The Balance of Payments

• measure of money inflows and outflows between the United States and the rest of the world (ROW)

     - inflow = credit

     - outflow = debit

• balance of payments is divided to 3 parts 

       - current account

       - capital/financial account 

       - official reserves account 

Double entry bookkeeping 

• every transaction in the balance of payments is recorded twice in accordance with standard account practice

      - Ex. U.S. Manufacturer, John Deere, exports $50 million worth of farm equipment to Ireland

             . A credit of $50 mil. To the current account 

             . A debit of $50 mil to the capital/financial account l

      - notice that the two transactions offset

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 debut to the balance of payments 

• net foreign income 

       - income earned by U.S. Owned foreign assets - income paid to foreign held US assets

      - ex. Interest payments on US owned Brazilian bonds - interest payments in German owned US treasury bonds

• net transfers ( lend to be unilateral)

      - foreign aid -> a debut to the current account 

Capital/financial account 

• the balance of capital ownership

• includes the purchase of both real and financial assets 

• direct investments in the United States is a credit to the capital account 

      - ex. The Toyota factory in San Antonio

• direct investment by U.S. Firms/individuals in a foreign country are debits to the capital account 

• purchase of foreign financial assets represents a debit to the capital account 

      - ex. Warren buffet buys stock in petrochina

• 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 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 account (surplus)

Official reserves 

• the foreign currency holding of the United States federal reserve system

• when there is a balance of payments surplus. Des 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 balances of payments 

• the official reserves should zero out the balance of payments 

Active v passive official reserves 

• the United States is passive in its use of official reserves. It does not seek to manipulate the dollars 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 with the United States 

•Goods and service exports - goods and services imports

• unofficial way of trade: good exports + goods imports 

• informal: Goods imports + service imports 

• Current account = balance of trade + net investments + net transfers 

• capital account = foreign purchases of U.S. Assets + US purchases of assets abroad 

• official reserves = Capitol account balance + current account balance