Balance of payments

The Balance of Payments (BOP) is a measure of all the financial transactions flowing between one country and all other countries during a specific period, usually a quarter or a year. It is also the name of the official record of these transactions. A positive, or favorable, balance of payments is one in which more payments have come in to a country than have gone out. A negative or unfavorable balance means more payments are exiting than arriving.

The BOP is a major indicator of a country's status in international trade.

Components

Within any country, the BOP record comprises three "accounts": the current account, which includes primarily trade in goods and services (often referred to as the balance of trade), along with earnings on investments; the capital account, including transfers of non-financial capital such as debt forgiveness, gifts and inheritance transfers; and the financial account, essentially trade in such assets as currencies, stocks, bonds, real estate, and gold, among others.

Each of these components is further divided into subcomponents. Thus, for example, the current account comprises trade in merchandise, trade in services (such as tourism and law), income receipts such as dividends, and unilateral transfers of money, including direct foreign aid. (To economists, the current account can be viewed as the difference between, on the one hand, exports and capital inflows, and other other hand, imports and capital outflows.)

Likewise, the capital account includes such "transfers" as debt forgiveness, money that migrant workers take home with them when they leave the country or bring with them as they enter the country, and sales and purchases of natural resources. And the financial account consists both of assets owned abroad, and of foreign-owned assets within the country. In the financial account, if foreign ownership of domestic financial assets has increased more quickly than domestic ownership of foreign assets in a given year, then the domestic country has a financial account surplus. On the other hand, if domestic ownership of foreign financial assets has increased more quickly than foreign ownership of domestic assets, then the domestic country has a financial account deficit. The United States persistently has the largest capital (and financial) surplus in the world.

Recording Procedures

The method of recording these payments explains the "balance." As payments leave or enter a country—for example, to finance a purchase, or to invest in a foreign corporation—the transactions are recorded as both debits and as credits, in accordance with double-entry bookkeeping that is standard business accounting practice. For example, when a country or any of its its citizens buys a foreign good—furniture, say—that is treated as an increase in the asset of furniture. Therefore that recording is made, according to convention, by a debit-entry in the books of the current account (i.e., on the left side of the ledger). At the same time, that same entry is countered, or balanced, by a decrease in the asset of money, which is recorded by a credit-entry (on the rights side).

In brief, according to the International Monetary Fund, a country "records credit entries for (a) exports of goods and services, provision of services, provision of the factors of production to another economy, and (b) financial items reflecting a reduction in the [country's] external assets or an increase in external liabilities." Likewise, it records debit entries for "(a) imports of goods, acquisition of services, use of production factors provided by another economy, and (b) financial items reflecting an increase in assets or a decrease in liabilities."

Beyond each account balancing internally, the current account should always balance, or equal, the sum of the capital and financial accounts. In practice, however, this is not always the case, given "statistical discrepancies, accounting conventions, and exchange rate movements that change the recorded value of transactions."

Balance of Payments transactions are valued largely by market prices, or the prices actually paid between a buyer and a seller, rather than the price that is officially quoted. Those prices, in turn, are usually recorded in terms of a country's domestic currency. However, for international comparisons, economists use a more stable or solid currency, such as the U.S. dollar.

History

Historically these flows simply were not carefully measured due to difficulty in measurement, and the flow proceeded in many commodities and currencies without restriction, clearing being a matter of judgment by individual private banks and the governments that licensed them to operate. Mercantilism was a theory that took special notice of the balance of 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) but mostly upon the theory that large domestic gold supplies will provide lower interest rates. This theory has not withstood the test of facts.

As mercantilism gave way to classical economics, and private currencies were taxed out of existence, the market 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 and German mark, which was redeemable nominally in gold. In the 1970s this redemption ceased, leaving the system with respect to the United States without a formal base, yet the peg to the Mark somewhat remained. Strangely, since leaving the gold standard and abandoning interference with Dollar foreign exchange, the surplus in the Income Account has decayed exponentially, and has remained negligible as a percentage of total debits or credits for decades. 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; however, no central bank stocks reserves of crude oil. Since OPEC oil transacts in US dollars, and most major currencies are subject to sudden large changes in price due to unstable central banks, the US dollar remains a reserve currency, but is increasingly challenged by the euro, and to a small degree the pound.

The United States has been running a current account deficit since the early 1980s. The U.S. current account deficit has grown considerably in recent years, reaching record high levels in 2006 both in absolute terms ($758 billion) and as a fraction of GDP (6%).

See also

• Current account
• Capital account
• Balance of trade
• Floating currency
• Capital surplus
• International investment position
• Foreign exchange reserves
• Sovereign wealth fund
• Money supply
• United States public debt
• FRED (Federal Reserve Economic Data)
• Pink Book
• Milton Friedman
• IMF Balance of Payments Manual
• List of countries by current account balance

References

ISBN links support NWE through referral fees

• Economics 8th Edition by David Begg, Stanley Fischer and Rudiger Dornbusch, McGraw-Hill
• Economics Third Edition by Alain Anderton, Causeway Press
• AS and A Level Economics, Cambridge University Press

External links

Data

• IMF
  • [1] (See "External Sector")
• BEA U.S. International Transactions Accounts Data
• BEA U.S. International Transactions Accounts Data Help
• Balance of Payments in Hong Kong

You can also download historical balance of payments information from 1960 under the "All Tables" link of the following page:

• BEA Balance of Payments Section

Analysis

• Where Do U.S. Dollars Go When the United States Runs a Trade Deficit? from Dollars & Sense magazine

Credits

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• Balance of payments  ^history

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• History of "Balance of payments"

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