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3. The Balance of Payments. Chapter Three. Chapter Objective: This chapter serves to introduce the student to the balance of payments. How it is constructed and how balance of payments data may be interpreted. INTERNATIONAL FINANCIAL MANAGEMENT. Third Edition. EUN / RESNICK.

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International financial management

3

The Balance of Payments

Chapter Three

Chapter Objective:

This chapter serves to introduce the student to the balance of payments. How it is constructed and how balance of payments data may be interpreted.

INTERNATIONAL

FINANCIAL

MANAGEMENT

Third Edition

EUN / RESNICK


Chapter three outline

Chapter Three Outline

  • Balance of Payments Accounting

  • Balance of Payments Accounts

    • The Current Account

    • The Capital Account

    • Statistical Discrepancy

    • Official Reserves Account

  • The Balance of Payments Identity

  • Balance of Payments Trends in Major Countries


Balance of payments accounting

Balance of Payments Accounting

  • The Balance of Payments is the statistical record of a country’s international transactions over a certain period of time presented in the form of double-entry bookkeeping.

    N.B. when we say “a country’s balance of payments” we are referring to the transactions of its citizens and government.


Balance of payments example

Balance of Payments Example

  • Suppose that Maplewood Bicycle in Maplewood, Missouri, USA imports $100,000 worth of bicycle frames from Mercian Bicycles in Darby England.

  • There will exist a $100,000 credit recorded by Mercian that offsets a $100,000 debit at Maplewood’s bank account.

  • This will lead to a rise in the supply of dollars and the demand for British pounds.


Balance of payments accounts

Balance of Payments Accounts

  • The balance of payments accounts are those that record all transactions between the residents of a country and residents of all foreign nations.

  • They are composed of the following:

    • The Current Account

    • The Capital Account

    • The Official Reserves Account

    • Statistical Discrepancy


The current account

The Current Account

  • Includes all imports and exports of goods and services.

  • Includes unilateral transfers of foreign aid.

  • If the debits exceed the credits, then a country is running a trade deficit.

  • If the credits exceed the debits, then a country is running a trade surplus.


The capital account

The Capital Account

  • The capital account measures the difference between U.S. sales of assets to foreigners and U.S. purchases of foreign assets.

  • The U.S. enjoys about a $444,000,000,000 capital account surplus—absent of U.S. borrowing from foreigners, this “finances” our trade deficit.

  • The capital account is composed of Foreign Direct Investment (FDI), portfolio investments and other investments.


Statistical discrepancy

Statistical Discrepancy

  • There’s going to be some omissions and misrecorded transactions—so we use a “plug” figure to get things to balance.

  • Exhibit 3.1 shows a discrepancy of $0.73 billion in 2000.


The official reserves account

The Official Reserves Account

  • Official reserves assets include gold, foreign currencies, SDRs, reserve positions in the IMF.


The balance of payments identity

The Balance of Payments Identity

BCA + BKA + BRA = 0

where

BCA = balance on current account

BKA = balance on capital account

BRA = balance on the reserves account

Under a pure flexible exchange rate regime,

BCA + BKA = 0


U s balance of payments data

Credits

Debits

Current Account

1

Exports

$1,418.64

2

Imports

($1,809.18)

3

Unilateral Transfers

$10.24

($64.39)

Balance on Current Account

($444.69)

Capital Account

0.73

4

Direct Investment

$287.68

($152.44)

5

Portfolio Investment

$474.39

($124.94)

6

Other Investments

$262.64

($303.27)

Balance on Capital Account

$444.26

7

Statistical Discrepancies

Overall Balance

$0.30

Official Reserve Account

($0.30)

U.S. Balance of Payments Data


U s balance of payments data1

Credits

Debits

Current Account

1

Exports

$1,418.64

2

Imports

($1,809.18)

3

Unilateral Transfers

$10.24

($64.39)

Balance on Current Account

($444.69)

Capital Account

0.73

4

Direct Investment

$287.68

($152.44)

5

Portfolio Investment

$474.39

($124.94)

6

Other Investments

$262.64

($303.27)

Balance on Capital Account

$444.26

7

Statistical Discrepancies

Overall Balance

$0.30

Official Reserve Account

($0.30)

U.S. Balance of Payments Data

In 2000, the U.S. imported more than it exported, thus running a current account deficit of $444.69 billion.


U s balance of payments data2

Credits

Debits

Current Account

1

Exports

$1,418.64

2

Imports

($1,809.18)

3

Unilateral Transfers

$10.24

($64.39)

Balance on Current Account

($444.69)

Capital Account

0.73

4

Direct Investment

$287.68

($152.44)

5

Portfolio Investment

$474.39

($124.94)

6

Other Investments

$262.64

($303.27)

Balance on Capital Account

$444.26

7

Statistical Discrepancies

Overall Balance

$0.30

Official Reserve Account

($0.30)

U.S. Balance of Payments Data

During the same year, the U.S. attracted net investment of $444.26 billion—clearly the rest of the world found the U.S. to be a good place to invest.


U s balance of payments data3

Credits

Debits

Current Account

1

Exports

$1,418.64

2

Imports

($1,809.18)

3

Unilateral Transfers

$10.24

($64.39)

Balance on Current Account

($444.69)

Capital Account

0.73

4

Direct Investment

$287.68

($152.44)

5

Portfolio Investment

$474.39

($124.94)

6

Other Investments

$262.64

($303.27)

Balance on Capital Account

$444.26

7

Statistical Discrepancies

Overall Balance

$0.30

Official Reserve Account

($0.30)

U.S. Balance of Payments Data

Under a pure flexible exchange rate regime, these numbers would balance each other out.


U s balance of payments data4

Credits

Debits

Current Account

1

Exports

$1,418.64

2

Imports

($1,809.18)

3

Unilateral Transfers

$10.24

($64.39)

Balance on Current Account

($444.69)

Capital Account

0.73

4

Direct Investment

$287.68

($152.44)

5

Portfolio Investment

$474.39

($124.94)

6

Other Investments

$262.64

($303.27)

Balance on Capital Account

$444.26

7

Statistical Discrepancies

Overall Balance

$0.30

Official Reserve Account

($0.30)

U.S. Balance of Payments Data

In the real world, there is a statistical discrepancy.


U s balance of payments data5

Credits

Debits

Current Account

1

Exports

$1,418.64

2

Imports

($1,809.18)

3

Unilateral Transfers

$10.24

($64.39)

Balance on Current Account

($444.69)

Capital Account

0.73

4

Direct Investment

$287.68

($152.44)

5

Portfolio Investment

$474.39

($124.94)

6

Other Investments

$262.64

($303.27)

Balance on Capital Account

$444.26

7

Statistical Discrepancies

Overall Balance

$0.30

Official Reserve Account

($0.30)

U.S. Balance of Payments Data

Including that, the balance of payments identity should hold:

BCA + BKA = – BRA

($444.69) + $444.26+ $0.73 = $0.30= –($0.30)


Balance of payments and the exchange rate

Credits

Debits

Current Account

1

Exports

$1,418.64

2

Imports

($1,809.18)

3

Unilateral Transfers

$10.24

($64.39)

Balance on Current Account

($444.69)

Capital Account

0.73

4

Direct Investment

$287.68

($152.44)

5

Portfolio Investment

$474.39

($124.94)

6

Other Investments

$262.64

($303.27)

Balance on Capital Account

$444.26

7

Statistical Discrepancies

Overall Balance

$0.30

Official Reserve Account

($0.30)

Balance of Payments and the Exchange Rate

Exchange rate $

P

S

D

Q


Balance of payments and the exchange rate1

Credits

Debits

Current Account

1

Exports

$1,418.64

2

Imports

($1,809.18)

3

Unilateral Transfers

$10.24

($64.39)

Balance on Current Account

($444.69)

Capital Account

0.73

4

Direct Investment

$287.68

($152.44)

5

Portfolio Investment

$474.39

($124.94)

6

Other Investments

$262.64

($303.27)

Balance on Capital Account

$444.26

7

Statistical Discrepancies

Overall Balance

$0.30

Official Reserve Account

($0.30)

Balance of Payments and the Exchange Rate

Exchange rate $

P

S

D

Q

As U.S. citizens import, they are supply dollars to the FOREX market.


Balance of payments and the exchange rate2

Credits

Debits

Current Account

1

Exports

$1,418.64

2

Imports

($1,809.18)

3

Unilateral Transfers

$10.24

($64.39)

Balance on Current Account

($444.69)

Capital Account

0.73

4

Direct Investment

$287.68

($152.44)

5

Portfolio Investment

$474.39

($124.94)

6

Other Investments

$262.64

($303.27)

Balance on Capital Account

$444.26

7

Statistical Discrepancies

Overall Balance

$0.30

Official Reserve Account

($0.30)

Balance of Payments and the Exchange Rate

Exchange rate $

P

S

D

Q

As U.S. citizens export, others demand dollars at the FOREX market.


Balance of payments and the exchange rate3

Credits

Debits

Current Account

1

Exports

$1,418.64

2

Imports

($1,809.18)

3

Unilateral Transfers

$10.24

($64.39)

Balance on Current Account

($444.69)

Capital Account

0.73

4

Direct Investment

$287.68

($152.44)

5

Portfolio Investment

$474.39

($124.94)

6

Other Investments

$262.64

($303.27)

Balance on Capital Account

$444.26

7

Statistical Discrepancies

Overall Balance

$0.30

Official Reserve Account

($0.30)

Balance of Payments and the Exchange Rate

Exchange rate $

P

S

S1

D

Q

As the U.S. government sells dollars, the supply of dollars increases.


Balance of payments trends

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.


Balances on the current bca and capital bka accounts of the united states

Balances on the Current (BCA) and Capital (BKA) Accounts of the United States

Source: IMF International Financial Statistics Yearbook, 2000


Balances on the current bca and capital bka accounts of united kingdom

Balances on the Current (BCA) and Capital (BKA) Accounts of United Kingdom

Source: IMF International Financial Statistics Yearbook, 2000


Balances on the current bca and capital bka accounts of japan

Balances on the Current (BCA) and Capital (BKA) Accounts of Japan

Source: IMF International Financial Statistics Yearbook, 2000


Balances on the current bca and capital bka accounts of germany

Balances on the Current (BCA) and Capital (BKA) Accounts of Germany

Source: IMF International Financial Statistics Yearbook, 2000


Balances on the current bca and capital bka accounts of china

Balances on the Current (BCA) and Capital (BKA) Accounts of China

Source: IMF International Financial Statistics Yearbook, 2000


Balance of payments trends1

Balance of Payments Trends

  • Germany traditionally had current account surpluses.

  • Since 1991 Germany has been experiencing current account deficits.

  • This is largely due to German reunification and the resultant need to absorb more output domestically to rebuild the former East Germany.

  • What matters is the nature and causes of the disequilibrium.


Balances on the current bca and capital bka accounts of five major countries

Balances on the Current (BCA) and Capital (BKA) Accounts of Five Major Countries

Source: IMF International Financial Statistics Yearbook, 2000


End chapter three

End Chapter Three


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