The Balance of Payments

1. The Balance of Payments Basic Facts

2. BALANCE OF PAYMENTS ACCOUNTS CREDIT ITEMS DEBIT ITEMS (MONEY IN) (MONEY OUT) CA EXPORTS IMPORTS KA CAPITAL CAPITAL INFLOWOUTFLOW

3. Current & Capital Accounts • Balance of Payments = Balance on Current Account + Balance on Capital Account • In short: BOP = CA + KA = 0 • Therefore, CA = - KA • Except for statistical discrepancies

4. Current Account Merchandise trade balance Service trade balance Net investment income Unilateral transfers

5. Capital Account • Because KA = - CA, the huge CA surpluses of Japan & Europe are matched by huge KA deficits • The US has a huge KA surplus

6. Capital Account • Two major categories • Portfolio investment: short-term capital, bonds, securities, equity or stocks if no control involved • Direct investment: equity if it involves some control of the company

7. Current Situation • Large capital account surpluses in the USA (and China) reflect high rates of return on capital and/or relatively low risk • The USA and China are attractive as destinations for capital investments relative to Europe and Japan • Vietnam?

8. Pre-Crisis Southeast Asia • Rapid economic growth => large KA surpluses • CA deficits equally large • Currency pegs to $US difficult, ultimately impossible to sustain • High interest rates attracted even more capital

9. Why? • Capital inflow => rapid money supply growth • Money supply growth => inflation & currency depreciation • Anti-inflation/depreciation policies limit M growth, but => higher interest rates • Higher interest rates attract even more capital