Balance of Payments

1. Balance of Payments

2. Balance of Payments Credits and Debits Credits: give rise to payments inward to the country create an immediate demand for the country�s currency reflect an increase in net claims of foreign countries on the home country increase in home country assets owned by foreign citizens or government, decrease in foreign assets owned by home country citizens or government).

3. Balance of Payments Credits and Debits Debits: give rise to payments outward from the country create an immediate demand for another country�s currency reflect a decrease in net claims of foreign countries on the home country decrease in home country assets owned by foreign citizens or government, increase in foreign assets owned by home country citizens or government).

4. Examples: Credits: exports of goods and services purchase of home country asset by foreign country sale of foreign country asset by home country investment income received from abroad gifts received from abroad

5. Examples: Debits: imports of goods and services purchase of foreign country asset by home country sale of home country asset by foreign country investment income sent abroad gifts sent abroad

6. Example: You classify I travel to South Carolina for a holiday Student comes to Canada to study Joe Canada buys Toyota stocks Sam US buys stock in MTS (Manitoba Telephone System) Jane Canada gives $300 to help AIDS victims in Zambia My brother in Ohio sends my Mom flowers (flowers are produced in Canada), money comes in to pay for them.

7. Double-Entry Bookkeeping Every international transaction is entered as both a credit and a debit in the balance of payments. If the main transaction is a credit, there is an offsetting transaction that is a debit. The final line in the Balance of Payments is always ZERO. (In the previous page, we classified Main transactions)

8. Classification of Transactions There are four categories in the Balance of Payments Current Account � most important Direct Investment and other long-term financial flows Also important in the long-run Short-term nonofficial financial flows � not important Changes in reserve assets of official monetary authorities � important for countries with fixed exchange rate

9. Current Account Credits exports of goods and services income from investments abroad other factor income earned abroad unilateral transfers to home country from abroad (gifts)

10. Current Account Debits imports of goods and services income to investors abroad payment to other countries� residents for factor services unilateral transfers to other countries from home country (gifts)

11. II Direct Investment and other long-term financial flows Changes in long-term physical assets (maturity of one-year or longer) Credits purchase of home country assets by foreign residents, citizens, corporations or governments sale of foreign country assets by home country residents, citizens, corporations or governments

12. II Direct Investment and other long-term financial flows Debits purchase of foreign country assets by home country residents, citizens, corporations or governments sale of home country assets by foreign residents, citizens, corporations or governments

13. III Short-term nonofficial financial flows Transactions in short-term assets (less than one year) Credit - Increase in foreign holding of home assets Cheque from home to foreign bank bank transfer to foreign bank account holder, credit card payment to foreign resident from home credit card account

14. III Short-term nonofficial financial flows Transactions in short-term assets (less than one year) Debit - Decrease in foreign holding of home assets (Increase in home holding of Foreign assets) Cheque from foreign resident to home bank bank transfer from foreign bank account holder to home country account holder credit card payment to home resident from foreign credit card account

15. IV Changes in reserve assets of official monetary authorities (Central Banks) Credit: Foreign central bank acquires home country currency or assets, home central bank sells foreign assets Debit: Home country central bank acquires international currency or foreign assets.

16. Practice Place the following transactions as a credit or debit in the appropriate category in Canada�s Balance of Payments Keep track of the answers because we will use them to build a Balance of Payments Summary Statement in a few minutes

17. Practice 1. The Katos family of Moose Jaw, Saskatchewan, purchase a $800 computer from Dell. It is shipped from the U.S. They pay for it with their credit card. The credit card company transfers the money to Dell�s account in Canada.

18. Practice Bill Snow comes to Canada to study for his MA and PhD in Economics. He pays $12,000 for his tuition by cheque on his account in Canada.

19. Practice 3. Laura Brown goes for a long-awaited holiday somewhere warm outside the country, in February. She spends $2000 on food and lodging on credit card. The bank pays by cheque to the appropriate companies using its account in that country.

20. Practice 4.Mike Malloy of Steinbach, Manitoba receives a $600 dividend cheque from his Microsoft stocks. Microsoft pays using its U.S. bank account to Mike�s US bank account.

21. Practice Mike buys $15,000 of Microsoft stocks. He pays by cheque on his US account.

22. Practice TD Bank sells $ 10,000 US. to the Canadian Central Bank.

23. Balance of Payments Entries Summary

24. Balance of Payments Summary Statement We can now enter these examples into a summary sheet to examine our various balances. There are a number of balances of interest within Category I, the Current Account.

25. Balances in the Current Account Start at zero Include only exports and imports of goods Merchandise Trade Balance Add: exports and imports of services Balance on Goods and Services Add: international factor income receipts and payments Balances on Goods, Services and Investment income (or other factor income) Add: unilateral transfers received and made Current Account

26. . Now we can build a Balance of Payments Summary Statement, using our six example entries. Note, this is a conceptual framework to help you think about the balance of payments. The Canada and US examples we examine later will differ slightly from this framework.

27. Balance of Payments Summary Table I Exports of Goods Imports of Goods Merchandise trade balance Exports of Services Imports of Services Balance on goods and services Factor income receipts from abroad Factor income payments abroad Balance on goods, services and investment income continued�����

28. Unilateral transfers received Unilateral transfers made I Current Account Balance II Net increase in foreign long-term assets at home Net increase in long-term assets abroad II Balance on current account and long-term assets (Basic Balance) III Net increase in foreign short-term assets Net increase in short-term assets abroad III Official reserve transaction balance (Overall Balance) IV Net increase in foreign short-term official reserve assets Net increase in official reserve assets abroad Zero

29. Note on the Balance of Payments Both the US and Canada have stopped using this statement for the balance of payments In recognition of the change in financial flows and the difficulty in distinguishing short-term and long-term flows, they present different breakdowns for the capital part of the balance of payments

30. Current Account and National Income The current account provides information on the balance of consumption, saving, investment and government taxes and spending. Because a current account surplus means we are purchasing less than we are earning, this must mean there is a direct relationship between the current account and domestic national income. The Current Account still uses the same conceptual framework

31. Current Account and National Income Accounting Recall the basic macroeconomic equality: Y = C + I + G + X � M Y = national income C = consumption spending I = Investment spending on plant, equipment, etc. G = government spending on goods and services X = exports (credit items in Current Acc) M = imports (debit items in Current Account)

32. Rearrange Y � (C+I+G) = (X � M) The left side represents national income less spending. This is domestic savings The right is the current account balance. If a country has a current account deficit, then it is living beyond its means. This is the case in the U.S. since 1982.

33. Current Account and National Income Another approach Income can be written as: Y = C + S + T S = private savings T = taxes This means that income can be used for consumption, including imports, savings or taxes. We can combine this with the national income identity�

34. Current Account and National Income � to obtain C + I + G + (X � M) = C + S + T and rearrange to get (X � M) = S + (T-G) � I This tells us that the current account depends on Private savings (S) Public savings (T � G) less investment spending

35. Current Account and National Income (X � M) = S + (T-G) � I This shows that a positive current account balance means the country is saving more than it is investing. A negative balance means that the country�s net investment is partly being financed abroad (more than we are financing other countries� investments)

36. Other Balances Long-term assets: movements in this category reflect the judgments of long-term investor on the relative profitability of investments made in the country. Basic Balance = Balance on Current Account and Long-Term Capital Account

37. Overall Balance The Overall Balance is the balance on the current account, long-term capital account and short-term capital account. Category IV is really only significant in fixed exchange rate regimes. If a country has a flexible exchange rate, the imbalance in the first three categories causes an adjustment in the exchange rate.

38. One more Balance Financial Account Balance Categories II, III and IV In example - 15,000 - 12,000? + 27,500 - 10,000 = -9,800 Balance emphasized depends on topic analyst is addressing, there is no one balance that matters most

39. Current Account Deficit Good or Bad It depends CA deficit means a country is spending beyond its means But, it also could mean it is recovering from a recession before its partners (income increase boosts imports, partners still lagging) it is attracting a lot of financial investment country�s companies are liquidating capital investments abroad, moving money home

40. Current Account Deficit If financial surplus is due to investment, that can be good and even needed by most countries. However, investment implies future factor payments outward. Therefore continual CA deficits may be a cause for concern.

41. Balance of Payments We will examine the US Balance of Payments and the Canadian Balance of Payments. The Canadian Balance Sheet differs somewhat from the textbook case for the US.

42. US Balance of Payments(2003, billions of $) Current Account: Exports of goods +$ 713.1 Imports of goods - 1,260.7 Merchandise trade balance - $ 547.6 Exports of Services + 307.4 Imports of Services - 256.3 Bal on Goods and Services - 496.5

43. US Balance of Payments(2003, billions of $) Main deficit is on merchandise trade balance, services are in surplus� The main deficits for the US are with Japan, China, OPEC countries and Canada As of 2003 the main purchasers of US exports were Canada, Mexico and Japan. continue�

44. Japan � China light R OPEC Black Canada Grey 0 to -140 ($Billions)

45. US Balance of Payments(2003, billions of $) Current Account: Income receipts from abroad +$ 294.4 Income payments to foreign - 261.1 Bal on Goods, Services and factor income - $ 463.2 Unilateral transfers (net) (gov. -$27.2, private -$40.2 - 67.4 Current Account balance - $ 530.7

46. US Balance of Payments(2003, billions of $) Current Account: Income receipts from abroad +$ 294.4 Income payments to foreign - 261.1 Bal on Goods, Services and factor income - $ 463.2 Unilateral transfers (net) (gov. -$27.2, private -$40.2 - 67.4 Current Account balance - $ 530.7

47. US Balance of Payments(2003, billions of $) Capital and Financial Account: Capital account transactions net -$ 3.1 U.S official reserve assets, net (increase, - ) + 1.5 U.S government assets abroad, other than official reserve assets (increase,-) + 0.5 U.S. private assets abroad (inc,-) - $285.5 For. Official assets in the US, net (inc, +) + 248.6 Other foreign assets in the US, net (inc, +)+ 580.6 Statistical discrepancy - 12.0

48. What does this tell us? Foreign assets, in the US, both official and private increased significantly. It is a consolidation of both long-term and short-term assets. Official assets increased a lot for that category. The overall balance for the US was about -$250 billion in 2003.

49. Asset position: US Assets Abroad US official reserve assets $ 183.6 US govt asets abroad not off. 84.8 US private assets abroad $6,934.3 Total $7,202.7 For Assets in the US For official assets in the US $1,474.2 Other for assets in the US $8,159.2 Total for assets in the US $9,633.4 Net International investment position for the US -$2,430.7

50. The US is the biggest debtor nation on the planet. Disadvantage will need to pay investors later foreign countries own a lot of US $ and may use that leverage politically Advantages foreign investment contributes to US growth in output keeps interests rates lower than would be otherwise

51. Canada�s Balance of Payments Statistics Canada Table with Canada�s Balance of Payments is set up for you to examine. Check link from JUMP site or go to http://www.statcan.ca/Daily/English/061129/d061129a.htm

52. Canada�s Current Account Note when reading this article. The acquisition of asset is a debit. A credit transaction results in a liability. We receive the funds, the foreign investor has the asset.