Balance of Payments: Current vs Financial Accounts

Trade Deficit

• The US generally has a trade deficit, meaning it imports more than it exports.
• This has led to trade controversies and tariffs aimed at changing the balance of trade.
• The trade deficit in the US is increasing.

Balance of Payments

• The balance of payments summarizes a country's entire international trade situation, considering all international transactions.
• It is calculated annually and denominated in the country's currency (e.g., the US dollar).
• The balance of payments is divided into two main accounts:
  • Current Account
  • Financial Account

Goal

• To understand the differences between the current and financial accounts and their components.

Other International Transactions

• Besides traded goods and services, other transactions between countries include:
  • Money transfers (e.g., remittances to friends or relatives)
  • Investments

Current Account

• The current account has three components:
  • Trade in Goods and Services (Net Exports):
    • The difference between a country's export of goods and services and its imports.
    • Examples: Toys imported from China, US cars exported to Mexico.
  • Investment Income:
    • Income earned from investments in another country.
    • Examples: Income from factories, bonds, or partial ownership of a company.
    • If a Japanese or Korean company (e.g., Kia) earns money in the US, that investment income is part of the current account and it flows out of the US.
  • Net Transfers:
    • Includes official programs, grants, individual donations, and money flowing between countries.
    • Can be private or public.

Financial Account (Capital Account)

• The financial account involves the buying and selling of financial assets, which are expected to continue earning money.
• Examples include buying a factory or purchasing bonds.

Foreign Direct Investment

• A foreign company buys and operates a business in another country.
• Kia building factories in the US is an example of foreign direct investment.
• It represents the difference between the purchase of foreign assets by American investors and domestic assets purchased by foreigners, known as net capital outflow.

Financial Account Surplus and Deficit

• Surplus: More money is flowing into the country than out.
• Deficit: More money is flowing out of the country than in.

Relationship between Current Account and Financial Account

• There is an inverse relationship between the current account and the financial account.
• When a country has a current account deficit (like a trade deficit), it tends to have a financial account surplus.