Balance of payments

From Free net encyclopedia

The balance of payments (or BOP) is a measure of the payments that flow into and out from a particular country from and to other countries. It is determined by a country's exports and imports of goods, services, and financial capital, as well as financial transfers.

1 Overview
2 History
3 United States balance
4 See also
5 External links
- 5.1 Data

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Overview

Image:Current account balance world.PNG In theory, the balance of payments of any country is zero (because every unit of currency must come from somewhere). It is this assumption that the Mundell-Fleming Model (based on the traditional IS/LM) is built on.

In practice the balance of payments rarely equal zero for any point in time. Imperfect capital mobility and transactions crossing between two fiscal years distort the balance for short-run analysis. If there is more money flowing into a country than there is flowing out, that country has a positive balance of payments; if, on the other hand, more money flows out than in, the balance of payments is negative.

A country's international transactions are grouped into three (usually just the first two) categories to keep track of the myriad of flows.

Current account: records net flow of money into a country resulting from trade in goods and services and transfer payments made from abroad. When the current account runs in the red, it is commonly called the "trade deficit." The current account itself comprises three accounts: trade account, income account and transfers account. In general, the current account is summed up as net exports or X which is a function of p (the real exchange rate), Y (domestic GDP) and Y* (foreign GDP). X=X(p, Y, Y*)

Current account

Exports

Merchandise (tangible goods)
Services (invisible trade, eg. legal, consulting, royalties, patents etc.)
Factor Income (interest, dividend or any other foreign investment income)

Imports

Merchandise
Services
Factor income

Net Unilateral Transfers Abroad (one way "unrequited" payments, eg.foreign aid, grants, gifts etc.)

Capital account: records net flow of money from purchases and sales of assets such as stocks, bonds and land. In general, the capital account is summed up as r(i−i*) + k, where r is the speed at which agents can exploit change in the market (aka degree of capital mobility); i is the domestic interest rate, i* is the foreign interest rate and k is an exogeneous variable which describes capital investments unrelated to the interest rate.

Capital account equals:

+ Exports

− Imports

− Increase of owned assets abroad

+ Increase of foreign-owned assets in the country

Money coming in (+), or leaving (−)

An account may show a surplus or a deficit. For example, a trade surplus implies that a country's exports are higher than its imports and hence there is a net flow of money into the country. A trade deficit, on the other hand, implies that the country's imports exceed its exports and hence there is a net flow of money out of the country.

For a country to have a zero balance of payments, a current account deficit must be balanced by a capital account surplus. The United States has been carrying a negative current account balance for many years, this debt has been primarily financed by issuing securities. The only way to buy more than you sell is to borrow the funds.

A country will have a negative balance of payments (i.e., there is to be a net flow of money out of the country) if the net of the current account and the capital account is a deficit. Similarly, there will be a positive balance of payments (i.e., a net flow of money into a country) if the net of the current and the capital account results in a surplus.

Capital Account

Foreign Direct Investment (FDI)
Portfolio Investment
- Equity Securities
- Debt Securities
Other Investment (transactions in currency, bank deposits, trade credits etc.)
Statistical discrepancies

Reserve account: Official reserve account includes official gold reserves, foreign exchange reserves, strategic defense reserves or SDRs (e.g. Strategic Petroleum Reserve) and IMF reserves.

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History

Historically these flows simply were not carefully measured, and the flow proceeded in many commodities and currencies without restriction, clearing being a matter of judgement by individual banks and the governments that licensed them to operate. Mercantilism was a theory that took special notice of the balance in payments and sought simply to monopolize gold, in part to keep it out of the hands of potential military opponents (a large "war chest" being a prerequisite to start a war, whereupon much trade would be embargoed).

As mercantilism gave way to classical economics, these crude systems were later regulated in the 19th century by the gold standard which linked central banks by a convention to redeem "hard currency" in gold. After World War II this system was replaced by the Bretton Woods institutions (the International Monetary Fund and Bank for International Settlements) which pegged currency of participating nations to the US dollar, which was redeemable nominally in gold. In the 1970s this redemption ceased, leaving the system without a formal base. Some consider the system today to be based on oil, a universally desirable commodity due to the dependence of so much infrastructural capital on oil supply. Since OPEC prices oil in US dollars, the US dollar remains a reserve currency, but is increasingly challenged by the euro, and to some degree the Japanese yen.

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United States balance

**Balance of payments (millions of dollars)**
Period ending	1960	1970	1980	1990	2000	2003
Current account
Exports of goods and services and income receipts (+)	30,556	68,387	344,440	706,975	1,421,429	1,302,876
Imports of goods and services and income payments (−)	−23,670	−59,901	−333,774	−759,290	−1,779,188	−1,778,117
Unilateral current transfers, net	−4,062	−6,156	−8,349	−26,654	−55,684	−67,439
Capital account
Capital account transactions, net	...	...	...	−6,579	−809	−3,079
Financial account
U.S.-owned assets abroad, net (increase/financial outflow (−))	−4,099	−8,470	−85,815	−81,234	−569,798	−283,414
Foreign-owned assets in the United States, net (increase/financial inflow (+))	2,294	6,359	62,612	141,571	1,046,896	829,173
Net	1,019	219	−20,886	−25,211	62,846	12,012