1. The Balance of Payments: Linking the United States to the International Economy The Current Account Trade Flows for the United States and Japan, 2006

2. The Balance of Payments of the United States, 2006 (billions of dollars) CURRENT ACCOUNT Exports of goods$1,023 Imports of goods−1,861 Balance of trade−838 Exports of services423 Imports of services−343 Balance of services80 Income received on investments650 Income payments on investments−614 Net income on investments36 Net transfers−90 Balance on current account−812 Don’t forget net compensation of nationals working abroad (= Labor Services) FINANCIAL ACCOUNT Increase in foreign holdings of assets in the United States1,860 Increase in U.S. holdings of assets in foreign countries−1,055 Balance on Financial Account805 BALANCE ON CAPITAL ACCOUNT -4 Statistical discrepancy11 Balance of payments0 The Balance of Payments balances: Current Account + Financial Account + Capital Account + Statistical Discrepancy = ZERO

3. U.S. Imports and Exports, 1970–2006

4. Financial account The part of the balance of payments that records purchases of assets a country has made abroad and foreign purchases of assets in the country. Net foreign investment The difference between capital outflows from a country and capital inflows. Also equal to net foreign direct investment (fdi) plus net foreign portfolio investment. Capital account The part of the balance of payments that records relatively minor transactions, such as migrants’ transfers, and sales and purchases of nonproduced, nonfinancial assets. Current account Records payments for currently produced goods and services, including capital and labor services. Mostly exports and imports of goods and services. Also includes net int’l earnings of country’s labor and capital resources. Unilateral transfers (exports and imports not paid for) are netted out.

5. Current Account Balance + Financial Account Balance = 0 Current Account Balance = -Financial Account Balance or: Net Exports = Net Foreign Investment … NX = NFI Private Saving = National Income – Consumption - Taxes S private = Y – C – T = (C + I + G + NX) - C - T = I + (G - T) + NFI Private saving finances domestic and foreign investment and the government’s deficit Public Saving = Taxes – Gov’t Spending = S public = T – G National Saving = Private Saving + Public Saving S = S private + S public S = [I + (G - T) + NX] + (T - G) = I + NFI A country that saves a lot has positive NX and invests abroad -NFI = I - S = I - S private - (T - G) = (I - S private ) + (G - T) = - NX Twin Deficit: G-T up  NX down Balance of Payment Arithmetic

6. Why Is the United States the “World’s Largest Debtor”? Large current account deficits have resulted in foreign investors purchasing large amounts of U.S. assets.

7. Can the U.S. Current Account Deficit Be Sustained?  Rebalancing! Sustaining the Unsustainable U.S. trade-weighted exchange index: Major currencies.