Balance of Payments

The Balance of Payments

• Measures of money inflows and outflows between the united states and the rest of the world (ROW).
• Inflows = credits
• Outflows = debits
• The balance of payment is divided into three accounts:
• Current account
• Capital/financial account
• Official reserves account

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
• Interest payments on U.S. owned foreign assets- Interest payments on German-owned U.S treasury bonds.
•  Net transfers (tend to be Unilateral)
•  Foreign aid- a debit to the current account.
•  Ex - 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 a debit to the capital account.
• Intel factory construction in Germany
• Purchase of foreign financial assets represents a Debit to the capital account. 
• Warren buffets buys stock in Petrochina.
• Purchase of domestic financial assets by foreigners represents a credit to the capital account.
• The UAE sovereign wealth fund purchases a large stake in the NASDAQ.

 Relationship between current and capital account

• Current account and capital account zero each other out.
• If current account has a negative balance (deficit) then capital account should have a positive balance (surplus).

 Official reserves

• Foreign currency holdings of the U.S. fed.
• When there is a balance of payments surplus, fed accumulates foreign currency and debits the balance of payments.
• When there is a balance of payments deficit, 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 transfer
4. Capital account = Foreign purchases + domestic purchases.