Unit 5: Balance of Payments

Balance of Payments

• Measure 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 Payments are divided into three accounts 

• Current Account
• Capital/Financial Account
• Official Reserves account

Current Account 

• Balance of Trade or Net Exports
• Exports of Good/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 - income paid to foreign held U.S. assets.
• Ex: Interest payments on U.S. owned Brazilian bonds - interest payments on German owned U.S. Treasury bonds

Net Transfers

• Foreign Aid --> a debit to the current account
• Ex: Mexican immigrant workers send money to family in Mexico.

Capital/Financial Account

• the balance of capital ownership
• includes the purchase of both real and financial assets.
• Direct investment in the U.S. is a credit to the capital account. Ex: The Toyota Factory in San Antonio .
• Direct investments by U.S. firms/individuals in a foreign country are debits to the capital account. Ex: The Intel Factory, in San Jose, Costa Rica.
• 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. Ex: The United Arab Emirates sovereign wealth fund purchases a large stake in the NASDAQ.

Relationship between current and capital account

• Should ZERO each other out. 

If the current account has a negative balance (deficit), then the capital account should have a positive balance (surplus).

Official Reserves

• The foreign currency holdings of the U.S. Federal Reserve System.
• 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.
• Official Reserves 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 dollar exchange rate.

Balance of Trade:

• Goods Exports + Good Imports

Balance on Goods and Services:

• Goods Exports + Service Exports + Goods Imports + Service Imports

Current Account 

• Balance on goods and services + Net Investment + Net Transfers

Capital Account 

• Foreign Purchases + Domestic Purchases