The Balance of Payments
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1 The Balance of Payments Chapter Objective: Chapter Three 3 INTERNATIONAL FINANCIAL MANAGEMENT This chapter serves to introduce the student to the balance of payments. How it is constructed and how balance of payments data may be interpreted. Second Edition EUN / RESNICK
2 Chapter Three Outline Balance of Payments Accounting Balance of Payments Accounts The Current Account The Capital Account Statistical Discrepancy Official Reserves Account The Balance of Payments Identity Balance of Payments Trends in Major Countries 3-1
3 Balance of Payments Accounting The Balance of Payments is the statistical record of a country s international transactions over a certain period of time presented in the form of double-entry bookkeeping. N.B. when we say a country s balance of payments we are referring to the transactions of its citizens and government. 3-2
4 Balance of Payments Example Suppose that Maplewood Bicycle in Maplewood Missouri, USA imports $100,000 worth of bicycle frames from Mercian Bicycles in Darby England. There will exist a $100,000 credit recorded by Mercian that offsets a $100,000 debit at Maplewood s bank account. This will lead to a rise in the supply of dollars and the demand for British pounds. 3-3
5 Balance of Payments Accounts The balance of payments accounts are those that record all transactions between the residents of a country and residents of all foreign nations. They are composed of the following: The Current Account The Capital Account Statistical Discrepancy The Official Reserves Account 3-4
6 The Current Account Includes all imports and exports of goods and services. Includes unilateral transfers of foreign aid. If the debits exceed the credits, then a country is running a trade deficit. 3-5
7 The Capital Account The capital account measures the difference between U.S. sales of assets to foreigners and U.S. purchases of foreign assets. The U.S. enjoys about a $150,000,000,000 capital account surplus absent of U.S. borrowing from foreigners, this finances our trade deficit. The capital account is composed of Foreign Direct Investment (FDI), portfolio investments and other investments. 3-6
8 Statistical Discrepancy There s going to be some omissions and misrecorded transactions so we use a plug figure to get things to balance. Exhibit 3.1 shows a discrepancy of $96.76 billion in
9 The Official Reserves Account Official reserves assets include gold, foreign currencies, SDRs, reserve positions in the IMF. 3-8
10 The Balance of Payments Identity BCA + BKA + BRA = 0 where BCA = balance on current account BKA = balance on capital account BRA = balance on the reserves account Under a pure flexible exchange rate regime, BCA + BKA = 0 3-9
11 U.S. Balance of Payments Data Current Account Credits 1 Exports $1, Debits 2 Imports ($1,295.53) 3 Unilateral Transfers $6.13 ($45.01) Balance on Current Account ($166.80) Capital Account 4 Direct Investment $ ($119.44) 5 Portfolio Investment $ ($79.28) 6 Other Investments $ ($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) 3-10
12 U.S. Balance of Payments Data Current Account Credits 1 Exports $1, Debits 2 Imports ($1,295.53) 3 Unilateral Transfers $6.13 ($45.01) Balance on Current Account ($166.80) Capital Account 4 Direct Investment $ ($119.44) 5 Portfolio Investment $ ($79.28) 6 Other Investments $ ($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) In 1997, the U.S. imported more than it exported, thus running a current account deficit of $166.8 billion. 3-11
13 U.S. Balance of Payments Data Current Account Credits 1 Exports $1, Debits 2 Imports ($1,295.53) 3 Unilateral Transfers $6.13 ($45.01) Balance on Current Account ($166.80) Capital Account 4 Direct Investment $ ($119.44) 5 Portfolio Investment $ ($79.28) 6 Other Investments $ ($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) During the same year, the U.S. attracted net investment of $ billion clearly the rest of the world found the U.S. to be a good place to invest. 3-12
14 U.S. Balance of Payments Data Current Account Credits 1 Exports $1, Debits 2 Imports ($1,295.53) 3 Unilateral Transfers $6.13 ($45.01) Balance on Current Account ($166.80) Capital Account 4 Direct Investment $ ($119.44) 5 Portfolio Investment $ ($79.28) 6 Other Investments $ ($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) Under a pure flexible exchange rate regime, these numbers would balance each other out. 3-13
15 U.S. Balance of Payments Data Current Account Credits 1 Exports $1, Debits 2 Imports ($1,295.53) 3 Unilateral Transfers $6.13 ($45.01) Balance on Current Account ($166.80) Capital Account 4 Direct Investment $ ($119.44) 5 Portfolio Investment $ ($79.28) 6 Other Investments $ ($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) In the real world, there is a statistical discrepancy. 3-14
16 U.S. Balance of Payments Data Current Account Credits 1 Exports $1, Debits 2 Imports ($1,295.53) 3 Unilateral Transfers $6.13 ($45.01) Balance on Current Account ($166.80) Capital Account 4 Direct Investment $ ($119.44) 5 Portfolio Investment $ ($79.28) 6 Other Investments $ ($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) Including that, the balance of payments identity should hold: BCA + BKA = - BRA ($166.80) + $ ($96.76) = $1.02= ($1.02) 3-15
17 Balance of Payments and the Exchange Rate Current Account Credits 1 Exports $1, Debits 2 Imports ($1,295.53) 3 Unilateral Transfers $6.13 ($45.01) Balance on Current Account ($166.80) Capital Account 4 Direct Investment $ ($119.44) 5 Portfolio Investment $ ($79.28) 6 Other Investments $ ($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) P S D Q Exchange rate $ 3-16
18 Balance of Payments and the Exchange Rate Current Account Credits 1 Exports $1, Debits 2 Imports ($1,295.53) 3 Unilateral Transfers $6.13 ($45.01) Balance on Current Account ($166.80) Capital Account 4 Direct Investment $ ($119.44) 5 Portfolio Investment $ ($79.28) 6 Other Investments $ ($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) Q Exchange rate $ As U.S. citizens import, they are supply dollars to the FOREX market P S D
19 Balance of Payments and the Exchange Rate Current Account Credits 1 Exports $1, Debits 2 Imports ($1,295.53) 3 Unilateral Transfers $6.13 ($45.01) Balance on Current Account ($166.80) Capital Account 4 Direct Investment $ ($119.44) 5 Portfolio Investment $ ($79.28) 6 Other Investments $ ($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) Q Exchange rate $ As U.S. citizens export, others demand dollars at the FOREX market P S D
20 Balance of Payments and the Exchange Rate Current Account Credits 1 Exports $1, Debits 2 Imports ($1,295.53) 3 Unilateral Transfers $6.13 ($45.01) Balance on Current Account ($166.80) Capital Account 4 Direct Investment $ ($119.44) 5 Portfolio Investment $ ($79.28) 6 Other Investments $ ($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) Q Exchange rate $ As the U.S. government sells dollars, the supply of dollars increases P S S 1 D
21 Balance of Payments Trends Since 1982 the U.S. has experienced continuous deficits on the current account and continuous surpluses on the capital account. During the same period, Japan has experienced the opposite. 3-20
22 Balance of Payments Trends 3-21
23 Balance of Payments Trends 3-22
24 Balance of Payments Trends Germany traditionally had current account surpluses. Since 1991 Germany has been experiencing current account deficits. This is largely due to German reunification and the resultant need to absorb more output domestically to rebuild the former East Germany. What matters is the nature and causes of the disequilibrium. 3-23
25 Balance of Payments Trends 3-24
26 End Chapter Three 3-25
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