Transcript Lecture #3

THE BALANCE OF PAYMENTS
J.D. Han,
King’s University College
12-1
Key Questions
• What is the Balance of Payment?
Supply and Demand of FOREX
2 methods of BP Accounts
• What ‘market’ does the BP affect?
FOREX
• What is the equilibrium of the BP?
• What will happen to FOREX rate if the
BP is not in equilibrium.
12-2
Balance of Payments Accounts
• A country’s balance of payments accounts
shows its payments to and its receipts from
foreigners.
• It shows the flow of “Money”, international
currencies or foreign exchanges.
12-3
Balance of Payments Accounts (cont.)
• The ‘New Format’ of Balance of Payment
Accounts are separated into 3 broad accounts:

current account: accounts for flows of goods and
services (imports and exports).

financial account: accounts for flows of financial
assets (financial capital).

capital account: flows of special categories of
assets (capital), typically non-market, nonproduced, or intangible assets like debt
forgiveness, copyrights and trademarks; minor for
the U.S. Economy
12-4
* A little More details:
•
•
Each of the 3 broad accounts are more finely
divided:
Current account: imports and exports
merchandise (goods like DVDs)
2. services (payments for legal services, shipping
services, tourist meals,…)
3. income receipts (interest and dividend payments,
earnings of firms and workers operating in foreign
countries
4. net unilateral transfers
gifts (transfers) across countries that do not
purchase a good or service nor serve as income
1.
Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.
12-5
Balance of Payments Accounts (cont.)
• Financial account: the difference between sales of
domestic assets to foreigners and purchases of
foreign assets by domestic citizens.
• Financial (capital) inflow


Foreigners loan to domestic citizens by acquiring domestic
assets.
Foreign owned (sold) assets in the domestic economy are a
credit (+)
• Financial (capital) outflow


Domestic citizens loan to foreigners by acquiring foreign
assets.
Domestically owned (purchased) assets in foreign economies
are a debit (-)
Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.
12-6
•
Financial account has
3 categories mixed together:
1.
All other (“Spontaneous”) financial assets
(transactions) by the Private Sector
2.
Official (international) reserve assets by the
Government
3.
Statistical discrepancy
12-7
• Official (international) reserve assets:
foreign assets held by central banks to
cushion against instability in international
markets.

Assets include government bonds, currency, gold
and accounts at the International Monetary Fund.

Official reserve assets owned by (sold to) foreign
central banks are a credit (+); Capital Inflow.

Official reserve assets owned by (purchased by)
the domestic central bank are a debit (-): Capital
Outflow.
- Overall + means the government is getting
credit from elsewhere (as outstanding debt), or
running down on the accumulated reserve
holdings.
Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.
12-8
Balance of Payments Accounts (cont.)
• The negative value of the official reserve assets is
called the official settlements balance or “balance
of payments”.

It is the sum of the current account, the capital account, the
non-reserve portion of the financial account, and the
statistical discrepancy.

A negative official settlements balance may indicate that a
country is depleting its official international reserve assets or
may be incurring debts to foreign central banks.
• selling foreign currency by the domestic central bank and
buying domestic assets by foreign central banks are
credits for official international reserve assets, and
therefore reduce the official settlements balance.
12-9
How Do the Balance of Payments
Accounts Balance?
1) “Identity”:
Meaning “the left is equal the right all at times”
Due to the double entry of each transaction, the Balance of
Payments Accounts will balance out at all times:
current account + financial account + capital account = 0
2) “Equilibrium Condition”:
The Balance of Payment is in equilibrium when
Current account + All other ‘Spontaneous’ financial assets
transaction account = 0
Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.
12-10
1. Current Account Balance
2. All other ‘spontaneous’ financial transactions Account in the
private sector
____________
(‘the above line’ Balance of Payment
= Official Settlement Balance)
3. Credits(+)/Debits(-) from Official Reserves
1+ 2 + 3 = 0 all the time
Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.
12-11
The above means
Items of 1+2 and item 3 are the mirrored
terms: of the same size, but of the
opposite sign.
Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.
12-12
• Credits in the Official Reserves(flows)
are equivalent to Cashing your
savings/wealth:
• When you are in deficits, you cash Your
Office Reserves(stock), or issue IOUs
and thus get Credits from Official
Reserves(flows):
“Your Official Reserves decrease(-) as you get
Credits from the Official Reserves(+)”
Modified by JD. Han based on Materials provided by Pearson Addison-Wesley.
12-13
U.S. has a very small stock of
International Reserves (of FOREX)
http://en.wikipedia.org/wiki/Foreign_excha
nge_reserves
http://www.ustreas.gov/press/releases/201
06291240258293.htm
Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.
12-14
• The Balance of Payment is the
important measure of ‘immediate’
pressures on a country’s Official
Reserves and thus on that country’s
FOREX rates.
* Overall or long-term pressure on the
country’s FOREX rate is measured by
the Current Account Deficits:
eg) pp.298 of Salvatore’s book (7th
edition)
12-15
Let’s take two examples of the U.S. BOP
table(2003; 2005), and read them so
that we can make a sense out of it:
Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.
12-16
US Balance of Payments Accounts, 2003
in Billions of Dollars
Modified by J.D. Han based on Materials provided by Pearson Addisn-Wesley.
12-17
US Balance of Payments Accounts, 2003
in Billions of Dollars (cont.)
Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.
12-18
U.S. Balance of Payment, 2005
Salvatore’s Page P. 457
Current Account Balance = $-791 billions
The ‘Spontaneous’ Financial Account Balance = + 567 billions
(‘The above line’ Balance of Payment = -224 billions )
_______________________________________________
Changes in Official Reserves = +213 billions
Statistical Errors = 11 billions
_________________________________
Net = 0
Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.
12-19
How to interpret this BP Table?
• The U.S. citizens and government could
buy foreign goods and services by $ 791
billions more from abroad than what
they sell to abroad. They got financing
by selling $ 567 billions of financial and
real assets to abroad.
• And the shortage of $ 213 billions had to
be funded by the government’s rundown and borrowings on the ‘safe’ of
“Official Reserves”.
BP disequilibrium and Pressures on
FOREX rates
• At disequilibrium, the price would
change so that the disequilibrium be
eliminated.
• BP deficits put upward pressures on
FOREX and downward pressure on
domestic currency.
Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.
12-21
Summary
• ‘Above the line BP’ = CA + ‘Spontaneous Part’ of FA
= CA + (Financial Account – Official Reserve
Assets )
• BPA = BP + Net Official Reserve Asset Credit
= 0 at all times
Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.
IMF Method of BP Account
• Current Account
• Capital Account
• Financial Account
• Errors
• Reserves
Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.
12-23
IMF’s Financial Account
1. (Foreign) Direct Investment abroad(outflows)
(Foreign) Direct Investment in the nation(inflows)
2. Portfolio Investment Assets(outflows)
Equity Securities; Debt Securities
Portfolio Investment Liabilities (inflows)
Equity Securities; Debt Securities
3. Financial Derivatives Asset
Financial Derivate Liabilities
4. Other Investment Assets
Banks; Government and Monetary Authorities
Other Investment Liabilities
Bank s