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Balance of Balance of Payments Payments Accounting Accounting

Balance of Payments Accounting. The Balance of Payments Recall the open economy accounting identity: Income = ExpendituresRecall the open economy accounting

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Balance of Balance of Payments Payments AccountingAccounting

The Balance of PaymentsThe Balance of Payments

• Recall the open economy accounting Recall the open economy accounting identity: Income = Expendituresidentity: Income = Expenditures

Y = C + I + G + NXY = C + I + G + NX• Trade Deficits imply NX< 0 Trade Deficits imply NX< 0 Therefore, Y- (C + I + G) = NX < 0Therefore, Y- (C + I + G) = NX < 0

Trade deficit countries are spending Trade deficit countries are spending more than they earn (borrowing from more than they earn (borrowing from the rest of the world)the rest of the world)

Balance of Payments Balance of Payments AccountingAccounting

• Anything that we buy or sell to the rest Anything that we buy or sell to the rest of the world must be paid for. of the world must be paid for.

• The current account (CA) tracks the flow The current account (CA) tracks the flow of goods and services between the US of goods and services between the US and the rest of the worldand the rest of the world

• The capital & financial account tracks The capital & financial account tracks the payments for those goods & the payments for those goods & services (KFA)services (KFA)

CA + KFA = 0CA + KFA = 0

The Current AccountThe Current Account• Any transaction that represents a flow of funds out of Any transaction that represents a flow of funds out of

the US is represented by debit (-). Transactions that the US is represented by debit (-). Transactions that represent a flow of money into the US are represented represent a flow of money into the US are represented by a credit(+)by a credit(+)• Net Exports of Goods and ServicesNet Exports of Goods and Services

Exports (+)Exports (+)Imports (-)Imports (-)

• Net Income From Abroad (NFP)Net Income From Abroad (NFP)Income Earned by US nationals abroad (+)Income Earned by US nationals abroad (+)Income earned by foreign nationals in the US (-)Income earned by foreign nationals in the US (-)

• Net Unilateral TransfersNet Unilateral TransfersPayments from foreign countries (+)Payments from foreign countries (+)Payments to foreign Countries (-)Payments to foreign Countries (-)

The US Current Account: The US Current Account: 2003 (in Millions of $s)2003 (in Millions of $s)

Exports of Goods, Services, and IncomeExports of Goods, Services, and IncomeGoods:Goods: $ 713,122 $ 713,122Services: Services: $ 307,381 $ 307,381Income Receipts:Income Receipts:

Investment Receipts: Investment Receipts: $ 291,354 $ 291,354Employee Compensation:Employee Compensation: $ 3,031 $ 3,031

Imports of Goods, Services and IncomeImports of Goods, Services and Income Goods:Goods: -$1,260,274-$1,260,274Services: Services: -$ 256,337-$ 256,337Income Receipts:Income Receipts:

Investment Receipts: Investment Receipts: -$ 252,573-$ 252,573Employee Compensation:Employee Compensation: -$ 8,533-$ 8,533

Net Unilateral Transfers:Net Unilateral Transfers: -$ 67,439-$ 67,439Current AccountCurrent Account :: -$530,668-$530,668

US ExportsUS Exports

Western Europe, 23%

South/ Central America, 8%

Pacific Rim, 26%

Mexico, 15%

Other, 5%

Canada, 23%

US ImportsUS Imports

Western Europe, 20%

South/ Cemtral America, 6%

Pacific Rim, 34%

Mexico, 11%

Other, 9%

Canada, 19%

The Capital & Financial The Capital & Financial AccountAccount

• Again, any transaction that represents Again, any transaction that represents funds flowing into (out of) the US are funds flowing into (out of) the US are credits (debits) in the KFAcredits (debits) in the KFA• Financial assetsFinancial assets

Foreign acquisition of US assets (+)Foreign acquisition of US assets (+)

US acquisition of foreign assets (-)US acquisition of foreign assets (-)

• Official Reserve AssetsOfficial Reserve AssetsForeign acquisition of US reserve assets (+)Foreign acquisition of US reserve assets (+)

US acquisition of foreign reserve assets (-)US acquisition of foreign reserve assets (-)

The US Capital & Financial The US Capital & Financial Account: 2003 (in Millions of Account: 2003 (in Millions of $s)$s)

Capital Account:Capital Account: -$ 3,079 -$ 3,079

US Owned Assets Abroad (Increase/Financial Outflow (-))US Owned Assets Abroad (Increase/Financial Outflow (-))

US Official Reserve Assets:US Official Reserve Assets: $ 1,523 $ 1,523US Government Assets:US Government Assets: $ 537 $ 537US Private Assets:US Private Assets: -$ 285,574 -$ 285,574

Foreign Owned Assets in the US (Increase/Financial inflow (+))Foreign Owned Assets in the US (Increase/Financial inflow (+))

Foreign Official Assets in the US: Foreign Official Assets in the US: $248,573 $248,573Foreign Private Assets in the US:Foreign Private Assets in the US: $580,600 $580,600

Capital And Financial Account:Capital And Financial Account: $542,680 $542,680

CA + KFA = -$530,668 + $542,680 = -$12,012CA + KFA = -$530,668 + $542,680 = -$12,012

Balance of Payments Balance of Payments AccountingAccounting

• Consider three transactions:Consider three transactions:1)1) Wal-Mart buys $100M worth of clothing from a Wal-Mart buys $100M worth of clothing from a

Chinese Manufacturer. Wal-Mart pays for the Chinese Manufacturer. Wal-Mart pays for the clothing by writing a check drawn off its account clothing by writing a check drawn off its account at Bank of America.at Bank of America.

2)2) Warren Buffet collects $50M in interest Warren Buffet collects $50M in interest payments from his financial investments payments from his financial investments overseas. The Payment is made by crediting overseas. The Payment is made by crediting Warren’s bank account in London.Warren’s bank account in London.

3)3) Microsoft sells $20M worth of software to the Microsoft sells $20M worth of software to the French government. They pay in cash. French government. They pay in cash.

Balance of Payments Balance of Payments AccountsAccounts

Current AccountCurrent AccountExports Exports

Goods: Goods: Services:Services:

ImportsImportsGoods:Goods:Services:Services:

Net Factor Income: Net Factor Income:

Net Unilateral Transfers:Net Unilateral Transfers: CA Balance:CA Balance:

Capital & Financial AccountCapital & Financial AccountForeign acquisition of US assets:Foreign acquisition of US assets:

US Treasuries:US Treasuries:Private Securities: Private Securities: FDI: FDI: Currency: Currency:

US acquisition of foreign assets:US acquisition of foreign assets: FDI:FDI:Foreign Securities: Foreign Securities:

Official Reserve AssetsOfficial Reserve AssetsForeign acquisition of US ORA:Foreign acquisition of US ORA:

US acquisition of foreign ORA:US acquisition of foreign ORA: KFA Balance:KFA Balance:

-$100M (1)-$100M (1)

$100M (1)$100M (1)

$50 (2)$50 (2)-$50 (2)-$50 (2)

$20M (3)$20M (3)

-$20M (3)-$20M (3)

-$30M-$30M

$30M$30M

Tsunami Relief AidTsunami Relief Aid

• President Bush recently authorized President Bush recently authorized $350M in aid for the Asian countries $350M in aid for the Asian countries affected by the Tsunami.affected by the Tsunami. • This will appear in the BOP accounts under This will appear in the BOP accounts under

unilateral transfers.unilateral transfers.• Assume we pay this transfer in cash (most Assume we pay this transfer in cash (most

likely we would pay by check)likely we would pay by check)

Balance of Payments Balance of Payments AccountsAccountsCurrent AccountCurrent AccountExports Exports

Goods: Goods: Services:Services:

ImportsImportsGoods:Goods:Services:Services:

Net Factor Income:Net Factor Income:Net Unilateral Transfers: Net Unilateral Transfers: --

$350M$350M

CA Balance:CA Balance: -$350M-$350M

Capital & Financial AccountCapital & Financial AccountForeign acquisition of US assets:Foreign acquisition of US assets:

US Treasuries:US Treasuries:Private Securities:Private Securities:FDI: FDI: Currency: Currency: $350M$350M

US acquisition of foreign assets:US acquisition of foreign assets: FDI:FDI:Portfolio Investment:Portfolio Investment:

Official Reserve AssetsOfficial Reserve AssetsForeign acquisition of US ORA:Foreign acquisition of US ORA:

US acquisition of foreign ORA:US acquisition of foreign ORA: KFA Balance: KFA Balance: $350$350

US Balance of PaymentsUS Balance of Payments

-160

-140

-120

-100

-80

-60

-40

-20

0

20

Jan-8

0

Jan-8

3

Jan-8

6

Jan-8

9

Jan-9

2

Jan-9

5

Jan-9

8

Jan-0

1

Current Account

US Balance of PaymentsUS Balance of Payments

-200

-150

-100

-50

0

50

100

150

200

250

Jan-8

0

Jan-8

3

Jan-8

6

Jan-8

9

Jan-9

2

Jan-9

5

Jan-9

8

Jan-0

1

Current AccountFKA

US Balance of PaymentsUS Balance of Payments

-200

-150

-100

-50

0

50

100

150

200

Jan-8

0

Jan-8

2

Jan-8

4

Jan-8

6

Jan-8

8

Jan-9

0

Jan-9

2

Jan-9

4

Jan-9

6

Jan-9

8

Jan-0

0

Jan-0

2

BOP

US Trade Weighted US Trade Weighted Exchange Rate Index Exchange Rate Index

5060708090

100110120130140

Jan-

85

Jan-

87

Jan-

89

Jan-

91

Jan-

93

Jan-

95

Jan-

97

Jan-

99

Jan-

01

Jan-

03

Balance of Payments and Balance of Payments and Exchange RatesExchange Rates

Should the Balance of Payments Accounts Should the Balance of Payments Accounts influence exchange rates?influence exchange rates? A BOP deficit (surplus) indicates that financial A BOP deficit (surplus) indicates that financial

assets flowing out of (into a) country. assets flowing out of (into a) country. Shouldn’t that indicate a currency Shouldn’t that indicate a currency depreciation?depreciation?

No really….the balance of payments is an No really….the balance of payments is an accounting statement. Given the pattern of accounting statement. Given the pattern of exchange rates, the BOP indicates the exchange rates, the BOP indicates the transactions that took place (Remember, by transactions that took place (Remember, by definition, BOP=0)definition, BOP=0)

US Trade AccountsUS Trade Accounts

00.20.40.60.8

11.21.41.61.8

2

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

Trillio

ns

of $

-20-1001020304050607080

Billions

of $ Exports

Imports

UnilateralTransfers

US Official Reserve US Official Reserve PositionPosition

-1.5

-1

-0.5

0

0.5

1

1.5

2

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002Billions

of $

Gold

US Official Reserve US Official Reserve PositionPosition

-30

-25

-20

-15

-10

-5

0

5

10

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

Billions

of $

Foreign Currency

US Foreign InvestmentUS Foreign Investment

-250

-200

-150

-100

-50

0

50

Billions

of $

FDI

PortfolioInvestment

Foreign Investment in the Foreign Investment in the USUS

-0.2

0

0.2

0.4

0.6

0.8

1

1.2

Trillio

ns

of $

Official Private

The US BOPThe US BOP

Consider an alternative form of the Consider an alternative form of the national income accounting national income accounting identity.identity.

Y = C + I + G + NX (Income = Expenditures)

- Y = C + S + T (Income = Outlays)

0 = I + (G-T) + NX – S

S = I + (G-T) + NX (Source of Funds = Use of Funds)

The US BOPThe US BOP

The US is running record trade deficits The US is running record trade deficits due to over consumption (US domestic due to over consumption (US domestic savings is low and the government deficit savings is low and the government deficit is large)is large)

Unlike past years, this trade deficit is NOT Unlike past years, this trade deficit is NOT being financed by foreign private being financed by foreign private investment in the US, but rather by investment in the US, but rather by central banks purchasing US government central banks purchasing US government debt…..this is potentially troubling!debt…..this is potentially troubling!