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International Finance 407
Balance of Payments
Zhen HuoTeaching Fellow: Max Perez Leon
Yale University
Wednesday 31st August, 2016
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Motivation: International Economics
The study of micro & macro issues in an inderdependent world
◦ dependence through trade and capital flows
◦ International Finance mostly interested in the second whereas InternationalTrade in the first
This class will study important large-scale economic problems
◦ focus on capital flows, but need to be understood in conjuction with trade flows
◦ how these flows affect economic activity and the economic fate of countries
◦ recent global events: macroeconomic imbalances, debt crises, macroeconomiccomovement, currency crises, etc
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This Class
Balance of Payments Accounting
Current Account and National Accounting
Global Imbalances
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Balance of Payments Accounting: Records International Transactions
Current Account: records trade transactions and income from abroad
◦ Exports - Imports + International income receipts - Payments to foreigners
Japanese TV imported: −
an American CEO’s income from trip to Germany to advise a company: +
in both cases there is an offseting entry in the financial account
Financial Account: records net change in ownership of assets
◦ Increase in foreign ownership of domestic assets - Increase in domesticownership of foreign assets
giving dollars to Japanese companies: +
receive Euros from Germany companies: −
purchasing a residence abroad: import of assets and export of dollars for the purchase
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Fundamental Balance of Payments Identity
Balance of Payment: Current Account+Financial Account=0
◦ every movement of goods is offset by a balancing movement of financial asset
◦ a U.S. retailer imports $1 of Japanese TVs
US current account goes down by $1
a corresponding flow of money to the Japanese producer and the US financial accountincreases by $1
Current Account and the Financial Account in more detail
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Current Account
Current Account = Trade Balance + Net income from abroad
= Trade Balance+ Income Balance + Net Unilateral Transfers
Trade Balance
◦ Merchandise: Exports - Imports of goods
◦ Services: Exports - Imports of services
Income Balance
◦ Net investment income: Net income receipts from assets
◦ Net international compensation to employees: Net compensation of employees
Net Unilateral Transfers
◦ Gifts or grants received from foreign countries minus gifts or grants to foreigncountries
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Current Account: Examples
Trade Balance
◦ Merchandise: Imports of Samsung from Korea −, Export of ipod to France +
◦ Services: Drinks in Paris bars −, German tourist watching Broadway +
Income Balance
◦ Net compensation to employee: stipend paid to foreign students in US −
◦ Net investment income: dividends for US bondholders of German stocks +
Net Unilateral Transfers
◦ Charity gift to Haiti −, Americans send money to relatives in Europe −
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Current Account
Current Account
Figure: US Current Account, 2012. Source: Bureau of Economic Analysis
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Trade Balance and the Current Account
In most countries, trade balance is the main driver of the current account
◦ except in cases where debt forgiveness and direct transfers are large amounts
Figure: Trade Balance and Current Account as a Fraction of GDP. Source, IMF
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US Current Account and Trade Balance to GDP
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Trade Balance and the Current Account
Figure: Trade Balance and Current Account Balance across Countries
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Current Account and National Accounting
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National Accounting and the Current Account
National Accounting
GDP = Gross National Expenditure + Trade Balance
= Consumption+Investment+Government Spending + Trade Balance
GNI (Gross National Income)=GDP + Income Balance
GNDI (Gross National Disposable Income)=GNI+Net Unil. Transfers
Current account
GNDI=Consumption+Investment+Government Spending+Current Account
National Saving: S = Y − C −G = I + CA
Current account: CA = S − I
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Current Account, Savings and Investment
CA surplus: the country saves more than it’s investment needs
◦ wealth increases
CA deficit: the country saves less than it’s investment needs
◦ wealth decreases
Non-zero CA: changes in Net International Investment Position (NIIP)
◦ NIIP=foreign assets owned by US residents - US assets owned by foreigners
◦ CA is a flow NIIP is a stock. They are related through
CA = ∆NIIP + ∆valuation
◦ we will return to the change of valuation later
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Global Imbalances
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Global Imbalances over time
Definition
Global Imbalance is the phenomenon of persistent current account surpluses ordeficits for some countries, that leads eventually to the accumulation of assetsor financial liabilities from those countries
How does this come about?
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US Current Account and Trade Balance to GDP
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Global Imbalances over time
Figure: Current Account Imbalances. Source Feenstra and Taylor, 2010 (F&T)
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Global Imbalances over time
Figure: Current Account, Saving and Investment as a Fraction of GDP. Source: F&T.
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Study case: US CA and China
What are the implications of the rise of the Chinese economy for the US CA?
A large part of US Trade deficit is accounted by Chinese imports
◦ In 2015 US trade balance with China was -$337 Billion! (census.gov)
(more than 1/3 of the total US deficit)
◦ In 1985 the same statistic was a mere -$6 Million!
In this sense, a main driver of the CA imbalance of the US is the rise of theChinese economy
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CA and NIIP
Recall that
CA = ∆NIIP + ∆valuation
True NIIP
NIIPt = NIIP0 + ∆valuation1 + CA1 + ∆valuation2 + CA2 + . . .
Hypothetical NIIP without valuation change
NIIPt = NIIP0 + CA1 + CA2 + . . .
What about US?
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CA and NIIP for the US
A dramatic change in the US NIIP.
◦ It could be much more if the value of US owned foreign assets did notappreciate so much!
Figure: The U.S. NIIP and the Hypothetical NIIP with No Valuation Changes
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Current Account and NIIP
Figure: Current Account and Valuation
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CA and NIIP for the US
Currency mismatch
◦ US assets are mostly denominated in foreign currency
◦ US liabilities are mostly denominated in dollars
◦ Dollar depreciates, which favors US NIIP
Return mismatch
◦ U.S. stock market outperformed by foreign stock market
Asian countries in 90s and Latin American countries in 80s experience largereversals in the international capital flows
◦ vivid debate of whether the US CA deficit is sustainable
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