BALANCE OF PAYMENTS

 

A large array of transactions take place between our country and any other particular country.

 

These include our imports of their goods, and payment for that.

Their purchase of the stock of some US company, such as GM, and payment for that.

Our tourists may visit their country and will need to get some of their money to spend there.

And, there are many other such situations.

 

For every country, there is a kind of balance sheet which summarizes their activity with the rest of the world -- called the Balance of Payments

 

The bop summarizes, in a sense, all the ways the country is losing money or paying out money  and all the ways it is gaining money.

 

Current Account

 

The most important part of the bop is the Current Account.

Basically, the current account is for recording trade transactions.

Specifically, the current account has these subaccounts:

        *Merchandise Trade -- Our exports  a positive factor, and our imports are a negative                   

        *Service Trade -- We can also "export" services (transport, insurance, consulting)

        *Investment Income -- Profits which are sent here from overseas investments are a +

(say, dividends on stock we may own in Japanese companies, or the repatriation of profits of a foreign subsidiary of a US co.)

        *Grants and Remittances (“Transfers”)-- included foreign aid to others (-), money sent home by someone living in the US(-)

Together these things give a Current Acct. Bal.(for a specified period of time such as a year)

 

Whether this account is overall positive or negative is a very important fact.

 

A deficit (-) on current account means, normally, that we are responsible for paying out more due to overseas trade transactions than we are taking in from them.

 

 

What causes the merchandise account to fluctuate?

        relative prosperity here vs overseas

        changes in the value of the dollar (exchange rate)

        changes in taste,

        and the effectiveness of our firms vs. foreign firm (competitiveness)

 

THE CAPITAL ACCOUNT

 

The capital account keeps track of transactions between nations involving financial transactions.

 

 

Direct Investment

When foreign persons/firms invest in the US, it is a + in the capital account.

One way that may occur is through direct investment.  If a foreign firm builds a plant in the US, it is direct investment in the US and a plus in the capital account.  If we do direct investment elsewhere, it is a negative in the capital account of the US balance of payments. 

If a firm does direct investment overseas, they are spending money over there, so therefore it is a negative. Whether a thing is a positive or a negative in our b.o.p. is mostly a matter of whether there is money flowing into the country (+) or out of the country (-), as a result of the action.

 

Portfolio Investment

This is mostly cross-border stock and bond purchases.  Recently there has been a lot of purchasing of foreign government bonds by US mutual funds, for example.  This would be a negative in our capital account.  At other times there has been a lot of foreign money flowing into the US stock market and bond market --  the safe haven idea.  This buying of stock in US companies by foreigners was a positive in our capital account.

 

Other

There are other financial transactions, such as foreigners depositing money in a CD account at a US bank (a +).  Incidentally, they will need to deposit dollars, and will need to convert their currency into dollars.

 

Another thing is inflow in the form of simple checking account balances or other bank deposits.  These are the same as above, and may represent "speculative" flows.  These would obviously be considered short term in comparison to direct investment.  The long term capital  flows (e.g.,dir. inv.) are likely to be "permanent" and not readily reversed.  They are supposed to be in response to fundamental conditions.  The short term flow may be very temporary and subject to reversal at any moment.

 

Errors and Omissions

A fudge factor  -- to make it balance, if it won't after everything that is known is taken into account.

 

Official Reserves

 

In the US this means the amount of gold and  foreign currency held by the central bank (Fed).  The reserves may increase or decrease due to actions of the government.  If the Fed sell off some foreign currency (in other words, gives up foreign currency in exchange for dollars) this will be a (+) in our b.o.p.  In a way we could say that if we have a balance of trade deficit, one way we can pay for that is by selling foreign currency that we are holding, or gold (or special drawing rights of the IMF).

 

BALANCES:

Current account balance: a negative current account balance is thought of as not so good.  It implies that the country is a net borrower and is not paying its way through trade.  A country with a current account deficit (like us) will normally have a capital account surplus  -- meaning there is a money inflow in the form of foreign lending to the US (including buying US securities), which is offsetting the money outflow due to too many imports.  When foreign firms purchase assets in the US, like factories, or Rockefeller Center, for examples, that will also be a plus in the capital account.  In short, we “pay” for our excess imports of foreign goods by borrowing abroad, and by selling our assets to them.

 

Basic balance:  taking both the current account and the long-term capital areas together.

 

Official Settlements balance:   the balance leaving out the changes in the official reserves account.  If the O.S. balance is a deficit, it may mean that the government is being forced to step in to prevent downward pressure on the exchange rate -- i.e., if it didn't there would be a depreciation of its exchange rate.