1. TRADE AND BALANCE OF PAYMENTS
THE ACCOUNTS

2. Introduction
Balance of payments = current account + capital account + financial account
The international transactions of a nation are divided into three separate accounts
Current account: record of the goods and services into and out of the country
Financial account: record of the flow of financial capital to and from the country
Capital account: record of some specialized types of relatively small capital flows

3. Merchandise Trade Balance
Let’s first define merchandise trade balance—part of the current account; measures the difference between exports and imports of goods, but not services
Trade deficit: negative merchandise trade balance
Trade surplus: positive merchandise trade balance
In 2002, the U.S. had a trade deficit of $418.0 billion
However, the U.S. had a large trade surplus in services ($64.8 billion)

4. Current Account
Current account balance: measures all current, non-capital transactions between a nation and the rest of the world
Current account has three main components:
Goods and services = the value of goods and services exported – the value of imports
Investment income = income from investments abroad – income paid to foreigners on their U.S. investments
Unilateral transfers = any foreign aid or other transfers received by foreigners – that given to foreigners

5. Components of the Current Account
IF A NATION’S PEOPLE INVEST IN ANOTHER NATION, THEN INCOME FROM FOREIGN NATION STOCKS, BONDS, DEPOSITS, COMMERCIAL PAPER IS A CREDIT IN THE CURRENT ACCOUNT --- FOREIGN INVESTMENTS IN ANOTHER NATION ARE A DEBIT TO THE CURRENT ACCOUNT

6. The U.S. Current Account Balance, 2005 (Millions of Dollars)

7. U.S. Current Account Balance, 1950–2005

8. U.S. current account deficit looks ominous
However, the deficit is not a sign of weakness: U.S. economic boom of the 1990s increased the demand for imports, while sluggish growth abroad limited the expansion if U.S. exports
But the U.S. deficit is not sustainable in the long term
With $ down in value– exports increase --- but oil payments paid out increase
TRADE IN GENERAL AROUND THE WORLD IS DOWN IN THIS CURRENT DEPRESSION

9. Financial Account
Financial account: record of the flow of financial capital to and from a country
Two main components
Net changes in the country’s assets abroad
Net changes in the foreign-based assets in the country

10. Capital Account
Capital account: record of the transfers of specific types of capital, such as
Debt forgiveness
Personal assets that migrants take with them abroad
The transfer of real estate and other fixed assets, such as a military base or an embassy building

11. U.S. BALANCE OF ACCOUNTS
IN $MILLIONS 2005
Balance of payments = current account + capital account + financial account

12. Three accounting caveats
Both the capital account and the financial account present the flow of assets during the year in question and not the stock of assets that have accumulated over time
All flows are net changes (differences between assets sold and bought, for example) rather than gross changes
As long as the capital account balance is zero, financial account balance = current account balance, but with the opposite sign

13. current acc. Capital acc. Financial acc
Statistical discrepancy: the amount by which the sum of the current, capital, and financial accounts is off the total of zero
Statistical discrepancy is calculated as the sum of the current, capital, and financial accounts, with the sign reversed
In 2005, U.S. statistical discrepancy was [(–1)  (–791,508 – 4, ,499)] = 10,410
current acc Capital acc. Financial acc
RECORDS ARE INCOMPLETE--- HENCE THE PLACE OF THE STATISTICAL DISCREPANCY

14. Financial Flows
Financial flows originate in the public and private sectors
Some financial flows are very mobile: move quickly in response to investor expectations
Mobility of financial flows brings economic volatility
Upon sudden financial outflows, a country can sink into a financial crisis
The volatility of financial flows has increased concern about the various types of flows

15. Five Types of U.S. Financial FLOWS
U.S. assets abroad (outflows)
Official reserve assets: gold bullion, IMF’s special drawing rights (SDRs), major currencies
Government assets: loans to foreign governments, rescheduled loans to foreign governments, payments received on outstanding loans, changes in non-reserve currency holdings (e.g., Mexican pesos)
Private assets: direct investment, foreign securities, loans to foreign firms and banks

16. Foreign assets in the U.S. (inflows)
Foreign official assets: gold bullion, IMF´s special drawing rights (SDRs), major currencies
Other foreign assets: direct investment, U.S. securities and currency, loans to U.S. firms and banks

17. 2005 U.S. FINANCIAL ACCOUNT

18. THE LARGEST SHARE OF FINANCIAL FLOWS IS PRIVATE ASSETS
Private assets: foreign direct investment (FDI), foreign securities, loans to foreign firms and banks
FDI: tangible items: real estate, factories, warehouses, transportation facilities, and other physical (real) assets
Securities and loans can be considered foreign portfolio investment—paper assets such as stocks and bonds
Both FDI and foreign portfolio investment give their holders a claim in a foreign economy’s future output
However, holders of FDI have longer time horizons

19. PRIVATE FLOWS IN THE
U.S. FINANCIAL ACCOUNT
2005

20. However, current account transactions were less heavily regulated
Until recently, most nations limited the movement of financial flows related financial account transactions across their borders
The European Union liberalized financial flows between member countries only in 1993
However, current account transactions were less heavily regulated
The movement toward open markets over the 1980s and 1990s has resulted in the lifting of controls on financial flows
Developing countries, in particular, have liberalized financial account transactions in order to get access to financial capital for development
Although financial flows can be volatile, economists agree that free flows are best for economic efficiency

21. The Current Account and the Macroeconomy
Balance of payments help us to understand the broader implications of current account imbalances and how to tame current account deficits
Balance of payments give cues how nations can avoid crises brought by volatile financial flows and how they can minimize the damage of financial crises if such occur

22. National Income and Product Accounts
National income and product accounts: accounting system for a country’s total production and income
Two fundamental concepts of the system:
Gross domestic product (GDP): the value of all final goods and services produced within a country´s borders during a period of time (usually a year) {add up value of goods and services}
Gross national product (GNP): the value of all final goods and services produced by the labor, capital, and other resources of a country within the country as well as abroad {here you add up value of goods & services in country as well as abroad for a nation}

23. GNP = GDP + foreign investment income received – investment income paid to foreigners + net unilateral transfers

24. Understanding National Accounts
Interplay of the variables of the national accounts
GDP = C + Id + G + X – M Using Id = domestic investment for I
GNP = GDP + (net foreign investment income + net transfers)
GNP = (C + Id + G) + (X – M + net foreign investment income + net transfers)
GNP in terms of current account balance: GNP = C + Id + G + CA = C + Id + G + (X – M) FOR CA ≈ (X – M)
GNP is also the value of income received: GNP = C + S + T
Since 4 and 5 are equivalent definitions of GNP, C + Id + G + CA = C +S + T
Id + G + CA = S + T
S + (T – G) = Id + CA = Id + (X – M)

25. The following figure illustrates the equation in the U.S. in 1991–2005
S + (T – G) = Id + CA summarizes the current account balance, investment, and public and private savings in the economy CA=S+(T-G) -Id
DEBT = (T – G)
The following figure illustrates the equation in the U.S. in 1991–2005
IF S IS LOW AND (T-G)< YOU CAN SEE THE EFFECT ON CA BECAUSE OF THE -Id

27. International Debt
Current account deficits must be financed through inflows of financial capital (loans)
Loans from abroad add to a country’s stock of external debt and generate debt service obligations --- CA DEFICIT = NET BORROWER
All countries, rich and poor, have external debt

28. Unsustainable debt occurs for numerous reasons:
In many low and middle income countries, external debt leads to financial problems
Unsustainable debt occurs for numerous reasons:
Falling commodity prices
Natural disasters
Corruption
Foreign lending behavior

29. DEBT IN 2005
SOME OF THE TOP NATIONS
IN DEBT

30. The International Investment Position
If a country runs a current account deficit, it borrows from abroad and increases its indebtedness
If a country runs a current account surplus, it lends to foreigners and reduces its overall indebtedness
International investment position = domestically owned foreign assets –foreign owned domestic assets

31. A positive international investment position = the home country could sell all its foreign assets and have more than enough revenue to purchase all the domestic assets owned by foreigners
In 2005, the U.S. international investment position = $11,079 billion – $13,625 billion = –$2,546 billion