Unit 7 Notes

Balance of Payments

• Measure of money inflows and outflows between the US and the rest of the world (ROW)
• Inflows: Credit *adding
• Outflows: Debits *taking
• The balance of payments is divided into 3 accounts
• Current Account
• Capital/Financial Account
• Official Reserves Account

Double Entry Bookkeeping

• Every transaction in the balance of payment is recorded twice in accordance with standard accounting practice
• Ex: US manufacturer John Deere exports $50 million worth of farm equipment to Ireland
• A credit of $50 million to the current account 
• A debit of $50 million to capital/financial

Current Account

• Balance of trade or net exports
• Exports of goods/services -import of goods/service
• Exports create a credit to the balance of payments
• Imports create a debit to the balance of payments
• Net Foreign Income
• Income earned by US owned foreign assets - Income paid to foreign held US assets
• Ex: Interest Payments on US owned Brazilian bonds - Interest payments on German owned US Treasury bonds.
• Net Transfers (tend to be unilateral)
• Foreign Aid -> A debit to the current account
• Ex: Mexican migrant workers send money to family in Mexico

Capital/Financial Account

• The balance of capital ownership
• Includes the purchase of both real and financial assets
• Direct Investment in the US is a credit to the capital account
• Ex: The Toyota Factory in San Antonio
• Direct investment by US 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.
• The United Arab Emirates sovereign wealth fund purchase a large stake in the NASDAQ

Relationship between Current and 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 than have a positive balance (surplus)
• Example: The constant net inflow of foreign financial capital to the United States (capital account) is what enables us to import more than we export(current account deficit)
• Official Reserves
  • The foreign currency holdings of the United States Federal Reserves System
  • When there is a balance of payments surplus the Fed accumulates foreign currency ad debits the balance of payments.
  • When there is a balance of payments deficit the Fed depletes its reserves of foreign currency and credits the balance of payments.

  Active v. Passive Official Reserves
  • The United States is passive in its use of official reserves. It doesn't seek to manipulate the dollar exchange rate.
  • The People's Republic of China is active in its use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate with the United States.