Unit 7: Balance of Payments

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.