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Balance of Payments: Introduction: A Country's Balance of Payments Is Commonly Defined As The Record of

The document discusses balance of payments, which records international transactions between a country's residents and foreign residents. It is divided into a current account and capital/financial account. The current account includes trade in goods/services and income/transfers. The capital/financial account includes capital transactions and changes in financial assets/liabilities. The US has experienced large and growing current account deficits for many reasons, including domestic economic growth outpacing foreign demand. While some are concerned about continued financing, the US remains an attractive destination for global savings due to its economic strength, investment protections, and high expected returns. Sustaining the deficit is possible if the US maintains economic strength relative to trading partners.

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77 views4 pages

Balance of Payments: Introduction: A Country's Balance of Payments Is Commonly Defined As The Record of

The document discusses balance of payments, which records international transactions between a country's residents and foreign residents. It is divided into a current account and capital/financial account. The current account includes trade in goods/services and income/transfers. The capital/financial account includes capital transactions and changes in financial assets/liabilities. The US has experienced large and growing current account deficits for many reasons, including domestic economic growth outpacing foreign demand. While some are concerned about continued financing, the US remains an attractive destination for global savings due to its economic strength, investment protections, and high expected returns. Sustaining the deficit is possible if the US maintains economic strength relative to trading partners.

Uploaded by

Pranav Mehta
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Balance Of Payments

Introduction: A country’s balance of payments is commonly defined as the record of


transactions between its residents and foreign residents over a specified period. A Country’s
balance of payments summarizes its international transactions. Countries prepare balance of
payments on monthly, quarterly and yearly basis.
Each transaction is recorded in accordance with the principles of double-entry
bookkeeping, meaning that the amount involved is entered on each of the two sides of the
balance-of-payments accounts. Consequently, the sums of the two sides of the complete balance-
of-payments accounts should always be the same, and in this sense the balance of payments
always balances.
However, there is no bookkeeping requirement that the sums of the
two sides of a selected number of balance-of-payments accounts should be the same, and it
happens that the (im)balances shown by certain combinations of accounts are of considerable
interest to analysts and government officials. It is these balances that are often referred to as
“surpluses” or “deficits” in the balance of payments.
It can focus on the following main aspects :
1) Economic and financial situation of a country in short run.
2) It refer to income and expenditure or changes in levels of outstanding assets and
liabilities.
3) Changes in supply and demand for foreign exchange, hence an impact on exchange rates,
reserve assets and on foreign exchange markets.
4) Capital flight and debt crises.

Theory
The BOP is divided into two main categories according to the broad nature of the transactions.
These categories are:

1. The Current Account


2. The Capital and Financial Account

1. Current Account
The current account includes
 Merchandise Trade. Merchandise trade records the value of exports and imports, of
tangible goods. The difference between exports and imports of tangible goods is the trade
balance.
 Goods and Services covers Travel services,Communication services,Construction
services,Insurance services ,Financial services, Computer and information
services,·Royalties and licences fees, Personal, cultural and recreational services, and
Government services
 Income covers the compensation of employees, i.e. salaries, wages and benefits of
seasonal and other nonresident workers.
 Current transfers-.Current transfers cover transactions such as taxes on income,
workers' remittances, and premiums and claims on non-life insurance.
2. Capital and Financial Account :
The Capital and Financial Account records transactions that directly affect the wealth and debt of
the country. The account is sub-divided into two main categories:
 The Capital Account- The Capital Account covers
1) Capital transfers - Capital transfers include the transfer of ownership of fixed assets,
the transfer of funds linked to disposal/acquisition of fixed assets and the
cancellation of debt by creditors
2) The acquisition/disposal of non-produced, non-financial assets.It mainly involves
intangibles such as patents and leases. It also includes purchases and sales of land by
foreign embassies.

 The Financial Account:


The Financial Account covers
(i) Direct investment,
(ii) Portfolio investment,
(iii) Other investments (trade credits, loans, currencies and deposits)
(iv) Changes in reserves.

The U.S. Current Account Deficit.

1) What are the causes of the U.S.current account deficit?

1) Escalating Current Account Deficits (2000-2005)


 In 2000, the dot-com, bubble burst mild recession in 2001 and 2002.
 Oil prices increased the value of U.S. petroleum imports from $68 billion in 1999 to
$104 billion in 2002.
 The respond of government was with a fiscal stimulus in the form of tax cut and the
Federal Reserve in the form of low interest rates.
 Between 2000 and 2004, all for the net supply of the US treasury was purchased by
foreigners and between 80% and 90% by foreign central banks.
 Low interest rates shown clearly in residential real estate many purchased against the
asset and let asset price appreciation substitute for a savings It drove high levels of house
hold debt.
 In contrast to Asian central banks and European central banks did not intervene the issue
.the dollar depreciated 54% against euro and 36%against the pound in 2004.
2) The interwar period: after war was over inflation in Europe and high level of European
debt to the United States.
3) New gold standards and intervene of the US in it also created the problem.
4) In the initial years of the Breton woods arrangement, current account regulated but after
European demand shortage of dollar created the economic problem.
5) Also Vietnam War which major increases in the military expenditure .dollar became over
valued and buying dollar increased the foreign domestic supply, which led to inflation
abroad.
2) Has it been the financial crises in the U.S. ?

 If we consider the inter war period for the financial crises as the war started the world
wide holding of the foreign assets fell .the gold standards fell monetary policy around the
world became directed towards the domestic goals.
 After the war ended inflation in Europe and high debt of Europe to the U.S.and new gold
policy .To stop the out flow of the gold US intervened and that created excess credit in
the country. In 1928 and 1929 , the federal reserve raised the interest rates to respond the
speculative bubble but failed to stop the stock market crash.
 Bretton Wood s system of fixed exchange rates 1951 initially it worked very well After
1965, the US economy began to overheat and inflation began to rise in the face of the
major increase in social spending and increasing military expenditure of Vietnam war.
Later in the 1971 new par values were set for currencies not backed by gold and that
forced the system collasp.1973 oil crises exuberated the things.
 Recently crash of the house debt .dot com bubble burst leading to mild recession.
 Taking in to consideration all above the reasons question one’s answer was supporting
the fact that financial crises of the US.

3) Will the world keep funding U.S in the same manner as in the past?
Answer : In 1993,95 % of domestic saving around the world in to domestic saving .By 2002 it
fall to the 80 %.In Particular Global savings flowed into the United states with it’s favorable
investment climate, strong investor policy protection framework, and expected real rates of
returns higher than any other countries. In 2004 ,former U.S. Treasury secretary Larry Summers
used the term “balance of Financial terror “to refer the situation in which the united states was
relying on the cost to rest of the world of not financing the U.S. current account deficit as
assurance that financing would continue. There was no guaranty that the Asian central Bank
would continue support the dollar. In mid March 2005 ,Yoon Jeung Hyun ,south korea’s top
banking regulator ,Japanese Prime minister Junichiro Koizumi and recently in 2009 China’s
priemer Wen Jiabao shown the concern over the investment in US. President Obama retorted that
“ There is no safer place in the world for investment other than US.”
Regardless of valuation effects U.S. liabilities to foreigners remain far in excess of U.S.
claims on foreigners. The net investment income portion of the current account of the US
remained positive.US received more income from its investment abroad than foreigners received
on their U.S. assets.(Exhibit 4 a). This shows that world will keep funding the US as in the past.

4) Will US be able to sustain its current account deficit ?


Answer : The U.S. current account deficit grew throughout most of the 1990s and into 2000. But,
clearly, the U.S. current account deficit as a share of GDP cannot increase forever without
disrupting the U.S. economy or the global economy. A sustainable current account is one that
changes in an orderly fashion through market forces without causing harsh movements in other
economic variables, such as the exchange rate.
Following are some of the points that will give strength to sustain current account deficit:-
1) First, in general, the average experience of industrial economies on which the estimate is
based might not be applicable to the United States because the United States’ economic
and financial importance in the world economy may make it “different.”
2) Second, the economic situation in the United States in the 1980s and early 1990s is quite
different from the economic situation today.
3) Third, the United States holds a special position in international financial markets. As the
dollar is an international reserve currency, the demand for dollars and dollar-denominated
assets is relatively strong.
4) After remaining low and stable in the early 1990s, the net international debt-GDP ratio
for the United States rose throughout most of the decade. By 1998, net international debt
had reached a 20-year high of 12.6 percent of GDP. In 1999, net international debt fell
slightly, to 11.6 percent of GDP. A net international debt-GDP ratio of nearly 12 percent
might suggest that the U.S. external position is unsustainable. However, comparing the
U.S. net international debt-GDP ratio with that of other countries reveals that the U.S.
situation is not particularly troubling.
5) Because foreign investors recognize that U.S. assets are relatively safe and offer
favorable yields compared with many other countries’ assets, net capital inflows into the
United States are likely to remain healthy at least in the near future.

The most likely scenario is that the U.S. current account deficit will narrow within the
next few years, in an orderly manner. Therefore U.S will be able to sustain current
account deficit.

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