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The Balance of Payments

The Balance of Payments. Chapter 3. 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.

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The Balance of Payments

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  1. The Balance of Payments Chapter 3

  2. 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

  3. 3.2 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.

  4. Balance of Payments Example • Suppose that Maple Bicycle in Maple, Ontario imports $100,000 worth of bicycle frames from Mercian Bicycles in Derby England. • There will exist a $100,000 credit recorded by Mercian that offsets a $100,000 debit at Maple’s bank account. • This will lead to a rise in the supply of dollars and the demand for British pounds.

  5. 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

  6. 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.

  7. Canada’s Increasing ‘Openness’

  8. Canada’s International Financial Flows

  9. 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

  10. Examples of Entries in Canada’s BoP Credits Current Account a. The Alberta Natural Gas Company exports natural gas to California. b. Bombardier sells aircraft to Australia. c. Corel sells a license to a Mexican software producer. d. The Barenaked Ladies give a concert in New York and deposit their receipts in a Toronto Bank. Capital Account e. Fidelity Mutual Fund of New York buys 10,000 shares of Nortel Networks. Debits Current Account a. Ford (Canada) buys automobile transmissions from a supplier in Michigan. b. The LCBO buys wine from Italy. c. Tom McNeil of Charlottetown goes to the London School of Economics and takes $20,000 to pay tuition and expenses. Capital Account d. Altamira Investments (Toronto) buys shares in Xerox (USA ). e. Barrick buys a gold mine in Peru.

  11. Canada’s International BoPCurrent Account $m

  12. Canada’s International BoPCurrent Account $m

  13. Canada’s International BoPCurrent Account $m

  14. Canada’s Trade in Goods

  15. The Capital Account • The capital account measures the difference between Canadian sales of assets to foreigners and Canadian purchases of foreign assets. • There are two main categories, recorded in the accounts: • Foreign direct investment • Portfolio investment • In 2005 Canada sent $41.3bn in FDI abroad, while foreigners invested $40bn in Canada. Outbound portfolio investment was 1.6bn, inbound portfolio investment was $8.5bn

  16. US Balance of Payments

  17. Canada’s Balance of Payments

  18. Statistical Discrepancy • There are going to be some omissions and mis-recorded transactions—so we use a “plug” figure to get things to balance.

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

  20. Credits Debits Current Account 1 Exports $1,418.64 2 Imports ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39) ($444.69) Balance on Current Account 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) $444.26 Balance on Capital Account 7 Statistical Discrepancies $0.30 Overall Balance Official Reserve Account ($0.30) U.S. Balance of Payments Data

  21. Credits Debits Current Account 1 Exports $1,418.64 2 Imports ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39) ($444.69) Balance on Current Account 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) $444.26 Balance on Capital Account 7 Statistical Discrepancies $0.30 Overall Balance 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.

  22. Credits Debits Current Account 1 Exports $1,418.64 2 Imports ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39) ($444.69) Balance on Current Account 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) $444.26 Balance on Capital Account 7 Statistical Discrepancies $0.30 Overall Balance 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.

  23. Credits Debits Current Account 1 Exports $1,418.64 2 Imports ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39) ($444.69) Balance on Current Account 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) $444.26 Balance on Capital Account 7 Statistical Discrepancies $0.30 Overall Balance 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.

  24. Credits Debits Current Account 1 Exports $1,418.64 2 Imports ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39) ($444.69) Balance on Current Account 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) $444.26 Balance on Capital Account 7 Statistical Discrepancies $0.30 Overall Balance Official Reserve Account ($0.30) U.S. Balance of Payments Data In the real world, there is a statistical discrepancy.

  25. Credits Debits Current Account 1 Exports $1,418.64 2 Imports ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39) ($444.69) Balance on Current Account 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) $444.26 Balance on Capital Account 7 Statistical Discrepancies $0.30 Overall Balance 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)

  26. Credits Debits Current Account 1 Exports $1,418.64 2 Imports ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39) ($444.69) Balance on Current Account 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) $444.26 Balance on Capital Account 7 Statistical Discrepancies $0.30 Overall Balance Official Reserve Account ($0.30) U.S. Balance of Payments Data Exchange rate $ P S D Q

  27. Credits Debits Current Account 1 Exports $1,418.64 2 Imports ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39) ($444.69) Balance on Current Account 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) $444.26 Balance on Capital Account 7 Statistical Discrepancies $0.30 Overall Balance Official Reserve Account ($0.30) U.S. Balance of Payments Data Exchange rate $ P S D Q As U.S. citizens import, they supply dollars to the FOREX market.

  28. Credits Debits Current Account 1 Exports $1,418.64 2 Imports ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39) ($444.69) Balance on Current Account 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) $444.26 Balance on Capital Account 7 Statistical Discrepancies $0.30 Overall Balance Official Reserve Account ($0.30) U.S. Balance of Payments Data Exchange rate $ P S D Q As U.S. citizens export, others demand dollars at the FOREX market.

  29. Credits Debits Current Account 1 Exports $1,418.64 2 Imports ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39) ($444.69) Balance on Current Account 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) $444.26 Balance on Capital Account 7 Statistical Discrepancies $0.30 Overall Balance Official Reserve Account ($0.30) U.S. Balance of Payments Data Exchange rate $ P S S1 D Q As the U.S. government sells dollars, the supply of dollars increases.

  30. 3.2 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 Canada has moved from a current account deficit to a surplus.

  31. US Current and Capital Account Balances

  32. Canada’s Balance of Payments 1982-2006

  33. Balance of Payments Trends • Like Japan, China tends to have a persistent current account surplus. Unlike Japan, China tends to have a capital account surplus as well. • In 2006, for instance, China had over a billion dollar surplus in both its capital and current accounts – this suggests that reserves must have increased: Its actual reserves have increased to over one trillion dollars in recent years.

  34. China’s Balance of Payments 1982-2005

  35. Summary • The Balance of Payments can be defined as the statistical record of a country’s international transactions over a certain period of time. • In the Balance of Payments, any transaction resulting in a receipt from foreigners is recorded as a credit, with a positive sign, whereas any transaction resulting in a payment to foreigners is recorded as a debit, with a minus sign. • A country’s international transactions can be grouped into three main categories: • Current Account, • Capital Account, • Official reserve account.

  36. Summary • The Current Account is divided into four subcategories: • Merchandise trade, • Services, • Factor income and • Transfers. • The Capital Account is divided into three subcategories: • Direct investment, • Portfolio investment , and • Other investment. • When we compute the cumulative Balance of Payments including the Current Account, Capital Account and the statistical discrepancies, we obtain the overall balance or official settlement balance. • A country can run a balance-of-payments surplus or deficit by increasing or decreasing its official reserves.

  37. End Chapter Three

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