The Balance of Payments Basic Facts

BALANCE OF PAYMENTS ACCOUNTS CREDIT ITEMSDEBIT ITEMS (MONEY IN)(MONEY OUT) CAEXPORTSIMPORTS KACAPITAL CAPITAL INFLOWOUTFLOW

Current & Capital Accounts Balance of Payments = Balance of Payments = Balance on Current Account + Balance on Capital Account In short: BOP = CA + KA = 0 In short: BOP = CA + KA = 0 Therefore, CA = - KA Therefore, CA = - KA Except for statistical discrepancies Except for statistical discrepancies

Current Account Merchandise trade balance Service trade balance Net investment income Unilateral transfers

Capital Account Because KA = - CA, the huge CA surpluses of Japan & Europe are matched by huge KA deficits Because KA = - CA, the huge CA surpluses of Japan & Europe are matched by huge KA deficits The US has a huge KA surplus The US has a huge KA surplus

Capital Account Two major categories Two major categories Portfolio investment: short-term capital, bonds, securities, equity or stocks if no control involved Portfolio investment: short-term capital, bonds, securities, equity or stocks if no control involved Direct investment: equity if it involves some control of the company Direct investment: equity if it involves some control of the company

Current Situation Large capital account surpluses in the USA (and China) reflect high rates of return on capital and/or relatively low risk Large capital account surpluses in the USA (and China) reflect high rates of return on capital and/or relatively low risk The USA and China are attractive as destinations for capital investments relative to Europe and Japan The USA and China are attractive as destinations for capital investments relative to Europe and Japan Vietnam? Vietnam?

Pre-Crisis Southeast Asia Rapid economic growth => large KA surpluses Rapid economic growth => large KA surpluses CA deficits equally large CA deficits equally large Currency pegs to $US difficult, ultimately impossible to sustain Currency pegs to $US difficult, ultimately impossible to sustain High interest rates attracted even more capital High interest rates attracted even more capital

Why? Capital inflow => rapid money supply growth Capital inflow => rapid money supply growth Money supply growth => inflation & currency depreciation Money supply growth => inflation & currency depreciation Anti-inflation/depreciation policies limit M growth, but => higher interest rates Anti-inflation/depreciation policies limit M growth, but => higher interest rates Higher interest rates attract even more capital Higher interest rates attract even more capital