The Balance of Payments and International Trade Linkages

1
The Balance of Payments and International Trade
Linkages
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Organization

• BOP Accounting/ Balance of Payment Categories
• National Income Accounting and International
  Trade
• Trade Balances Problem (?) and Solution

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Balance of Payment Accounting The purpose is to
measure the flow of economic transactions over a
period of time. The conventions of double-entry
bookkeeping are used to keep track of whats
going on.

• Credit anything that leaves the country such as
  an export good. (It makes sense to think of this
  as a credit since it triggers payments coming
  into the country.)
• Debit anything that comes into the country
  payments to foreigners

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Example An American trades a Mike Modano
bobble-head doll to a Canadian for 3 pounds of
seal oil.

• Credit bobble-head Mike
• Debit Seal oil.

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Example An American sells the doll for 200
accepting a check from the Canadian buyer

• Credit the doll
• Debit 200 (remember, anything that comes into
  the country is a debit, even if it is a financial
  asset, like an IOU)

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Example An American buys 200 worth of seal
oil, paying with a check.

• Credit 200 demand deposit liability (the IOU
  is now going to a Canadian)
• Debit the oil

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Example Honda buys a 50 M parts warehouse in
California.

• Credit 50 M building (of course the building
  isnt physically moved from the US to Japan, but
  the title that asset is transferred out of the
  US)
• Debit 50 M liability (the check)

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Example An American sells 5 billion yen to the
U.S. Federal Reserve for 50 million. (Think
about why the Fed might be interested in buying
these yen).

• Credit 50 million DD liability owned by a
  private citizen (the funds are no longer
  controlled by a private citizen)
• Debit 50 million official reserves (to be
  defined more carefully later).

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Balance of Payment Accounting convention is to
assign every entry into one of three broad class

• Current Account
• Capital Account
• Official Reserves

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Current Account

• Goods
• Services (e.g., tourism, transportation,
  professional services, and interest)
• Unilateral transfers (e.g., government grants and
  private remitances).
• Current Account Balance (BCA) Credits-Debits
  Capital Account Purchases and sale of assets

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Capital Account

• Foreign Direct Investment The acquisition of
  control over business enterprise in other country
• Portfolio Investment
• Long Term Assets with maturity greater than one
  year (e.g., stocks and LT bonds)
• Short Term less than one year
• Other Investments currency transactions, bank
  deposits and other trade credits
• Capital Accounts Balance (BKA)Credits-Debits

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Official Reserve Account Central Bank
Transactions in International Reserve Assets
Including

• Foreign exchange
• gold
• Special Drawing Rights (SDRs) a special kind
  of reserve asset created by the International
  Monetary Fund
• IMF reserve positions
• Official Reserve Balance (BRA)Credits-Debits

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Balance of Payments Accounting Identity

• Since credits must equal debits, BCA BKA BRA
  0
• Interesting observation if BRA 0, then BCA
  - BKA

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Example US exports 300 Billion and is paid by
accepting 300 billion in credit from the
foreigners

• Credit 300 (CA)
• Debit 300 (KA)

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Example US imports 225 billion and pays by
writing checks on foreign bank accounts

• Credit 225 (KA)
• Debit 225 (CA)

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Example US corporations pay 15 billion in
dividends to foreigners by writing checks on US
banks

• Credit 15 (KA)
• Debit 15 (CA)

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ExampleUS tourists spend 30 billion in travelers
checks while abroad

• Credit 30 (KA)
• Debit 30 (CA)

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Example US investors buy 60 billion in foreign
stocks, paying with checks drawn on foreign banks
accounts

• Credit 60 (KA)
• Debit 60 (KA)

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Observation from the example

• BCA 300 (225 15 30) 30
• BKA (22515 30 60)-(30060) -30
• It would seem that BKA -BCA
• And of course, this makes sense as an exercise in
  accounting identities. In the example all the
  transactions involve current or capital account
  items and since the accounting rules require that
  debits must equal credits this identity has to
  obtain.

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But this also makes good economic sense.

• The stuff we get from foreigners has to be paid
  for somehow. It can be paid for by giving them
  our stuff, or by giving them financial assets
  (which are just claims on some undetermined
  stuff).
• If we exported just as much as we imported
  (that is, if we paid for their stuff with our
  stuff), the current account would balance would
  be zero.
• If we import more than we export, we pay by
  giving them complicated pieces of paper (called
  financial assets) which define some claim they
  have on our stuff .

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Complication what if we want more of their
stuff than they want of our stuff, but they are
unwilling to accept private financial assets in
payment? Suppose

• US imports 100 billion and pays by writing
  checks on US banks
• Credit 100 (KA)
• Debit 100 (CA)
• Notice that at this point, BCA -100 and BKA
  100

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Complication (Cont.) But now suppose those
foreigners decide they dont want to hold US
demand deposit liabilities and instead buy
something from the Federal Reserve, say gold or
their own currency.

• Credit 100 (OR)
• Debit 100 (KA)
• Notice that now BCA -100, BKA 100-100 0
  and BRA 100

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U.S. Balance of Payments Data
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U.S. Balance of Payments Data
In 2004, the U.S. imported more than it exported,
thus running a current account deficit of 665.9
billion.
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U.S. Balance of Payments Data
During the same year, the U.S. attracted net
investment of 611.2 billionclearly the rest of
the world found the U.S. to be a good place to
invest.
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U.S. Balance of Payments Data
Under a pure flexible exchange rate regime, these
numbers would balance each other out.
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U.S. Balance of Payments Data
In the real world, there is a statistical
discrepancy.
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U.S. Balance of Payments Data
Including that, the balance of payments identity
should hold BCA BKA BRA
(665.9) 611.2 51.9 (2.8)
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Current Account Deficit, Private Savings and the
Budget Deficits
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To understand all of this consider the sources
and uses of funds in three increasingly complex
worlds
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A world where there is no international trade and
no government.

• Sources Producing consumer goods (C) and
  capital goods (I)
• Uses Consuming and saving (S)
• Conclusion CICS, or SI

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A world where there is international trade, but
no government

• Sources Producing consumer goods, capital
  goods, government goods,and exports (X)
• Uses Consuming, saving, paying taxes and
  imports (M)
• Conclusion CIXCSM or X-M(S-I)(I.e.,
  CAnet private saving)

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A world with government and trade

• Sources Producing consumer goods, capital
  goods, government goods,and exports (X)
• Uses Consuming, saving, paying taxes and
  imports (M)
• Conclusion CIGXCSTM or X-M(S-I)-(G-T)
  (I.e., CAnet private saving - budget surplus)

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Are Current Account Deficits Bad?

• Bilateral deficits can be interesting but hardly
  relevant to issues beyond political and economic
  relationships between the countries.
• Multilateral CA deficit can be interpretted as
• An indication that the home country is dissaving
  (spending more on I and G than S and T)
• An indication that the home country is a good
  place for foreigners to invest (remember a CA
  deficit means that capital is flowing into the
  home country).

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Balance of Payments Trends

• Since 1982 the U.S. has experienced continuous
  deficits on the current account and continuous
  surpluses on the capital account.
• During the same period, Japan has experienced the
  opposite.

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Balances on the Current (BCA) and Capital (BKA)
Accounts of the United States
Source IMF International Financial Statistics
Yearbook, various issues
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Balances on the Current (BCA) and Capital (BKA)
Accounts of United Kingdom
Source IMF International Financial Statistics
Yearbook, various issues
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Balances on the Current (BCA) and Capital (BKA)
Accounts of Japan
Source IMF International Financial Statistics
Yearbook, various issues
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Balances on the Current (BCA) and Capital (BKA)
Accounts of Germany
Source IMF International Financial Statistics
Yearbook, various issues
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Balances on the Current (BCA) and Capital (BKA)
Accounts of China
Source IMF International Financial Statistics
Yearbook, various issues
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Balance of Payments Trends

• Germany traditionally had current account
  surpluses.
• From 1991 to 2001Germany experienced current
  account deficits.
• This was largely due to German reunification and
  the resultant need to absorb more output
  domestically to rebuild the former East Germany.
• Since 2001 Germany returned to its earlier
  pattern.
• What matters is the nature and causes of the
  disequilibrium.

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Balances on the Current (BCA) and Capital (BKA)
Accounts of Five Major Countries
Source IMF International Financial Statistics
Yearbook, 2000
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How to fix a CA deficit (if you want to)

• Protectionism of various sorts (such as quotas
  and tarrifs), but
• Tariffs and quotas may provoke trading partners
  to institute similar policies, reducing exports.
• Tariffs and quotas discourage efficient exchange,
  lowering national income and reducing exports
• Domestic monetary policy
• Raising interest rates
• Controlling inflation

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Can devaluations work? (The J-Curve)

• A devaluation raises the price of imports and so
  discourages the volume of imports (e.g., the
  German car that cost 50,000 before the
  devaluation might cost 55,000 after)
• But, the imports have a higher dollar value and
  so if the volume of imports drops by a smaller
  percentage than the price of imports, the dollar
  value of imports may actually increase, worsening
  the CA deficit.