Balance of Payments

Phil Bryson
Global Trade and Finance
 Part I
Balance of Payments
Accounting
Balance of Payments Accounting

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 Californias
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?

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?

The basic technique is standard, double-entry

accounting,

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.
Debits, Credits, and International Payments

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.
Debits, Credits, and International Payments

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.
Debits, Credits, and International Payments

A credit records a transaction reducing assets

or increasing liabilities.
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.
 Sources and Uses of Funds
How does a country derive foreign currencies
it needs to conduct its international business?

The sources of funds, the supply of foreign

exchange, are
exports,
investment income,
 Sources and Uses of Funds
The sources of funds, the supply of foreign
exchange, are

transfer payments received,

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.
 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,
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
4. 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.
 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?

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?

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?

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
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.
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)
The rising current account deficit in recent
years has been accompanied by a rising rate of
U.S. domestic investment. (p. 237)