Download 4.5 PPT Balance of Payments

Balance of Payments
The balancing act of
international trade
Balance of Payments
Balance of Payments (“BOP”) is an
accounting of a country’s international
transactions over a certain time period.
 BOP includes two main components:
 Current Account
 Capital Account
 The Current Account and Capital
Account always balance each other out.

Current Account



Record of daily trade of goods and services
between a nation and the rest of the world.
Split into two pieces:
 Merchandise trade (or Visible) account –
records trade in goods
 Invisible account – records trade in services
Current Account includes investment income
flows (interest and dividends), private transfers
and direct foreign aid, in addition to “pure”
goods and services.
Current Account
The net exports (exports minus imports)
of goods and services for a country is its
trade balance (balance of trade).
 If a country has positive net exports of
goods and services (more exports than
imports), it has a trade surplus.
 Negative net exports of goods and
services means the country has a trade
deficit.

Welker
Capital Account



Records the difference between the
purchase of foreign assets by domestic
residents and the purchase of domestic
assets by foreigners.
Includes direct purchases of hard assets
(land or mineral rights, production facilities,
etc.) and financial assets (stocks, bonds,
bank deposits).
The net change in the Capital Account is a
country’s net capital outflow (or net foreign
investment).
Welker
Why does BOP Balance?




Remember – BOP is an accounting of a
country’s international transactions.
What do you know about accounting?
In a country, what 2 numbers should equal
to have a “balanced” budget?
Basic principle is that the two offsetting
sides of every entry (debits and credits)
must always be equal – and therefore are
always in balance.
Welker
Balance of Payments



BOP works exactly the same way.
For every change in the Current Account
(think net exports) there must be an equal
change in net capital outflow.
Let’s walk through a couple of examples …
Import Transaction
1.
2.
3.
4.
5.
Domestic Oil Company buys $1 billion of
petroleum from foreign government supplier
(transaction is denominated in US$).
U.S. net exports declines by $1 billion.
Foreign government purchases $1 billion of US
Treasury bonds.
U.S. net capital outflow (Capital Account)
declines by $1 billion.
Change in Current Account = Change in Capital
Account
Export Transaction
1.
2.
3.
4.
5.
Boeing sells 20 new aircraft to a foreign
carrier for 500 million Euro.
U.S. net exports increases by 500 million
Euro.
Boeing exchanges 500 million Euro for $385
million at their money center bank of choice.
Bank purchases 500 million Euro of shortterm LIBOR based securities.
U.S. net capital outflows increase by 500
million Euro.
Balance of Payments
The equation to remember:
Net Balance of Payments =
Current Account Balance + Capital Account
Balance = 0
And, if it’s helpful:
Net Capital Outflow = Net Exports
Are Trade Deficits Bad?



It depends …
First, all countries cannot have a trade surplus
(positive Current Account balance).
All open economies are part of the same
global economic system – one country’s
surplus must eventually be balanced by
another country’s deficit.
Trade Deficits (Cont’d)



Would a country normally prefer to be a net
exporter (run a trade surplus)?
Perhaps, but like an individual who takes on
personal debt, whether or not they are better
off in the long run depends on how they got
into debt and what they do with the money.
Which is why a discussion of trade deficits
inevitably leads to an analysis of the
underlying causes – and often a debate
about trade policy.
Current Account


Any guesses on the current trade balance for the
United States?
Let’s take a look.
U.S. Trade Deficit





You have analyzed the flow of goods and
services underlying the current U.S. trade
deficit.
What do you think?
Is it sustainable?
Is it dangerous (or healthy)?
Are we in trouble?