Download Chapter 9

Chapter 9
Trade and
the Balance
of Payments
Copyright © 2011 Pearson Addison-Wesley. All rights reserved.
Chapter Objectives
• Present the accounting system of a nation's
international transactions: current, capital, and
financial accounts
• Explain the relationship among domestic
investment, domestic savings, and international
flows of goods, services, and financial assets
• Examine the meaning of international
indebtedness and discuss its consequences
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Introduction:
The Current 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
• Let’s examine each of these in greater detail…
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The Trade Balance
• Let’s first define the trade balance- measures
the difference between exports and imports of
goods and services
– Trade deficit: negative trade balance
• In 2008, the U.S. had a trade deficit of $695.0 billion
– Trade surplus: positive merchandise trade balance
• However, the U.S. had a large trade surplus in services
($144 billion)
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The Current Account Balance
• Current account balance: Measures all current, non-capital
transactions between a nation and the rest of the world
• The 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
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TABLE 9.1
Components of the Current Account
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TABLE 9.2
The U.S. Current Account Balance,
2008
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TABLE 9.2 (continued)
The U.S. Current Account Balance,
2008
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FIGURE 9.1
U.S. Current Account Balances, 19502008
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U.S. Current Account Deficit
• There were two periods of large current
account deficits in the U.S.:
- The first lasted through most of the 80’s
- The second began in the early 1990s and
continues today
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U.S. Current Account Deficit
(cont.)
• A current account deficit is not a sign of
weakness: in the U.S., the economic boom of
the 1990s increased the demand for imports,
while sluggish growth abroad limited the
expansion if U.S. exports
• However, everyone agrees the U.S. deficit is
not sustainable in the long term
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Introduction to the
Financial and Capital Accounts:
Financial Account
• Financial account: A record of the flow of
financial capital to and from a country
• Financial account is divided into three
categories:
– Net changes in the country’s assets abroad
– Net changes in the foreign-based assets in the
country
– Net change in financial derivatives
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Introduction to the
Financial and Capital Accounts:
Financial Account (cont.)
• Assets include bank accounts, stocks and
bonds, and real property such as factories,
businesses, and real estate
• Financial derivatives are complex financial
contracts and only recently included in the
balance of payments
• Value of financial derivatives is derived
from the value of a variable such as interest
rates, exchange rates, or commodity prices
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Capital Account
• Capital account: A 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
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The Three Accounts are
Interdependent
• The current, capital, and financial accounts
are interdependent
• Current account measures flow of goods
and services
• Capital and financial accounts measure flow
of financing
• Therefore, sum of capital account and
financial accounts equal to current account
with opposite sign
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TABLE 9.3
The U.S. Balance of Payments, 2008
• Balance of payments =
current account + capital account + financial account
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TABLE 9.3 (continued)
The U.S. Balance of Payments, 2008
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Balance of Payments
•
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 (stock)
changes
3. As long as the capital account balance is zero, financial
account balance = current account balance, but with the
opposite sign
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Statistical Discrepancy in the
Balance of Payments
• 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 2008, U.S. statistical discrepancy was
[(–1)  (–706,068 + 506,013)] = 200,055
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Statistical Discrepancy (cont.)
• Statistical discrepancy exists because
the record of all the transactions in the
balance of payments is incomplete
-Errors tend to lie in the financial account
calculation, as it is the hardest to
measure correctly
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Table 9.4 Components of the U.S. Financial
Account, 2008
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Types of Financial Flows
• Financial flows originate in the public and private
sectors
• Some financial flows are very mobile: move quickly
in response to investor expectations
– Mobility of financial flows brings economic volatility
– Upon sudden financial outflows, a country can sink into a
financial crisis
– The volatility of financial flows has increased concern
about the various types of flows
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Main Categories of U.S. Financial Flows
1. U.S. assets abroad (outflows)
A. U.S. Official reserve assets: gold bullion, IMF’s
Special Drawing Rights (SDRs), EU euros, British
pounds, or Japanese yen
B. U.S. 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. U.S. Private assets: direct investment, foreign
securities, loans to foreign firms and banks
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Main Categories of U.S. Financial Flows
(con’t.)
2. Foreign assets in the U.S. (inflows)
A. Foreign official assets: gold bullion,
IMF´s special drawing rights (SDRs), major
currencies
B. Other foreign assets: direct
investment, U.S. securities and currency,
loans to U.S. firms and banks
3. Net change in financial derivatives
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Largest Share of Financial Flows:
Private Assets
• Subcomponents of 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
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TABLE 9.5
Private Flows in the U.S. Financial
Account, 2008
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TABLE 9.5 (continued)
Private Flows in the U.S. Financial
Account, 2008
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Role of Expectations in
Financial Flows
• Shifts in expectations can lead to sudden
stoppages of financial inflows
• The result is a destabilizing of outflows of
financial capital
• This occurrence has been labeled a sudden
stop
• Sudden stops have been involved in the most
financial crises in last 30 years
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Limits on Financial Flows
• 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
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Financial Account
Liberalization
• 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
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The Current Account and
the Macroeconomy
• Why study the balance of payments?
– Balance of payments help 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
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The 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)
– 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
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The National Income and
Product Accounts (cont.)
• GNP = GDP + foreign investment income
received – investment income paid to
foreigners + net unilateral transfers
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TABLE 9.6
The U.S Financial Accounts, 2007-2008
(millions of dollars)
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TABLE 9.6 (continued)
The U.S Financial Accounts, 2007-2008
(millions of dollars)
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Table 9.7 Variable Definitions
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Understanding
National Accounts
• Interplay of the variables of the national accounts
1. GDP = C + I + G + X – M
2. GNP = GDP + (net foreign investment income + net transfers)
3. GNP = (C + I + G) + (X – M + net foreign investment income +
net transfers)
4. GNP in terms of current account balance:
GNP = C + I + G + CA
5. GNP is also the value of income received: GNP = C + S + T
6. Since 4 and 5 are equivalent definitions of GNP,
C + I + G + CA = C +S + T
7. I + G + CA = S + T
8. S + (T – G) = I + CA
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Understanding
National Accounts (cont.)
• S + (T – G) = I + CA summarizes the current
account balance, investment, and public
and private savings in the economy
• The following figure illustrates the equation
in the U.S. in 1990-2007
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FIGURE 9.2
U.S. Savings and Investment, 1990–2007
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Understanding
National Accounts (cont.)
• The four macroeconomic variables demonstrate there
is not a fixed relationship between the current
account balances and government budget balances,
or between savings and investment
• The four variables are determined by the other three
• A change in any one of them influences all of them
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Are Current Account
Deficits Harmful?
• The relationship between the current
account balance, investment, and total
national savings is an identity
• Consequently, it does not tell us why an
economy runs a current account deficit or
surplus
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International Debt
• Debt is defined as money owed o
nonresidents with must be paid in a foreign
currency.
• 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
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International Debt (cont.)
• 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
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TABLE 9.8
The Five Largest Developing Country
Debtors, 2007
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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
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The International
Investment Position (cont.)
• 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
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