The Balance of Payments

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. BoP Credits vs. Debits • Credit – money flowing into the country • Debit – money flowing out of the country • Canadian firm pays dividends to UK investors: debit for Canada, credit for UK • Mexican farm worker in Leamington sends remittances to his family (remesas familiares) in Oaxaca: debit for Canada, credit for Mexico.

4. 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.

5. 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. • UK current account credit; Canada current account debit. • This will lead to a rise in the supply of dollars and the demand for British pounds.

6. 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: due to diverse data sources, default assumption: SD = 0

7. The Current Account (3 components) • Exports and imports of goods and services: Net exports = exports – imports. • Invisibles means services. • Net foreign investment earnings FIE, i.e., interest, dividends: FIE of Canadians – FIE of non-Canadians on Canadian securities. • Unilateral transfers e.g. foreign aid, family remittances.

8. Trade Account vs. Current Account • Trade account = net exports • If net exports < 0, trade account deficit • If net exports > 0, trade account surplus • Current account = net exports + Net foreign investment earnings + net unilateral transfers • If the current account debits exceed the credits, then a country is running a current account deficit • If the current account credits exceed the debits, then a country is running a current account surplus

9. Canada’s Increasing ‘Openness’

10. Capital Account (KA, K mean capital) • Refers to money raised from the issuance of securities • Manulife issues bonds to Australian superannuation funds: Canadian KA credit, Australian KA debit • BHP issues new shares in London: Australian KA credit, UK KA debit

11. Canada’s International Financial Flows

12. 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 • -BRA = increase in central bank reserves • BCA + BKA = increase in central bank reserves • Under a pure flexible exchange rate regime, • BCA + BKA = 0 (approximately)

13. 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.

14. Canada’s International BoPCurrent Account $m

15. Canada’s International BoPCurrent Account $m

16. Canada’s International BoPCurrent Account $m

17. Canada’s Trade in Goods

18. 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

19. US Balance of Payments

20. Canada’s Balance of Payments

21. Statistical Discrepancy • There are going to be some omissions and mis-recorded transactions—so we use a “plug” figure to get things to balance. • Default assumption: statistical discrepancy = zero.

22. The Official Reserves Account • Official reserves assets include gold, foreign currencies, SDRs, reserve positions in the IMF. • Official reserves held by the country’s central bank: Bank of Canada, the Fed, Reserve Bank of Australia, People’s Bank of China, el Banco Central de la República Dominicana, etc.

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 .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

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 .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.

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 .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.

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 .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.

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 In the real world, there is a statistical discrepancy.

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 Including that, the balance of payments identity should hold: BCA + BKA = – BRA ($444.69) + $444.26 + $0.73 = $0.30

29. Nexus: Market for USDs & US BoP debits/credits • USD supply curve linked to US BoP debits: US entities are supplying USDs to purchase non-US goods/services • USD demand curve linked to US BoP credits: Non-US entities are demanding USDs to purchase US good/services

30. 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 Market for $s P S D Q

31. 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 Market for $s P S D Q As U.S. citizens import, they supply dollars to the FOREX market.

32. 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.

33. 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-444.69 + 444.26 + .73 - .30 = 0

34. 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.

35. US Current and Capital Account Balances

36. Canada’s Balance of Payments 1982-2006

37. 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.

38. China’s Balance of Payments 1982-2005

39. 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.

40. Summary • The Current Account is divided into four subcategories: • Merchandise trade, • Services, • Factor income (net foreign investment income) • Transfers. • The Capital Account is divided into two subcategories: • Direct investment, • Portfolio 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.