Balance of payments
BOP are measures of money inflows and outflows between the United
States and the rest of the world (ROW).
Inflows are referred to as 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
book keeping
Every transaction in the balance of payments is recorded
twice in accordance
Current account
Balance of trade or
Net exports
Exports of goods/services- import 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 the U.S. owned foreign
assets
Interest payments on U.S. owned foreign
assets- Interest payments on German-owned U.S treasury bonds.
Net transfers (tend
to be Unilateral).
Foreign aid- a debit to the current
account.
Example- Mexican migrant worker sends money
to family.
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.
Direct
investment by United States firms/individuals in a foreign country are a debit
to the capital account.
Intel
factory construction in Germany
· Purchase of
foreign financial assets represents a Debit to the capital account.
(Warren buffets buys stock in Petrochina.)
· Purchase of
domestic financial assets by foreigners represents a credit to the capital
account.
(The UAE 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….if
the current account has a negative balance (deficit) then the capital account
should then have a positive balance (surplus).
Official reserves
The foreign currency
holdings of the U.S. fed.
When there is a
balance of payments surplus the fed accumulates foreign currency and debits the
balance of payments.
When there is a
balance of payments deficit, the fed depletes its reserves of foreign currency
and credits the balance of payments.
Active v. 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 People's 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 w/ the United States.
Formulas
Balance of
trade: Good
exports + goods imports
Balance on
goods & services: Goods
exports + service exports + goods imports + service imports.
Current
Account: Balance on
goods and services + net investment + net transfers
Capital
account: Foreign
purchases + domestic purchases.
