The Balance of Payments

(or chapter 3)

Talk Agenda
How nations measure intl economic activity? Define Current Account, Capital/Financial Account? How can one use the BOP sub-accounts to make
financial decisions? What leads to capital flight? Some History. Some Q & A (I ask the Q, you give the A)

The Balance of Payments

Balance of Payments (BOP):
measures all international economic transactions b/n residents & foreign residents.

Monetary and fiscal policy must take the BOP into

account at the national level BOP data may be important
Indicates pressure on exchange rate May signal imposition/ removal of controls over payments, dividends, interest. Helps forecast countrys market potential
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For example
BOP transactions (US side)

Daimler-Chrysler purchases manufacturer in Chicago. GM China pays dividends to parent in US. An American tourist purchases a necklace in India. A Mexican lawyer purchases US bond via investment broker in Cleveland.

Rule of thumb: follow the cash flow

B of P
A. Current Account A. B. C.
B.

Net exports/imports goods&services (Balance of Trade) Net Income (investment income from direct portfolio investment plus employee compensation Net transfers (sums sent home by migrant abroad)

Capital Account Capital transfers related to purchase and sale of fixed assets such as real estate

C.

Financial Account
A. B. C. Net foreign direct investment Net portfolio investment Other financial items

Basic Balance = A+B+C

D.

Net Errors and Omissions Missing data such as illegal transfers

Overall Balance = A+B+C+D

E.

Reserves and Related Items

Changes in official monetary reserves including gold and foreign exchange reserves
(A:E) = Overall Balance
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BOP Accounting
The BOP must balance How to measure international economic activity?
Is it an international economic transaction? How do flow of goods/services/assets/money translate
in debits & credits? Bookkeeping procedures for BOP?

Mistakes are common BOP is a flow statement, not a stock statement.

Main transactions in BOP:
Exchange of real assets. Exchange of financial assets.
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The Current Account

Goods Trade or Balance of Trade (BOT) export/import of goods. Services Trade export/import of services (financial, construction, and tourism). Income predominately current income associated with investments made in previous periods, + wages & salaries paid to non-resident workers. Current Transfers financial settlements due to change in ownership of real resources or financial items. Any transfer b/n countries which is one-way, a gift or a grant. CA typically dominated by export/import of goods, for this reason Balance of Trade (BOT) is widely quoted.

Trade balance

For example

Debit: Sun Microsystems buys LCDs from Hong Kong. Credit: Singapore Airlines buys Boeing jet. Trade in services Debit: American rents an apartment in Singapore. Credit: TUI - Germany places an ad in the NYT.

Income payments
Debit: Honda US pays dividend to Honda Japan. Credit: Bank Austria pays salary to rep in NY office.

Unilateral Current Transactions

Debit: Peace Corps pays US volunteer teachers in Bosnia. Credit: TotalFina pays tuition of employee for Stern MBA.
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The Current Account

US Current Account, 1997-1999 (US$ bn)

Goods exports Goods imports Goods trade balance (BOT) Services exports Services imports Services trade balance Income receipts Income payments Income balance Current transfers, credits Current transfers, debits Net transfers

1997 682 (876) (194) 255 (167) 88 257 (251) 6 8 (49) (41)

1998 672 (917) (245) 261 (183) 78 258 (265) (7) 9 (53) (44)

1999 687 (1030) (343) 270 (191) 79 276 (295) (19) 9 (57) (48)
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U.S. Trade Balance vs. Balance on Services & Income, 1985-99 (US$ bn)
$150 $100 $50 $0 -$50 -$100 -$150 -$200 -$250 -$300 -$350 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
Balance on goods Services & income

Source: International Monetary Fund, Balance of Payments Statistics Yearbook, 2000.

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The Capital/Financial Account

Capital account: transfers of fixed assets, real estate,
acquisitions/disposal of non-produced/non-financial assets Financial account: three components; classified by degree of control,

Direct Investment Net balance of capital which is

dispersed from and into US for the purpose of exerting control over assets.
E.g. US company acquires foreign company stake (-) Foreign company acquires US company stake (+) foreign direct investment (FDI): 10%+ of voting shares acquired.
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The Capital/Financial Account

Portfolio Investment Net balance of capital which
flows in/out of US but does not reach 10% ownership.
No voting or control rights over the asset. Purchase/sale of equity securities. Purchase/sale of debt securities.
E.g. T-bill purchases by foreigners (net portfolio investment) E.g. US$ debt issues by foreign companies/ governments.

Risk/Return motivated. Far more volatile than FDI.

Other Investment Assets/Liabilities Short & longterm trade credits, cross-border loans, currency & bank deposits, & other accounts receivable and payable in cross-border trade.
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Direct Investment Concerns

How much shall the country control the direct
investments?
What can foreigners buy?
Land, real estate sale to foreigners limited (Eastern Europe) Certain stock can not be purchased (China, Russia)

How shall profit be distributed?

Profit drain? Many foreign firms in US reinvest most of their profits.

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The Capital/Financial Account

US Capital/Financial Account, 1997-1999 (billions of US$)

Direct investment abroad Direct investment in the US Net direct investment Portfolio Investment Assets purchased by US residents, net Assets purchased by foreign residents, net Net portfolio investment Other Investment Other investment assets Other investment liabilities Net other investment Financial Account Balance

(105) 106 1

(146) 186 40

(151) 276 125

(119) 386 267

(136) 269 133

(129) 342 213

(264) 265 1 269

(47) 27 (20) 153

(159) 136 (23) 315

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For example
Direct Investment
Debit: Ford builds factory in Australia. Credit: Ford sells its factory in UK.

Portfolio Investment
Debit: US investor buys BASF stock @ Frankfurt Stock Exchange

Credit: Korean govt buys US T-bills to hold as forex reserves.

Other investment Debit: HP deposits $10m in a bank account in London. Credit: HP generates accounts receivable in Canada.
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US Financial Account, 1985-99 (US$ bn)

$300 $250 $200 $150 $100 $50 $0 -$50 -$100 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
Net direct investment Net portfolio investment Net other investment

Source: International Monetary Fund, Balance of Payments Statistics Yearbook, 2000.

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Current & Financial/Capital Account Balances, US, 1992 - 1999 (US$ bn)
$400 $300 $200 $100 $0 -$100 -$200 -$300 -$400 1992 1993 1994
Current account

1995

1996

1997

1998

1999

Financial/capital account

Source: International Monetary Fund, Balance of Payments Statistics Yearbook, 2000.

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The Other Accounts

Net Errors and Omissions Account is used to
account for statistical errors and/or untraceable monies within a country Official Reserves (ORA) total reserves held by official monetary authorities within a country.

Comprised of major currencies used in international

trade and financial transactions, & reserve accounts (SDR) held @ IMF.
Important indicator for countries w/ fixed exchange rate regimes
Need to maintain parity rate w/ official reserves.

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The Balance of Payments in Total

A. Current Account Goods exports FOB Goods imports FOB Goods trade balance (BOT) Services exports Services imports Services trade balance Income credit Income debit Balance on Goods, Services & Income Current transfers, credits Current transfers, debits B. Capital Account Capital account credit Capital account debit Total, Groups A plus B C. Financial Account Direct invesment Direct investment abroad Direct investment in the US Portfolio investment assets Equity securities Debt securities Portfolio investment liabilities Equity securities Debt securities Other investment assets Monetary authorities General government Banks Other sectors Other investment liabilites Monetary authorities General government Banks Other sectors Total, Groups A through C D. Net Errors and Ommisions Total, Groups A through D E. Reserves and Related Items 1997 (140.55) 681.65 (876.37) (194.72) 255.29 (166.51) 88.78 257.35 (251.16) 6.19 8.47 (49.27) 0.35 0.35 0.00 (140.20) 269.04 1.02 (105.02) 106.04 (118.98) (57.58) (61.40) 385.60 67.85 317.75 (263.94) 0.00 0.07 (141.12) (122.89) 265.34 (18.85) (2.86) 171.31 115.74 128.84 (127.83) 1.01 (1.01) 1998 (217.13) 672.29 (917.19) (244.90) 260.69 (182.68) 78.01 258.45 (264.66) (6.21) 9.33 (53.36) 0.64 0.64 0.00 (216.49) 153.59 40.27 (146.05) 186.32 (136.00) (101.24) (34.76) 269.33 41.95 227.38 (46.60) 0.00 (0.42) (35.57) (10.61) 26.59 6.88 (3.48) 30.27 (7.08) (62.90) 69.65 6.75 (6.73) 1999 (331.48) 686.66 (1029.92) (343.26) 269.58 (191.30) 78.28 276.17 (294.65) (18.48) 9.41 (57.43) (3.50) 0.49 (3.99) (334.98) 314.64 124.64 (150.90) 275.54 (128.59) (114.40) (14.19) 342.19 98.07 244.12 (159.45) 0.00 2.75 (69.86) (92.34) 135.85 24.71 (1.37) 80.10 32.41 (20.34) 11.63 (8.71) 8.73

US Balance of Payments, Analytic Presentation, 1997-1999

Q: Why did FDI increase so much?

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What if?
BOP shows surplus:
D > S for that currency. Allow currency value to increase, Or accumulate foreign reserves.

BOP shows deficit:

S > D for that currency. Devalue currency, Or use official reserves to support currency.

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Capital Mobility
Very important for BoP these days Some history on it
1860-1914 increasing capital openness, countries
adopted gold standard 1914-1945 couple of wars & depression 1945-1971 Annees des miracles of international trade 1971-2003 floating exchange rates, financial volatility, rapidly expanding capital flows

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Capital Mobility
Capital Mobility High
Gold Standard 1880-1914

1900

1914

Float 1971-2000

2000

1929

Low

1880

Bretton Woods 1945-1971

1860

1918

Interwar, 1914-1945

1971

1980

1960

1925

1945
1960 1980 2000

1860

1880

1900

1920

1940

Source: Globalization and Capital Markets, Maurice Obstfeld and Alan M. Taylor, NBER Conference Paper, May 4-5, 2001, p. 6.

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Capital Flight
How to move capital across borders:

International payments, regular bank transfers. Transfer by bearer (smuggling). Transfer of collectibles/ precious metals. Money laundering
Off-shore zones & tax heavens.

Invoicing international trade transactions.

Transfer pricing

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Where can I find this in BOP?

Calpers (the Cal mutual fund) buys shares of stock on the Tokyo & London stock exchanges? American tourist pays hotel in Paris w/ AMEX credit card (US issued)?

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