Balance of Payments

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)
Government transfers to foreigners
(E.g., Foreign aid or wheat from 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
ASSETS
Flows of financial assets and similar claims, or
Foreign direct and other investments 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 assets,
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.

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.

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.

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

MATHEMATICAL
INTERPRETAION

Balance of Payments Accounting

Balance of Payments Accounts

The Current Account

The Capital Account
Statistical Discrepancy
Official Reserves Account

The Balance of Payments Identity

Balance of Payments Trends in Major
Countries

BOP Accounting

The Balance of Payments is the statistical

record of a countrys international transactions
over a certain period of time presented in the
form of double-entry bookkeeping.
N.B. when we say a countrys balance of
payments we are referring to the transactions
of its citizens and government.

Balance of Payments Example

Suppose that Maplewood Bicycle in

Maplewood, Missouri, USA imports $100,000
worth of bicycle frames from Mercian
Bicycles in Darby England.
There will exist a $100,000 credit recorded by
Mercian that offsets a $100,000 debit at
Maplewoods bank account.
This will lead to a rise in the supply of dollars
and the demand for British pounds.

Balance of Payments Accounts

The balance of payments accounts are those

that record all transactions between the
residents of a country and residents of all
foreign nations.
They are composed of the following:

The Current Account

The Capital Account
The Official Reserves Account
Statistical Discrepancy

The Current Account

Includes all imports and exports of goods and

services.
Includes unilateral transfers of foreign aid.
If the debits exceed the credits, then a country
is running a trade deficit.
If the credits exceed the debits, then a country
is running a trade surplus.

The Capital Account

The capital account measures the difference between

U.S. sales of assets to foreigners and U.S. purchases
of foreign assets.
The U.S. enjoys about a $444,000,000,000 capital
account surplusabsent of U.S. borrowing from
foreigners, this finances our trade deficit.
The capital account is composed of Foreign Direct
Investment (FDI), portfolio investments and other
investments.

Statistical Discrepancy

Theres going to be some omissions and

misrecorded transactionsso we use a plug
figure to get things to balance.
Exhibit 3.1 shows a discrepancy of $0.73
billion in 2000.

The Official Reserves Account

Official reserves assets include gold, foreign

currencies, SDRs, reserve positions in the
IMF.

The Balance of Payments Identity

BCA + BKA + BRA = 0
where
BCA = balance on current account
BKA = balance on capital account
BRA = balance on the reserves account

Under a pure flexible exchange rate regime,

BCA + BKA = 0

U.S. Balance of Payments Data

Credits

Debits

Current Account
1

Exports

Imports

Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7

Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account

Statistical Discrepancies
Overall Balance
Official Reserve Account

$1,418.64
($1,809.18)
$10.24

($64.39)
($444.69)

$287.68
$474.39
$262.64
$444.26
0.73
$0.30

($152.44)
($124.94)
($303.27)

($0.30)

U.S. Balance of Payments Data

Credits

Debits

Current Account
1

Exports

Imports

Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7

Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account

Statistical Discrepancies
Overall Balance
Official Reserve Account

$1,418.64
($1,809.18)

$10.24

($64.39)
($444.69)

$287.68
$474.39
$262.64
$444.26
0.73
$0.30

($152.44)
($124.94)
($303.27)

($0.30)

In 2000, the
U.S. imported
more than it
exported, thus
running a
current account
deficit of
$444.69 billion.

U.S. Balance of Payments Data

Credits

Debits

Current Account
1

Exports

Imports

Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7

Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account

Statistical Discrepancies
Overall Balance
Official Reserve Account

$1,418.64
($1,809.18)

$10.24

($64.39)
($444.69)

$287.68
$474.39
$262.64
$444.26
0.73
$0.30

($152.44)
($124.94)
($303.27)

($0.30)

During the same

year, the U.S.
attracted net
investment of
$444.26
billionclearly
the rest of the
world found the
U.S. to be a
good place to
invest.

U.S. Balance of Payments Data

Credits

Debits

Current Account
1

Exports

Imports

Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7

Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account

Statistical Discrepancies
Overall Balance
Official Reserve Account

$1,418.64
($1,809.18)

$10.24

($64.39)
($444.69)

$287.68
$474.39
$262.64
$444.26
0.73
$0.30

($152.44)
($124.94)
($303.27)

($0.30)

Under a pure
flexible
exchange rate
regime, these
numbers would
balance each
other out.

U.S. Balance of Payments Data

Credits

Debits

Current Account
1

Exports

Imports

Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7

Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account

Statistical Discrepancies
Overall Balance
Official Reserve Account

$1,418.64
($1,809.18)

$10.24

($64.39)
($444.69)

$287.68
$474.39
$262.64
$444.26
0.73
$0.30

($152.44)
($124.94)
($303.27)

($0.30)

In the real
world, there
is a statistical
discrepancy.

U.S. Balance of Payments Data

Credits

Debits

Current Account
1

Exports

Imports

Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7

Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account

Statistical Discrepancies
Overall Balance
Official Reserve Account

$1,418.64
($1,809.18)

$10.24

($64.39)
($444.69)

$287.68
$474.39
$262.64
$444.26
0.73
$0.30

($152.44)
($124.94)
($303.27)

Including that,
the balance of
payments identity
should hold:
BCA + BKA = BRA

($0.30)

($444.69) + $444.26 + $0.73 = $0.30= ($0.30)

Balance of Payments and the

Exchange Rate
Credits

Debits

Exchange rate $

Current Account
1

Exports

Imports

Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7

Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account

Statistical Discrepancies
Overall Balance
Official Reserve Account

$1,418.64

($1,809.18)

$10.24

($64.39)
($444.69)

$287.68
$474.39
$262.64
$444.26
0.73
$0.30

($152.44)
($124.94)
($303.27)

D
Q

($0.30)

Balance of Payments and the

Exchange Rate
Credits

Debits

Exchange rate $

Current Account
1

Exports

Imports

Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7

Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account

Statistical Discrepancies
Overall Balance
Official Reserve Account

$1,418.64

($1,809.18)

$10.24

($64.39)
($444.69)

$287.68
$474.39
$262.64
$444.26
0.73
$0.30

($152.44)
($124.94)
($303.27)

D
Q

($0.30)

As U.S. citizens import, they are supply dollars to the FOREX market.

Balance of Payments and the

Exchange Rate
Credits

Debits

Exchange rate $

Current Account
1

Exports

Imports

Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7

Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account

Statistical Discrepancies
Overall Balance
Official Reserve Account

$1,418.64

($1,809.18)

$10.24

($64.39)
($444.69)

$287.68
$474.39
$262.64
$444.26
0.73
$0.30

($152.44)
($124.94)
($303.27)

D
Q

($0.30)

Balance of Payments and the

Exchange Rate
Credits

Debits

Exchange rate $

Current Account
1

Exports

Imports

Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7

Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account

Statistical Discrepancies
Overall Balance
Official Reserve Account

$1,418.64
($1,809.18)

$10.24

($64.39)
($444.69)

$287.68
$474.39
$262.64
$444.26
0.73
$0.30

($152.44)
($124.94)
($303.27)

S
S1

D
Q

($0.30)

As the U.S. government sells dollars, the supply of dollars increases.

Thank you