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Balance-of-Payments Accounts and Net Financial Flows Financial Inflow • Balance of Payments is a flow account, which consists of the current account and the capital and financial account • A flow of capital, real and/or financial, into a country, takes the form of increased purchases of domestic assets by foreigners and/or reduced holdings of foreign assets by domestic residents. Inflows are recorded as positive, or a credit, in the capital and financial account. • Each country also has an international balance sheet, which is a stock account which shows assets and liabilities abroad and foreign assets and liabilities at home -- Called the international investment positions accounts in the U.S. (the accumulated stocks of U.S.-owned assets abroad and of foreign-owned assets in the United States) . • The net change in the international investment positions accounts from the beginning of one year to the end of the next is the net capital/financial flow for the year Economic Summits Fred Thompson 2 Exchange and Net Flows • Exchange of Real Assets – exchange of goods and services for other goods and services or for financial claims (will give rise to a net change in financial claims if x≠m) • Exchange of Financial Assets – Exchange of financial claims for other financial claims (net financial claims are unchanged) • Hence, m-x = net capital flow, also = I-S [ignoring reporting errors and official settlements] Economic Summits Fred Thompson 3 Balance of Payments Statistics for the United States, 1966 (Amounts in millions of dollars) Sources of Foreign Exchange Uses of Foreign Exchange • Exports of Goods and Services $43,142 • Imports of Goods and Services $38,063 • Remittances and Pensions $1,015 Balance on goods, services, remittances, and pensions +$4065 • Foreign Capital Flow, net $2,532 • • • U.S. Government grants, net $3,444 U.S. private Capital Flow, net $4,298 Errors and Omissions $210 Balance of all of the above -$1357 • • Change in U.S. Reserve Assets $568 Change in Liquid Liabilities of Foreign Accounts $789 . Source: Federal Reserve Bulletin, April 1969, pp A70-71 Economic Summits Fred Thompson 4 The Balance of Payments Accounting System International Bookkeeping International Transactions Accounts (Balance of Payments) A quarterly statistical summary of transactions between U.S. and foreign residents organized into three major categories: – The current account – The capital account – The financial account Economic Summits Fred Thompson 6 Balance of Payments • System of accounts which is a subset of the National Income and Production Accounts – A double-entry bookkeeping system. – Debit Entries: Transactions that generate a payment outflow (e.g., import). – Credit Entries: Transactions that generate a payment inflow (e.g., export). Economic Summits Fred Thompson 7 Balance of Payments • The current account includes exports and imports of goods, services, income, and current transfers. – – – – Goods Services Income Receipts and Payments Unilateral Transfers Economic Summits Fred Thompson 8 Balance of Payments • Goods: Exports and imports of tangible items. • Services: Exports and imports of services, for example: – Typical business services such as banking and financial services, insurance, and consulting. – Tourism Economic Summits Fred Thompson 9 Balance of Payments • Income Receipts: Includes items such as – Investment income on US-owned assets abroad. – Receipts of income on US direct investment abroad. – Government income receipts Economic Summits Fred Thompson 10 Balance of Payments • Income Payments: Includes items such as – Investment income on foreign-owned assets in the United States. – Payments of income on foreign direct investment in the United States – US Government income payments Economic Summits Fred Thompson 11 Balance of Payments • Unilateral Transfers: Includes items such as: – Government grants abroad – Private remittances – Private grants abroad Economic Summits Fred Thompson 12 Balance of Payments (2000) Exports Millions Goods Services Income Receipts Imports Goods Services Income Payments Unilateral Transfers Current Account Balance Economic Summits Fred Thompson 1,414,925 773,304 296,227 345,394 -1,797,061 -1,222,772 -215,239 -359,050 -53,241 -435,377 13 Balance of Payments The Financial Sector • In June 1999, US capital account definitions were modified to bring them more in line with definitions recommended by the International Monetary Fund. • Now there are two accounts: – The capital account includes capital transfers, such as debt forgiveness. – The financial account includes transactions for official assets, for U.S. Government assets other than official reserve assets, for direct investment, for portfolio investment, and for other investment. Economic Summits Fred Thompson 14 Balance of Payments The Financial Sector • The new Capital Account includes items that were previously included in unilateral transfers, such as: – Debt forgiveness – Migrants’ transfers (as they leave the country). • The new capital account is small for the US (< 0.1 percent of capital flows), but expected to grow. Economic Summits Fred Thompson 15 Balance of Payments The Financial Sector • The Financial Account – Records international transactions in the financial sector – Includes portfolio and foreign direct investment – Includes changes in banks’ and brokers’ cash deposits that arise from international transactions. Economic Summits Fred Thompson 16 Balance of Payments The Financial Sector • US-Owned Assets Abroad: Increase or decrease in US ownership of foreign financial assets. • Foreign-Owned Assets in the US: Increase or decrease in foreign ownership of domestic assets. • Reserve Assets: Primarily the assets of central banks. Economic Summits Fred Thompson 17 Balance of Payments The Financial Sector • Portfolio Investment: Individual or business purchase of stocks, bond, or other financial assets or deposits. (An income strategy) • Foreign Direct Investment: Purchase of financial assets that results in a 10 percent or greater ownership share. (A financial control strategy) Economic Summits Fred Thompson 18 Capital and Financial Account (2000) Capital Account, Net Financial Account US-Owned Assets Abroad 680 -553,349 US Official Reserve Assets US Government Assets US Private Assets Foreign-Owned Assets Foreign Official Assets Other Foreign Assets Net Financial Flows Economic Summits -290 -715 -552,344 952,430 35,909 916,521 399,761 Fred Thompson 19 The Balance of Payments The Statistical Discrepancy Balance on Current Account Capital Account, net 680 Net Financial Flows 399,081 Statistical Discrepancy Economic Summits -435,377 Fred Thompson 35,616 20 International Allocation of Capital Feldstein - Horioka • Savings and Investment Relation • Based on a closed economy income condition: y = c + i + g. • Rearrange as: y - c - g = i. Economic Summits Fred Thompson 22 Feldstein - Horioka • Rearranged as: y - c - g = i. • Note that y - c - g equals savings, s. Then: s = i. • In a closed economy, domestic investment is equal to domestic saving by definition, but is also correlated in practice, i.e., correlation coefficient is necessarily close to 1 in value. Economic Summits Fred Thompson 23 International Flow of Goods, Services, & Capital • Domestic Savings and Investment & NFF National Income (GNY) = Consumption (C) + Savings (S) National Spending (GNE) = Consumption (C) + Investment (I) GNY - GNE = S - I GNY - GNE = Exports (x) - Imports (m) S-I=x-m Net Foreign Investment = x - m Economic Summits Fred Thompson 24 Government Budget Deficits and NFF GNE = Household spending + Private I + Government spending = GNY - Private S - Taxes + Private I + Government spending GNE - GNY = Private (I - S) + GovDeficit/Surplus NFF = Private savings surplus - GovDeficit Economic Summits Fred Thompson 25 US Balance of Payments U.S. TRADE AND CURRENT ACCOUNT BALANCES EXPRESSED AS A PERCENTAGE OF GDP 4% 2% 0% C/A TB -2% -4% -6% 46 50 54 58 Economic Summits 62 66 70 74 78 82 Fred Thompson 86 90 94 98 2 27 Basic Premise A current account deficit must be financed by capital inflows, or it cannot be incurred in the first place FACT Over 1982-2003, U.S. current account deficits have averaged $183 billion per year. $4 trillion worth of assets have been transferred to foreign ownership. Trade and Scale Variables I QuickTime™ and a TIFF (Uncompressed) decompressor are needed to see this picture. Economic Summits Fred Thompson 30 Scale Variables I U.S. monthly GDP: $1 trillion • Monthly goods and services exports: $130 billion = 13% • Monthly goods and services imports: $185 billion = 18.5% • Balancing item: net capital flow: $55 billion = 5.5% Economic Summits Fred Thompson 31 Scale Variables II U.S. GDP per worker: $84,000 per year • Exports of $10,900 per year • Imports of $15,500 per year Economic Summits Fred Thompson 32 Result: Foreign claims on U.S. assets now exceed U.S. claims on foreign assets by about $2.7 trillion. –Storing up purchasing power for the future –Private political risk insurance –Public political risk insurance International Investments (market value, end-2003) U.S. foreign investments: Foreign investments in U.S.: Net: $7.9 trn $10.5 trn -$2.7 trn Much of this capital inflow has been portfolio investment. Some has been direct investment. Foreign Direct Investment (market value, end-2003) U.S. DI abroad: Foreign DI in U.S.: Net: $2.7 trillion $2.4 trillion $0.3 trillion Direct Investment Positions At current market value, $ trillion 3.0 2.5 2.0 1.5 U.S. Direct Investment Abroad 1.0 0.5 Foreign Direct Investment in U.S. 02 00 Fred Thompson 98 96 94 92 Economic Summits 90 88 86 84 0.0 36 US f o re ign dire c t inv e s t m e nt , 2 0 0 1 Asia,Pacif ic Ot her 11% 2% Japan U.K. 18% 5% Caribbean 8% L.America 12% Europe Canada 34% 10% Economic Summits Fred Thompson 37 Foreign direct investment in US, 2001 Japan Other 12% 5% Caribbean 3% UK 16% Canada 8% other Europe 56% Economic Summits Fred Thompson 38