Balance of Trade & Balance of Payments

BALANCE OF TRADE:
The difference between the value of goods and services exported out of a
country and the value of goods and services imported into the country. The
balance of trade is the official term for net exports that makes up the
balance of payments. The balance of trade can be a "favorable" surplus
(exports exceed imports) or an "unfavorable" deficit (imports exceed
exports). The official balance of trade is separated into the balance of
merchandise trade for tangible goods and the balance of services....
A balance of trade surplus is most favorable to domestic producers
responsible for the exports. However, this is also likely to be unfavorable to
domestic consumers of the exports who pay higher prices.
Alternatively, a balance of trade deficit is most unfavorable to domestic
producers in competition with the imports, but it can also be favorable to
domestic consumers of the exports who pay lower prices....
Balance of Payments
The balance of payments accounts of a country record the payments and
receipts of the residents of the country in their transactions with residents
of other countries. If all transactions are included, the payments and
receipts of each country are, and must be, equal. Any apparent inequality
simply leaves one country acquiring assets in the others. For example, if
Americans buy automobiles from Japan, and have no other transactions
with Japan, the Japanese must end up holding dollars, which they may
hold in the form of bank deposits in the United States or in some other U.S.
investment. The payments of Americans to Japan for automobiles are
balanced by the payments of Japanese to U.S. individuals and institutions,
including banks, for the acquisition of dollar assets. Put another way,
Japan sold the United States automobiles, and the United States sold
Japan dollars or dollar-denominated assets such as Treasury bills and New
York office buildings....
Although the totals of payments and receipts are necessarily equal, there
will
be
inequalitiesexcesses
of
payments
or
receipts,
calleddeficits or surplusesin particular kinds of transactions. Thus, there
can be a deficit or surplus in any of the following: merchandise trade
(goods), services trade, foreign investment income, unilateral transfers
(foreign aid), private investment, the flow of gold and money between

central banks and treasuries, or any combination of these or other

international transactions.
It comprises three subordinate sets of accounts: the current account, the
capital account, and the official settlements account. All transactions a
country has with the rest of the world during the accounting period (such
as a year) are recorded in these accounts.
The current account is divided into three components: the largest, net
exports (the value of goods and services exported minus the value of
goods and services imported); net interest payments (interest received
from foreign investments minus payments of interest to foreigners on their
investments in the domestic economy); and a relatively small catch-all
category called "other transfers" (mainly gifts and foreign aid paid to and
received from foreigners).
The capital account records the amounts a country borrows from the rest
of the world and the amounts loaned to the rest of the world. These
borrowings and loans are both private and government.
The official settlements account records changes in the governments
holdings of foreign exchange reserves (gold and assets denominated in
foreign currencies).
The balance of payments accounts always achieve an overall balance
because any difference between the balance on current account and the
balance on capital account results in a change in the official settlements
account in whatever amount is necessary to bring the total of payments to
the rest of the world equal to the total of payments received from the rest of
the world. Thus, if a country has a deficit on current account of 20 billion
dollars and a surplus on capital account of 18 billion dollars, the official
reserves will drop by 2 billion dollars.