Unit 7 Part 1

Balance of Payments: 

·          Measure of money inflows and outflows between the United States and the Rest of the World (ROW). 

• Inflows are referred to as CREDITS
• Outflows are referred to as DEBITS

·         The Balance of Payments is divided into 3 accounts:

o    Current Account

o    Capital/Financial Account

o    Official/Reserves Account

Current Account: 

·         Balance of Trade or Net Exports

o    Exports of Goods/Services

o    Exports create a credit to the balance
      of payments

·         Net Foreign Income 

o    Income earned by U.S. owned foreign assets - income paid to foreign held U.S assets

·         Net Transfers 

·         Foreign Aid:

o    a debit to the current account 

o    Ex: Mexican migrant worker sends money to Mexico

Capital/ Financial Account: 

• The balance of capital ownership
• Includes the purchase of both real and financial assets 
• Direct investment in the United States is a credit to the capital account
• Ex: The Toyota Factory in San Antonio

• Direct investment by U.S. firms/individuals in a foreign country are debits to the capital account
• Ex: The Intel Factory in San Jose, Costa Rica.

• Purchase of foreign financial assets represents a debit to the capital account
• Ex: Warren Buffet buys stock in Petrochina 

• Purchase of domestic financial assets by foreigners represents a credit to the capital account
• Ex: The UAE sovereign wealth fund purchases a large stake in the NASDAQ

Relationship between Current Account & Capital Account:

• The Current Account and the Capital Account should zero each other out
• That is... If the Current Account has a negative balance (deficit), then the Capital Account should then have a positive balance (surplus)

Official Reserves:

• The foreign currency holdings of the U.S. Federal Reserve system
• Balance of payments surplus ---> Fed accumulates foreign currency and debits the balance of payments
• Balance of payments deficit ---> Fed depletes its reserves of foreign currency and credits the balance of payments
• Official reserves zero out balance of payments

Active v. Passive Official Reserves:

·         The U.S. is passive in its use of official reserves. If does not seek to manipulate the dollar exchange rate.

Formulas:

Balance of Trade

• Goods Exports + Goods Imports 

Balance of Goods & Services 

• Goods Exports + Service Exports + Goods Imports + Service Imports

Current Account: 

• Balance of goods & services + Net Investments + Net Transfers 

Capital Account:

• Foreign Purchases + Domestic Purchases

Helpful Links for Further Understanding:

Balance of Payments

Balance of Payments