chapter 10 balance of payment

Balance of Payments

C h a p t e r 1 0

International FinanceInternational Economics

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Content

I. Balance of payment

II. Double-entry accounting

III. International payment process

IV. Balance of Payments Structure

a. Current Account

b. Capital and Financial Account

V. U.S. Balance of Payments

VI. Current account deficit and surplus2

a. Current account deficit problem

b . Continue to run current account deficit?

c. Net Foreign Investment and the Current

Account Balance

d. Business Cycles, Economic Growth, and the

Current Account

VII. Global saving glut

VIII. Balance of International Indebtedness

a. United Stated as a Debtor Nation

IX. Summary3

I. Balance of Payments

o Definition

Balance of payments is a record of the economic transactions between the residents of one country and the rest of the word.

An international transaction is an exchange of goods, services or assets between businesses, individuals, and governments of one country and those of another.

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II. Double-Entry Accounting

o All transaction are either credit or debit transaction.

o Credit transaction – receipt of payment from foreigner.

• merchandise exports

• transportation & travel receipts

• Income received from investments abroad

• gifts received from foreign residents

• Aid received from foreign governments

• investment in U.S. by overseas residents5

o Debit transactions - leads to payments to foreigners.

• Merchandise imports

• Transportation and travel expenditures

• Income paid on investments of foreigners

• Gifts to foreign residents

• Aid given by the U.S government

• Overseas investments by U.S residents

II. Double-Entry Accounting

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III. International Payments Process210,000 won TV

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IV. Balance of Payment Structure

o Current account - refers to the monetary value of

international flows associated with transactions in goods,

services, income flows and unilateral transfers.

o Merchandise trade balance – includes all goods that

U.S. exports (Credit) or imports (Debit).

o surplus (positive balance) implies exports > imports

o deficit (negative balance) implies imports > exports

a. Current account

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IV. Balance of Payment Structure

o Goods and services balance – added services to the

merchandise trade balance

o Unilateral transfers – include transfers of goods &

services (gifts in kind) or financial assets (money gifts)

between the U.S. and the rest of the world.

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b. Capital and Financial Account

o Capital and Financial Account– all international

purchases and sales of real estate, corporate stocks

and bonds, government securities and commercial

bank deposits.

IV. Balance of Payment Structure

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o examples:

• Direct investment – residents of one country acquire 10% or more of business in another country.

• Securities – private sector purchases of short-and long-term debt securities.

• Bank claims – loans, overseas deposits, acceptances, foreign commercial paper.

• Bank liabilities – demand deposits, NOW accounts, savings deposits, CDs.

o Official settlements transactions – movement of financial assets among official holders such as the U.S Fed and Bank of England.

IV. Balance of Payment Structure

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V. U.S. Balance of Payments - 2006(Billions of Dollars)

oCurrent Account:

Merchandise trade balance -$838.3Exports 1,023.1Imports - 1,862.4

Services balance 79.8Travel and transportation, net -10.6Military transactions, net -14.0Royalties and license fees , net 35.9Other services, net 68.5

Goods and Services balance -758.5

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Income Balance 36.6

Investment income, net 43.1

Compensation of employees, net -6.5

Unilateral transfers balance -89.6

U.S Government grants -27.2

U.S Government pensions -6.5

Private remittances -55.9

Current account balance -811.5

oCapital and Financial AccountCapital account transactions, net -$3.9

Financial account transactions, net 833.4

Statistical discrepancy -18.0

Balance on capital and financial account 811.5

V. U.S. Balance of Payments - 2006(Billions of Dollars)

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o Trade deficits can decrease value of dollar and decreasing U.S. purchasing power abroad.

o Trade deficits can also decrease employment in domestic industries but are offset by capital inflows generating employment in other industries

V. U.S. Balance of Payments 1980- 2006(Billions of Dollars)

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VI. Current account deficit and surplus

o Current account and capital & financial account are not related, when one is in surplus the other must be in deficit.

o Current account surplus means an excess of exports over imports of goods and services, investment income and unilateral transfers.

o Current account deficit implies an excess of imports over exports of goods and services, investment income and unilateral transfers.

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a. Current Account Deficit a Problem

o A current account deficit has little to do with foreign trade practices or any inherent inability of a country to sell goods in world market.

o Current account deficits are not efficiently reversed by trade policies that attempt to alter the levels of import or exports.

o Resulting debt is less problematic if funds are used for investment spending rather than consumption spending.

VI. Current account deficit and surplus

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b. Continuous to run Current Account Deficit?

o no economic reason why current account deficit cannot

continue indefinitely.

o From 1820-1875, the U.S ran current account deficits

almost continuously.

o Two principles to reduce the deficit, first U.S has an

interest in polices that stimulate for foreign growth and

second, increased national saving than through reduced

domestic investment

VI. Current account deficit and surplus

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c. Net Foreign Investment and the Current Account Balance

o current account surplus => excess of exports over imports => net supplier of funds (lender) => improves net foreign investment position

o current account deficit => excess of imports over exports => net demander of funds from abroad=> decline in net foreign investment position

o net borrowing:

(G - T) + (I – S) = Current Account Deficit Government Private Private (net borrowing)

Deficit Investment Saving

VI. Current account deficit and surplus

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d. Business Cycles, Current Account & Economic Growth

o Business cycles => if rapid growth and employment => growing trade and current account deficits. And if slow output and employment growth => growing surpluses.

o short run: recession => current account surplus• Saving and investment tend to fall.• imports tend to fall with overall consumption and

investment demand.

VI. Current account deficit and surplus

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d. Current Account & Economic Growth

VI. Current account deficit and surplus

o long run: rapid economic growth leads to current account deficits, whereas those with weaker economic growth have long-run current account surpluses.

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VII. Global saving glut

o Excess global savings hold interest rate down which allowed U.S. borrowing from:• corporate profits in Japan• savings greater than investment in China or

China’s investment rate was the world’s highest by far, but its saving rate was even greater.

• oil profits in the Saudi Arabia and Russia

o Surge in savings, lowered interest rates have the potential to boost productivity and creates the problem of Fed’s control of economy.

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o U.S. absorbed an estimated 75% of excess

world supply of savings in 2006

o Concern: reduction in such investment in the

U.S. will cause significant depreciation in the

dollar and a substantial increase in interest

rates

VII. Global saving glut

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VIII. Balance of international indebtedness

o Definition – a statment that summarizes a country's stock of

assets and liabilities against the rest of the world at a fixed point

in time.

o The balance of international indebtedness looks at short-and

long-term investment positions of both private and goverment

sectors of the economy.

o Indicates sensitive items, such as short term debt held by

foreigners which could be liquidated quickly, straining finances

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VIII. Balance of international indebtedness

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a. U.S. as Debtor Nation

o net creditor – U.S. claims on foreigners exceed

foreign claims on U.S.

o net debtor – foreign claims on U.S. exceed U.S.

claims on foreigners

o reasons U.S. is net debtor: foreign investors placed

more funds in the U.S. because of economic growth

and political stability

VIII. Balance of international indebtedness

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