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TRADE AND BALANCE OF PAYMENTS
THE ACCOUNTS
Introduction
•Balance of payments =
current account + capital account +
financial account
• The international transactions of a nation are divided
into three separate accounts
– Current account: record of the goods and services into and
out of the country
– Financial account: record of the flow of financial capital to
and from the country
– Capital account: record of some specialized types of
relatively small capital flows
Merchandise Trade Balance
• Let’s first define merchandise trade balance—
part of the current account; measures the
difference between exports and imports of
goods, but not services
– Trade deficit: negative merchandise trade balance
– Trade surplus: positive merchandise trade balance
• In 2002, the U.S. had a trade deficit of $418.0 billion
• However, the U.S. had a large trade surplus in services
($64.8 billion)
Current Account
• Current account balance: measures all current, non-capital
transactions between a nation and the rest of the world
• Current account has three main components:
– Goods and services = the value of goods and services exported – the
value of imports
– Investment income = income from investments abroad – income paid to
foreigners on their U.S. investments
– Unilateral transfers = any foreign aid or other transfers received by
foreigners – that given to foreigners
Components of the Current
Account
IF A NATION’S PEOPLE INVEST IN ANOTHER NATION,
THEN INCOME FROM FOREIGN NATION STOCKS,
BONDS, DEPOSITS, COMMERCIAL PAPER IS A CREDIT
IN THE CURRENT ACCOUNT --- FOREIGN INVESTMENTS
IN ANOTHER NATION ARE A DEBIT TO THE CURRENT
ACCOUNT
The U.S. Current Account Balance, 2005
(Millions of Dollars)
U.S. Current Account Balance, 1950–2005
• U.S. current account deficit looks ominous
• However, the deficit is not a sign of weakness:
U.S. economic boom of the 1990s increased
the demand for imports, while sluggish growth
abroad limited the expansion if U.S. exports
• But the U.S. deficit is not sustainable in the
long term
• With $ down in value– exports increase --- but
oil payments paid out increase
• TRADE IN GENERAL AROUND THE WORLD IS
DOWN IN THIS CURRENT DEPRESSION
Financial Account
• Financial account: record of the flow of
financial capital to and from a country
• Two main components
– Net changes in the country’s assets abroad
– Net changes in the foreign-based assets in the
country
Capital Account
• Capital account: record of the transfers of
specific types of capital, such as
– Debt forgiveness
– Personal assets that migrants take with them
abroad
– The transfer of real estate and other fixed
assets, such as a military base or an embassy
building
•
Balance of
payments =
current account +
capital account +
financial account
U.S. BALANCE OF ACCOUNTS
IN $MILLIONS 2005
•
Three accounting caveats
1. Both the capital account and the financial account
present the flow of assets during the year in
question and not the stock of assets that have
accumulated over time
2. All flows are net changes (differences between
assets sold and bought, for example) rather than
gross changes
3. As long as the capital account balance is zero,
financial account balance = current account
balance, but with the opposite sign
• Statistical discrepancy: the amount by which the
sum of the current, capital, and financial accounts
is off the total of zero
• Statistical discrepancy is calculated as the sum of
the current, capital, and financial accounts, with
the sign reversed
– In 2005, U.S. statistical discrepancy was
[(–1)  (–791,508 – 4,351 + 785,499)] = 10,410
•
current acc.
Capital acc. Financial acc
RECORDS ARE INCOMPLETE--- HENCE THE PLACE OF
THE STATISTICAL DISCREPANCY
Financial Flows
Five Types of U.S. Financial FLOWS
1. U.S. assets abroad (outflows)
A. Official reserve assets: gold bullion, IMF’s special
drawing rights (SDRs), major currencies
B. Government assets: loans to foreign governments,
rescheduled loans to foreign governments,
payments received on outstanding loans, changes
in non-reserve currency holdings (e.g., Mexican
pesos)
C. Private assets: direct investment, foreign
securities, loans to foreign firms and banks
2. Foreign assets in the U.S.
(inflows)
D. Foreign official assets: gold
bullion, IMF´s special
drawing rights (SDRs),
major currencies
E. Other foreign assets: direct
investment, U.S. securities
and currency, loans to U.S.
firms and banks
2005 U.S. FINANCIAL ACCOUNT
THE LARGEST SHARE OF FINANCIAL FLOWS IS
PRIVATE ASSETS
Private assets: foreign direct investment
(FDI), foreign securities, loans to foreign
firms and banks
FDI: tangible items: real estate, factories,
warehouses, transportation facilities, and
other physical (real) assets
Securities and loans can be considered
foreign portfolio investment—paper assets
such as stocks and bonds
Both FDI and foreign portfolio investment
give their holders a claim in a foreign
economy’s future output
However, holders of FDI have longer time
horizons
PRIVATE FLOWS IN THE
U.S. FINANCIAL ACCOUNT
2005
Until recently, most nations limited the movement of
financial flows related financial account transactions
across their borders
The European Union liberalized financial flows
between member countries only in 1993
However, current account transactions were less
heavily regulated
The movement toward open markets
over the 1980s and 1990s has resulted
in the lifting of controls on financial
flows
Developing countries, in particular,
have liberalized financial account
transactions in order to get access
to financial capital for development
Although financial flows can be
volatile, economists agree that free
flows are best for economic
efficiency
The Current Account and the
Macroeconomy
Balance of payments help us to understand the
broader implications of current account imbalances
and how to tame current account deficits
Balance of payments give cues how nations can
avoid crises brought by volatile financial flows and
how they can minimize the damage of financial
crises if such occur
National Income and Product Accounts
• National income and product accounts: accounting
system for a country’s total production and income
• Two fundamental concepts of the system:
– Gross domestic product (GDP): the value of all final goods
and services produced within a country´s borders during a
period of time (usually a year) {add up value of goods and services}
– Gross national product (GNP): the value of all final goods
and services produced by the labor, capital, and other
resources of a country within the country as well as abroad
{here you add up value of goods & services in country as well as abroad for a nation}
• GNP = GDP + foreign investment income
received – investment income paid to
foreigners + net unilateral transfers
Understanding National Accounts
• Interplay of the variables of the national accounts
1. GDP = C + Id + G + X – M
Using Id = domestic
investment for I
2. GNP = GDP + (net foreign investment income + net
transfers)
3. GNP = (C + Id + G) + (X – M + net foreign investment income
+ net transfers)
4. GNP in terms of current account balance:
GNP = C + Id + G + CA = C + Id + G + (X – M) FOR CA ≈ (X – M)
5. GNP is also the value of income received: GNP = C + S + T
6. Since 4 and 5 are equivalent definitions of GNP,
C + Id + G + CA = C +S + T
7. Id + G + CA = S + T
8. S + (T – G) = Id + CA = Id + (X – M)
• S + (T – G) = Id + CA summarizes the
current account balance, investment,
and public and private savings in the
economy CA=S+(T-G) -Id
DEBT = (T – G)
• The following figure illustrates the
equation in the U.S. in 1991–2005
• IF S IS LOW AND (T-G)< 0 --- YOU CAN SEE
THE EFFECT ON CA BECAUSE OF THE -Id
International Debt
Current account deficits must be financed
through inflows of financial capital (loans)
Loans from abroad add to a country’s stock
of external debt and generate debt service
obligations --- CA DEFICIT = NET
BORROWER
All countries, rich and poor, have external
debt
• In many low and middle income countries,
external debt leads to financial problems
• Unsustainable debt occurs for numerous
reasons:
– Falling commodity prices
– Natural disasters
– Corruption
– Foreign lending behavior
DEBT IN 2005
SOME OF THE TOP NATIONS
IN DEBT
The International Investment Position
If a country runs a current account
deficit, it borrows from abroad and
increases its indebtedness
If a country runs a current account
surplus, it lends to foreigners and
reduces its overall indebtedness
International investment position =
domestically owned foreign assets –
foreign owned domestic assets
• A positive international investment position =
the home country could sell all its foreign
assets and have more than enough revenue to
purchase all the domestic assets owned by
foreigners
– In 2005, the U.S. international investment position
= $11,079 billion – $13,625 billion = –$2,546 billion