Factor income payments abroad-$736.0 Balance on goods, services, and investment income-$618.5 Unilateral transfers, net CURRENT ACCOUNT BALANCE-$

U.S. International Transactions, 2007 (billions of $) Capital account, net-$1.8 U.S. official reserve assets, net+$0.1 U.S. government assets abroad (other than reserves), net +$22.3 U.S. private assets abroad, net-$1,267.5 Foreign official assets in the U.S., net+$411.1 Other foreign assets in U.S., net (incl. financial derivatives) +$1,653.1 Statistical discrepancy+$

International Investment Position of the U.S.  The BOP accounts are flow concepts– they represent changes over a time period.  The international investment position is a stock concept – it involves totals up to the present.  If foreign assets outweigh foreign liabilities, a country is a net creditor; otherwise it is a net debtor.

Int’l Investment Position of the U.S. (end of 2007) – billions of $ A. U.S.-owned assets abroad U.S. official reserve assets$277.2 U.S. gov’t assets (not reserve assets)94.5 Financial derivatives2,284.6 U.S. private assets abroad14,983.7 direct investment abroad$3,332.8 foreign bonds1,478.1 foreign corporate stocks5,170.6 U.S. claims on foreigners by U.S. banks and nonbanks not reported elsewhere 5,002.2 TOTAL U.S. ASSETS ABROAD$17,

Int’l Investment Position of the U.S. (end of 2007) – billions of $ B. foreign-owned assets in the U.S. Foreign official assets in the U.S.$3,337.0 Financial derivatives2,201.1 Other foreign assets in the U.S.14,543.7 foreign direct investment$2,422.8 U.S. Treasury securities272.0 Corporate and other bonds3,299.3 Corporate stocks2,833.1 U.S. liabilities to foreigners not reported elsewhere 4,981.7 TOTAL FOREIGN ASSETS IN THE U.S.$20,081.8 Net international investment position of the U.S.-$2,

International Investment Position of the U.S.  The U.S. is a net international debtor.  No other country in the world is as indebted.  Disadvantages  We must transfer future goods and income abroad.  Foreign ownership may threaten U.S. sovereignty.  Still, productive investments should allow repayment.