Unit 7- Balance Payments

Balance of Payments
The measure of money inflows and outflows between the US and the rest of the world (ROW)

• Inflows are referred to as credits
• Outflows are referred to as debits

The Balance of Payments is divided into 3 accounts.

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

Current Account
Balance of Trade or Net Exports

• Exports of Goods and Services (G&S)
• Exports create a credit to the balance of payments
• Imports create a debit to the balance of payments
• Net Foreign Income
• Income earned by US owned foreign assets - Income paid to foreign held US assets.
• Example: Interest payments on US owned Brazilian bonds - Interest payments on German owned US treasury bonds.
• Net Transfers (tend to be unilateral)
• Foreign aid ➝ a debit to the current account
• Example: Mexican migrant workers send money to family in Mexico.

Capital/Financial Account

The balance of capital ownership.

• Includes the purchases of both real and financial assets
• Direct investment in the US is a credit to the capital account.
• Ex. Toyota factory in San Antonio
• Direct investment by US 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 stocks 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
• The current account and the 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 balance (surplus)

Official Reserves

The foreign currency holdings of the US 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.
• The official reserves zero out the balance of payments.

Formulas

• Balance of trades
• Good exports + good imports
• Balance of Goods and Services
• (Goods exports + service exports) + (Goods imports + services imports)
• Current Account
• Balance of Goods and Services + Net investment income + Net transfers
• Capital Account
• Foreign purchases of assets + US purchase of assets
• Official Reserves
• Current Account + Capital Account