Detailed Notes on the Balance of Payments

Balance of Payments (BoP)

  • Definition: Measures monetary inflows and outflows between the United States and the rest of the world.
    • Inflows: Referred to as CREDITS.
    • Outflows: Referred to as DEBITS.

Structure of the Balance of Payments

  • Accounts:
    • Current Account: Tracks the export and import of goods and services, net investment income, and unilateral transfers.
    • Financial Account: Previously called the capital account; tracks investment flows and ownership of assets.

Current Account Overview

  • Components:
    • Exports and Imports:
    • Includes both goods and services.
    • Balance of Trade:
      • Exports create a credit (money flowing in).
      • Imports create a debit (money flowing out).
    • Net Investment Income:
    • Income from U.S. owned foreign assets (credit): Example - Interest on U.S. bonds in Brazil.
    • Income paid to foreign-held U.S. assets (debit): Example - Interest on German-owned U.S. Treasury bonds.
    • Unilateral Transfers:
    • Ex: Foreign aid and remittances which are typically analyzed as one-way payments.

Example of Global Remittances (2016 data)

  • Countries with high remittance inflows as a % of GDP:
    • Nepal: 31%
    • Kyrgyzstan: 30%
    • Tajikistan: 27%
    • Liberia: 26%
    • Haiti: 29%

Key Characteristics of Current Accounts

  • No Future Liabilities: Current accounts do not incur future liabilities.
  • Liabilities vs. Assets:
    • Liability: Something owed (debt).
    • Asset: Something owned (machinery, property).

Financial Account Overview

  • Future Liabilities: Some transactions create future obligations.
  • Types of Investments:
    • Direct Investments: Investment in real assets (e.g., factories).
    • Financial Investments: Purchase of bonds, stocks, etc.

Examples of Financial Account Transactions

  • Credits and Debits:
    • Direct investment by foreigners in the U.S. is a credit (e.g., Toyota factory in San Antonio).
    • Direct investment by U.S. firms abroad is a debit (e.g., Intel in Costa Rica).
    • Purchase of foreign assets (e.g., Warren Buffet buying stock in Petrochina) is a debit; foreign purchase of U.S. assets (e.g., UAE buying NASDAQ stock) is a credit.

Relationship Between Current and Financial Account

  • Zero-sum Balance:
    • A negative balance in the current account (deficit) should align with a positive balance in the financial account (surplus).
    • Example: Inflow of foreign capital allows for higher imports than exports.

Recording Transactions on the U.S. Balance of Payments

  • Paris Hilton buys shares in Samsung:
    • Debit (Financial)
  • Queen Elizabeth II imports a Ram from the U.S.:
    • Credit (Current)
  • Homer buys a Bentley:
    • Debit (Current)
  • Air India buys a Boeing:
    • Credit (Current)
  • Interest on a Chinese bond:
    • Credit (Current)
  • Buying a Chinese bond:
    • Debit (Financial)
  • Buying a home in Shanghai:
    • Debit (Financial)