UNIT 7: Balance Of Payments

UNIT 7: Balance Of Payments

                                         Balance of payments

·         Measures of money inflows and outflows between the united states and the rest of the world (ROW)

-          Inflows are referred to as credits

-          Outflows are referred to as debits

The balance of payment is divided into three accounts:

1.      Current account

2.      Capital/financial account

3.      Official reserves account

                               Double entry book keeping

Every transaction in the balance of payments is recorded twice in accordance.

                                               Current account

·         Balance of trade or Net exports

-          Exports of goods/services- import of goods/services.

-          Exports create a credit to the balance of payments.

-          Imports create a debit to the balance of payments.

·         Net foreign income

-          Income earned by the U.S. owned foreign assets

·         Net transfers (tend to be Unilateral).

-          Foreign aid- a debit to the current account.

-          Example- Mexican migrant worker sends money to family.

                                            Capital / Financial Account

·         The balance of capital ownership.

·         Includes the purchase of both real and financial assets

·         Direct investment in the United States is a credit to the capital account.

-          For example the Toyota company in San Antonio.

·         Direct investment by United States firms/individuals in a foreign country are debits to the capital account.

·         Purchase of foreign financial assets represents a Debit to the capital account. For example Warren buffets buys stock.

·         Purchase of domestic financial assets by foreigners represents a credit to the capital account.

                                          Relationship between current and capital account

·         Remember double entry bookkeeping?

·         The current account and the capital account should zero each other out.

·         That is….if the current account has a negative balance (deficit) then the capital account should then have a positive balance (surplus).

                                                      Official reserves

·         The foreign currency holdings of the U.S. fed.

·         When there is a balance of payments surplus the fed accumulates foreign currency and debits the balance of payments.

·         When there is a balance of payments deficit, the fed depletes its reserves of foreign currency and credits the balance of payments.

Active v. passive official reserves

-The U.S. is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate.
-The People's Republic of China is active in its use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate w/ the United States.

                         Formulas

1.      Balance of trade

-          Good exports + goods imports

2.      Balance on goods : services :

-          Goods exports + service exports + goods imports + service imports.

3.      Current Account:

-          Balance on goods and services + net investment + net transfers

4.      Capital account:

-          Foreign purchases + domestic purchases.