The Balance of Payments 2 Chapter Objective: This chapter serves to introduce the students to the meaning, and measurement of the balance of payments. And defines the concepts of deficit and surplus in a nation’s balance of payments.

Chapter 2 Balance of Payments 1.Introduction :Meaning 2.Balance of Payments Accounting principles (1)Credits and Debits (2)Double-Entry Bookkeeping 3. International Transactions 4.Accounting Balances and Disequilibrium in International Transactions 5.Balance of Payments Trends in Major Countries

(1)Meaning The Balance of Payments is the statistical record of a country’s international transactions over a certain period of time presented in the form of double-entry bookkeeping. A summary statement, a few major categories

(1)Meaning N.B. International transaction Resident (when we say “a country’s balance of payments” we are referring to the transactions of its citizens and government.) A certain or a particular period of time

(1)Meaning For example: in one year in the U.S. Following international transaction A U.S. firm exports $500 of goods to be paid for three months. A U.S. resident visits London and spent $200 on hotels, meals and so on. The U.S. government gives a U.S bank balance of $100 to the government of a developing nation as part of the U.S. aid program. A U.S. resident purchases a foreign stock for $400. A foreign investor purchases $300 of U.S. T-bills.

(1)Meaning Goods Services Unilateral transfers Capital,net Total Credit(+) Debit(-) $500 $ $500

2.Balance of Payments Accounting Principles (1)Credits and Debits Credit: any transaction that results in receipt from foreigners, recorded with a positive sign “+” Debt: any transaction that give rise to a payment to foreigners, recorded with a negative sign “-” Capital inflows:an increase in foreign assets in the nation or a reduction in the nation’s assets abroad

(2) Double-Entry Bookkeeping Example1:Suppose that Boeing Corporation exported a Boeing 747 aircraft to Japan Airlines for $50million, and that Japan pays from its dollar bank account kept with Chase Manhattan Bank in New York City. Then the receipt of $50 million by Boeing will be recorded as a credit(+), which will matched by a debit(-) of the same amount representing a reduction of the U.S. bank’s liabilities.

(2) Double-Entry Bookkeeping Example 2: Boeing imports jet engines produced by Rolls-Royce for $30million, that Boeing makes payment by transferring the funds to a New York bank account kept by Rolls-Royce. Payment by Boeing will be recorded as a debit(-), whereas the deposit of the funds by Rolls-Royce will be recorded as a credit (+).

(2) Double-Entry Bookkeeping Example 3: Suppose that Ford acquires Jaguar, a British car manufacturer, for $750 million, and that Jaguar deposits the money in Barclays Bank in London, which,in turn,uses the sum to purchase U.S treasury notes. In this case,the payment of $750million by Ford will be recorded as debit(-), Barclays’ purchase of the U.S. Treasury notes recorded as a credit(+)

Transactions (million) Credit Debit Boeing’s export $50 Withdrawal from -$50 U.S. bank Boeing’s import -$30 Deposit at U.S.bank $30 Ford’s acquisition of Jaguar -$750 Barclays’ purchase $750 of U.S. securities

3. International transactions The balance of payments accounts are those that record all transactions between the residents of a country and residents of all foreign nations. They are composed of the following: (1)The Current Account (2)The Capital Account (3)Statistical Discrepancy (4)The Official Reserves Account

(1)The Current Account Includes all imports and exports of goods and services. Includes unilateral transfers of foreign aid. If the debits exceed the credits, then a country is running a trade deficit.

(2)The Capital Account The capital account measures the difference between U.S. sales of assets to foreigners and U.S. purchases of foreign assets. The U.S. enjoys about a $382 billion capital account surplus—absent of U.S. borrowing from foreigners, this “finances” our trade deficit. The capital account is composed of Foreign Direct Investment (FDI), portfolio investments and other investments.

(3)Statistical Discrepancy There’s going to be some omissions and misrecorded transactions—so we use a “plug” figure to get things to balance. Exhibit shows a discrepancy of $11 billion in 2001.

(4)The Official Reserves Account Official reserves assets include gold, foreign currencies, SDRs, reserve positions in the IMF.

4.Accounting Balances and Disequilibrium in International Transactions Autonomous transactions: items above the line All transactions in the current and capital account Accommodating transactions: items below the line the official reserve account

4.Accounting Balances and Disequilibrium in International Transactions In BCA and BKA, If debit >credit deficit If credit>debit surplus where BCA = balance on current account BKA = balance on capital account BRA = balance on the reserves account BCA + BKA + BRA = 0 Under a pure flexible exchange rate regime, BCA + BKA = 0

U.S. Balance of Payments Data2001(in billion) CreditsDebits Current Account 1 Exports$1,282 2 Imports ($1,626) 3 Transfers Unilateral($49) Balance on Current Account ($393) Capital Account 4 Direct Investment$131($128) 5 Portfolio Investment$400($95) 6 Other Investments$218($143) Balance on Capital Account $382 ($11) 7 Statistical Discrepancies Overall Balance $0 Official Reserve Account ($0)

U.S. Balance of Payments Data CreditsDebits Current Account 1Exports$1, Imports ($1,295.53) 3Unilateral Transfers$6.13($45.01) Balance on Current Account ($166.80) Capital Account 4Direct Investment$107.93($119.44) 5Portfolio Investment$387.62($79.28) 6Other Investments$194.95($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) In 1997, the U.S. imported more than it exported, thus running a current account deficit of $166.8 billion.

U.S. Balance of Payments Data CreditsDebits Current Account 1Exports$1, Imports ($1,295.53) 3Unilateral Transfers$6.13($45.01) Balance on Current Account ($166.80) Capital Account 4Direct Investment$107.93($119.44) 5Portfolio Investment$387.62($79.28) 6Other Investments$194.95($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) During the same year, the U.S. attracted net investment of $ billion—clearly the rest of the world found the U.S. to be a good place to invest.

CreditsDebits Current Account 1Exports$1, Imports ($1,295.53) 3Unilateral Transfers$6.13($45.01) Balance on Current Account ($166.80) Capital Account 4Direct Investment$107.93($119.44) 5Portfolio Investment$387.62($79.28) 6Other Investments$194.95($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) Under a pure flexible exchange rate regime, these numbers would balance each other out. U.S. Balance of Payments Data

CreditsDebits Current Account 1Exports$1, Imports ($1,295.53) 3Unilateral Transfers$6.13($45.01) Balance on Current Account ($166.80) Capital Account 4Direct Investment$107.93($119.44) 5Portfolio Investment$387.62($79.28) 6Other Investments$194.95($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) In the real world, there is a statistical discrepancy. U.S. Balance of Payments Data

CreditsDebits Current Account 1Exports$1, Imports ($1,295.53) 3Unilateral Transfers$6.13($45.01) Balance on Current Account ($166.80) Capital Account 4Direct Investment$107.93($119.44) 5Portfolio Investment$387.62($79.28) 6Other Investments$194.95($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) Including that, the balance of payments identity should hold: BCA + BKA = - BRA ($166.80) + $ ($96.76) = $1.02= –($1.02)

U.S. Balance of Payments Data CreditsDebits Current Account 1Exports$1, Imports ($1,295.53) 3Unilateral Transfers$6.13($45.01) Balance on Current Account ($166.80) Capital Account 4Direct Investment$107.93($119.44) 5Portfolio Investment$387.62($79.28) 6Other Investments$194.95($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) Q P Exchange rate $ D S

U.S. Balance of Payments Data CreditsDebits Current Account 1Exports$1, Imports ($1,295.53) 3Unilateral Transfers$6.13($45.01) Balance on Current Account ($166.80) Capital Account 4Direct Investment$107.93($119.44) 5Portfolio Investment$387.62($79.28) 6Other Investments$194.95($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) As U.S. citizens import, they are supply dollars to the FOREX market. D S Q P

CreditsDebits Current Account 1Exports$1, Imports ($1,295.53) 3Unilateral Transfers$6.13($45.01) Balance on Current Account ($166.80) Capital Account 4Direct Investment$107.93($119.44) 5Portfolio Investment$387.62($79.28) 6Other Investments$194.95($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) As U.S. citizens export, others demand dollars at the FOREX market. Exchange rate $ P Q D S U.S. Balance of Payments Data

CreditsDebits Current Account 1Exports$1, Imports ($1,295.53) 3Unilateral Transfers$6.13($45.01) Balance on Current Account ($166.80) Capital Account 4Direct Investment$107.93($119.44) 5Portfolio Investment$387.62($79.28) 6Other Investments$194.95($227.2) Balance on Capital Account $ Statistical Discrepancies ($96.76) Overall Balance $1.02 Official Reserve Account ($1.02) As the U.S. government sells dollars, the supply of dollars increases. Exchange rate $ D S S1S1 Q P U.S. Balance of Payments Data

China’s Balance of Payments Data(2005) CreditsDebits Current Account 1Exports$ Imports ($74.041) 3Unilateral Transfers$2.773($0.349) Balance on Current Account Capital Account 4Direct Investment$8.607.($1.825) 5Portfolio Investment$2.199($2.693) 6Other Investments$30.673($31.075) Balance on Capital Account $ Statistical Discrepancies ($1.676) Overall Balance $ Official Reserve Account ($20.701) $16.081

5.Balance of Payments Trends Since 1982 the U.S. has experienced continuous deficits on the current account and continuous surpluses on the capital account. See case study13.3, 13.4 During the same period, Japan has experienced the opposite.see case study13.3

5.Balance of Payments Trends Germany traditionally had current account surpluses. Since 1991 Germany has been experiencing current account deficits. This is largely due to German reunification and the resultant need to absorb more output domestically to rebuild the former East Germany. What matters is the nature and causes of the disequilibrium.

Key words Balance of payments Credit Debit Capital inflows and outflows Double-entry bookkeeping Capital account Current account FDI Official reserve assets Official reserve account Surplus and deficit

Discuss the short term and long term effects of foreigners’ portfolio investment on the balance of payments 1.Since the early 1980s, foreign portfolio investors have purchased a significant portion of U.S. Treasury bond issues.

Discuss what policy actions might have remained the increasing of economy. 2.China experienced large scale trade surplus, and a major currency parity. Document the trend in China’s key economic indicators, such as the balance of payments, the exchange rate and foreign reserve holdings, during the period 2004 through

Explain how each of the following transactions will be classified and recorded in the U.S. balance of payments 1)A Japanese insurance company purchases U.S. Treasury bonds and pays out of its bank account kept in New York City. 2)A U.S citizen consumes a meal at a restaurant in Paris and pays with her American Express card.

3)An Indian immigrant living in Los Angeles sends a check drawn on his LA bank account as a gift to his parents living in Bombay. 4)A U.S. computer programmer is hired by a British company for consulting and gets paid from the U.S. bank account maintained by the British company.