Balance-of-Payments Accounts and Net Financial Flows

Economic SummitsFred Thompson2 Financial Inflow Balance of Payments is a flow account, which consists of the current account and the capital and financial accountBalance of Payments is a flow account, which consists of the current account and the capital and financial account A flow of capital, real and/or financial, into a country, takes the form of increased purchases of domestic assets by foreigners and/or reduced holdings of foreign assets by domestic residents. Inflows are recorded as positive, or a credit, in the capital and financial account.A flow of capital, real and/or financial, into a country, takes the form of increased purchases of domestic assets by foreigners and/or reduced holdings of foreign assets by domestic residents. Inflows are recorded as positive, or a credit, in the capital and financial account. Each country also has an international balance sheet, which is a stock account which shows assets and liabilities abroad and foreign assets and liabilities at home -- Called the international investment positions accounts in the U.S. (the accumulated stocks of U.S.-owned assets abroad and of foreign-owned assets in the United States).Each country also has an international balance sheet, which is a stock account which shows assets and liabilities abroad and foreign assets and liabilities at home -- Called the international investment positions accounts in the U.S. (the accumulated stocks of U.S.-owned assets abroad and of foreign-owned assets in the United States). The net change in the international investment positions accounts from the beginning of one year to the end of the next is the net capital/financial flow for the yearThe net change in the international investment positions accounts from the beginning of one year to the end of the next is the net capital/financial flow for the year

Economic SummitsFred Thompson3 Exchange and Net Flows Exchange of Real Assets – exchange of goods and services for other goods and services or for financial claims (will give rise to a net change in financial claims if x≠m)Exchange of Real Assets – exchange of goods and services for other goods and services or for financial claims (will give rise to a net change in financial claims if x≠m) Exchange of Financial Assets – Exchange of financial claims for other financial claims (net financial claims are unchanged)Exchange of Financial Assets – Exchange of financial claims for other financial claims (net financial claims are unchanged) Hence, m-x = net capital flow, also = I-SHence, m-x = net capital flow, also = I-S [ignoring reporting errors and official settlements] [ignoring reporting errors and official settlements]

Economic SummitsFred Thompson4 Balance of Payments Statistics for the United States, 1966 (Amounts in millions of dollars) Sources of Foreign Exchange Exports of Goods and Services $43,142 Balance on goods, services, remittances, and pensions +$4065 Foreign Capital Flow, net $2,532 Balance of all of the above -$1357 Change in U.S. Reserve Assets $568 Change in Liquid Liabilities of Foreign Accounts $789. Uses of Foreign Exchange Imports of Goods and Services $38,063 Remittances and Pensions $1,015 U.S. Government grants, net $3,444 U.S. private Capital Flow, net $4,298 Errors and Omissions $210 Source: Federal Reserve Bulletin, April 1969, pp A70-71

The Balance of Payments Accounting System International Bookkeeping

Economic SummitsFred Thompson6 International Transactions Accounts (Balance of Payments) A quarterly statistical summary of transactions between U.S. and foreign residents organized into three major categories: –The current account –The capital account –The financial account

Economic SummitsFred Thompson7 Balance of Payments System of accounts which is a subset of the National Income and Production Accounts –A double-entry bookkeeping system. –Debit Entries: Transactions that generate a payment outflow (e.g., import). –Credit Entries: Transactions that generate a payment inflow (e.g., export).

Economic SummitsFred Thompson8 Balance of Payments The current account includes exports and imports of goods, services, income, and current transfers. –Goods –Services –Income Receipts and Payments –Unilateral Transfers

Economic SummitsFred Thompson9 Balance of Payments Goods: Exports and imports of tangible items. Services: Exports and imports of services, for example: –Typical business services such as banking and financial services, insurance, and consulting. –Tourism

Economic SummitsFred Thompson10 Balance of Payments Income Receipts: Includes items such as –Investment income on US-owned assets abroad. –Receipts of income on US direct investment abroad. –Government income receipts

Economic SummitsFred Thompson11 Balance of Payments Income Payments: Includes items such as –Investment income on foreign-owned assets in the United States. –Payments of income on foreign direct investment in the United States –US Government income payments

Economic SummitsFred Thompson12 Balance of Payments Unilateral Transfers: Includes items such as: –Government grants abroad –Private remittances –Private grants abroad

Economic SummitsFred Thompson13 Balance of Payments (2000)

Economic SummitsFred Thompson14 Balance of Payments The Financial Sector In June 1999, US capital account definitions were modified to bring them more in line with definitions recommended by the International Monetary Fund. Now there are two accounts: –The capital account includes capital transfers, such as debt forgiveness. –The financial account includes transactions for official assets, for U.S. Government assets other than official reserve assets, for direct investment, for portfolio investment, and for other investment.

Economic SummitsFred Thompson15 Balance of Payments The Financial Sector The new Capital Account includes items that were previously included in unilateral transfers, such as: –Debt forgiveness –Migrants’ transfers (as they leave the country). The new capital account is small for the US (< 0.1 percent of capital flows), but expected to grow.

Economic SummitsFred Thompson16 Balance of Payments The Financial Sector The Financial Account –Records international transactions in the financial sector –Includes portfolio and foreign direct investment –Includes changes in banks’ and brokers’ cash deposits that arise from international transactions.

Economic SummitsFred Thompson17 Balance of Payments The Financial Sector US-Owned Assets Abroad: Increase or decrease in US ownership of foreign financial assets. Foreign-Owned Assets in the US: Increase or decrease in foreign ownership of domestic assets. Reserve Assets: Primarily the assets of central banks.

Economic SummitsFred Thompson18 Balance of Payments The Financial Sector Portfolio Investment: Individual or business purchase of stocks, bond, or other financial assets or deposits. (An income strategy) Foreign Direct Investment: Purchase of financial assets that results in a 10 percent or greater ownership share. (A financial control strategy)

Economic SummitsFred Thompson19 Capital and Financial Account (2000)

Economic SummitsFred Thompson20 The Balance of Payments The Statistical Discrepancy

International Allocation of Capital

Economic SummitsFred Thompson22 Feldstein - Horioka Savings and Investment Relation Based on a closed economy income condition: y = c + i + g. Rearrange as: y - c - g = i.

Economic SummitsFred Thompson23 Feldstein - Horioka Rearranged as: y - c - g = i. Note that y - c - g equals savings, s. Then: s = i. In a closed economy, domestic investment is equal to domestic saving by definition, but is also correlated in practice, i.e., correlation coefficient is necessarily close to 1 in value.

Economic SummitsFred Thompson24 International Flow of Goods, Services, & Capital Domestic Savings and Investment & NFF National Income (GNY) = Consumption (C) + Savings (S)GNY National Spending (GNE) = Consumption (C) + Investment (I) GNY - GNE = S - I GNY - GNE = Exports (x) - Imports (m) S - I = x - m Net Foreign Investment = x - m

Economic SummitsFred Thompson25 Government Budget Deficits and NFF GNE = Household spending + Private I + Government spending = GNY - Private S - Taxes + Private I + Government spending GNE - GNY = Private (I - S) + GovDeficit/Surplus NFF = Private savings surplus - GovDeficit

US Balance of Payments

Economic SummitsFred Thompson27

Basic Premise Basic Premise A current account deficit must be financed by capital inflows, or it cannot be incurred in the first place

Over , U.S. current account deficits have averaged $183 billion per year. $4 trillion worth of assets have been transferred to foreign ownership. FACT

Economic SummitsFred Thompson30 Trade and Scale Variables I

Economic SummitsFred Thompson31 Scale Variables I U.S. monthly GDP: $1 trillion Monthly goods and services exports: $130 billion = 13%Monthly goods and services exports: $130 billion = 13% Monthly goods and services imports: $185 billion = 18.5%Monthly goods and services imports: $185 billion = 18.5% Balancing item: net capital flow: $55 billion = 5.5%Balancing item: net capital flow: $55 billion = 5.5%

Economic SummitsFred Thompson32 Scale Variables II U.S. GDP per worker: $84,000 per year Exports of $10,900 per yearExports of $10,900 per year Imports of $15,500 per yearImports of $15,500 per year

Foreign claims on U.S. assets now exceed U.S. claims on foreign assets by about $2.7 trillion. –Storing up purchasing power for the future –Private political risk insurance –Public political risk insurance Result:

International Investments (market value, end-2003) U.S. foreign investments: $7.9 trn U.S. foreign investments: $7.9 trn Foreign investments in U.S.: $10.5 trn Foreign investments in U.S.: $10.5 trn Net: -$2.7 trn Net: -$2.7 trn Much of this capital inflow has been portfolio investment. Some has been direct investment.

Foreign Direct Investment (market value, end-2003) U.S. DI abroad:$2.7 trillion U.S. DI abroad:$2.7 trillion Foreign DI in U.S.:$2.4 trillion Foreign DI in U.S.:$2.4 trillion Net: $0.3 trillion Net: $0.3 trillion

Economic SummitsFred Thompson36 Direct Investment Positions At current market value, $ trillion U.S. Direct Investment Abroad Foreign Direct Investment in U.S.

Economic SummitsFred Thompson37

Economic SummitsFred Thompson38