Balance of Payments

• measure of money inflows and outflows between U.S. and Rest of the World ( ROW )
• system of accounting used for international trade
• credit ( in ) and debit ( out )
• inflow ( adding ) and outflow ( subtracting ) from account

3 Accounts

1. Current Account
2. Capital / Financial Account
3. Official Reserves Account

Double Entry Bookkeeping

• every transaction in the balance of pavements is recorded twice in accordance with standard accounting practice
• ex : always = 0 ; offset each other and should = 0 ( theoretically )
• ex : John Deere export $ 50 million
• credit $ 50 million to current account
• debit $ 50 million to capital / financial account

Current Account

• balance of trade or net exports
• exports of goods and services - imports of goods and services
• exports create a credit to balance of payments
• imports create a debit to balance of payments
• Net Foreign Income
• income earned by U.S. owned foreign assets - income paid to foreign held U.S. assets
• ex : interest payment to U.S. owned Brazilian bonds - interest payment to German owned U.S. Treasury bonds
• Net Transfer ( tend to be unilateral )
• foreign aid → a debit to the current account
• ex : Mexican migrant workers send money to family in Mexico

Capital / Financial Account

• balance of capital ownership
• includes purchase of both real and financial assets
• direct investment in U.S. is a credit to the capital account
• ex : Toyota Factory in San Antonio
• direct investment by U.S. firms / individuals in a foreign country are debits to the capital account
• ex : Intel Factory in San Jose, Costa Rica
• Purchase of Foreign financial assets represent debit of capital account
• ex : Warren Buffet buys stocks in Petrochina
• Purchase of domestic financial assets by foreigners represent a credit to the capital account
• ex : United Arab Emirates Sovereign Wealth Fund purchases a large stake in NASDAQ

Relationship between Current and Capital Account?

• Current and Capital Account MUST = 0 ( or cancel each other out )
• if the current account has a negative balance ( deficit ) , then the capital account should then have a positive balance ( surplus )
• ex : the constant net inflow of foreign financial capital to the U.S. ( capital account surplus ) is what enables us to import more than when we export ( current account deficit )

Official Reserves ( encompassing gold and reserves )

• foreign currency holdings of the U.S. Federal Reserves System
• when there is a balance of payments surplus the FED accumulates foreign currency and debits the balance of payments
• when there is balance of payments deficit the FED depletes its reserves of foreign currency and credits the balance of payments

Active v.s. Passive Official Reserves

• 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 with the U.S.