Unit 7 - Balance of Payments

Balance of Payments

• it is a measure of money inflations and outflows between the U.S. and the rest of the world
• inflations are referred to as credits
• outflows are referred to as debits
• the balance of payments is divided into 3 accounts:
1. current account
2. capital/financial account
3. official reserves
• Current Account
1. balance of trade/net exports
• export = credit or asset
• import = debit or liability
2. net foreign income/net investment
• income earned by U.S. owned foreign assets
• encompasses income paid to foreign held U.S. assets
3. net transfers
• foreign aid (ex: U.S. gives money to other country for disaster)
• tends to be unilatteral
• Capital/Financial Account
• balance of capital ownership
• includes purchase of both real and financial assets
• real assets = real estates
• financial assets = stocks and bonds
• direct investment in U.S. is a credit to the capital account (ex: Toyota factory in U.S.)
• direct investment by U.S. firms/individuals in a foreign country are debits to the capital account (ex: Dell computer factory in Costa Rica)
• the purchase of foreign financial assets represents a debit to the capital account (ex: Bill Gates buys stock in Petrol China)
• purchase of domestic financial assets by foreigners represents a credit to the capital account (ex: Venezuela buys stock in McDonalds)
• Official Reserves
• the foreign currency holdings of the U.S> Federal Reserve System
• the official reserves should zero out the balance of payments
• the capital and current account must zero each other out

Formulas

• Balance of Traders = goods exports + goods imports
• Balance on Goods & Services = (goods exports + service exports) - (goods imports + service imports)
• Balance on Current Account = balance of traders + net investment + net transfers
• Balance on Capital Accounts = foreign purchase of assets + U.S. purchase of assets abroad