UNIT 7: BALANCE OF PAYMENTS NOTES (4/9/15)

• Measure of money inflows and outflows b/w the U.S and the rest of the world (ROW)
• inflows -> credits
• outflows -> debts
• Divided into three accounts
• (1) current account
• (2) capital/financial account
• (3) official reserves account

Double-Entry Bookkeeping

• Every transaction in the B.O.P is recorded twice on accordance w/ standard practice
• Ex.: US manufacturer, John Deere, exports $50 million worth of farm equipment to Ireland
• credit of $50 million to the current account (-$50 million worth of farm equipment or physical assets)
• debt of $50 million to the capital/financial account (+$50 million worth of Euros or financial assets)

Current Accounts

• Balance of Trade/ Net Exports
• exports of goods/services - imports of goods/services
• exports create a credit to B.O.P
• imports create a debt to B.O.P
• Net Foreign Income
• income earned by US owned foreign assets - income paid to foreign held US assets
• Ex.: Interest payments on US owned Brazilian bonds - interest payments on German owned US Treasury bonds
• Net Transfers (tend to unilateral)
• foreign aid -> debt to the current account
• Ex.: Mexican immigrant workers send money to family in Mexico

Capital/Financial Accounts

• Balance of capital ownership
• Includes purchases of real (property) and financial (stocks) assets
• Direct investment in the US is a credit to capital account
• Ex.: Toyota factory in San Francisco
• Direct investment by US firms/individuals in a foreign country are debts to the capital account
• Ex.: Intel factory in San Jose, Costa Rica
• Purchase of foreign financial assets represents a debt to the capital account 
• Ex.:Warren Buffet buys stocks in Petrochina
• Purchase of domestic financial assets by foreigners represents a credit to the capital account
• Ex.: United Arab Emirates Sovereign Wealth Fund purchases a large stake in NASDAQ

Relationship B/w Current & Capital Account

• Current account and capital account should zero each other out 
• If the current account has a negative balance (deficit), than the capital account should have a positive balance (surplus)

Official Reserves

• Foreign currency holdings of the US Federal Reserve System 
• When there is a B.O.P surplus the Fed accumulates foreign currency and debts the B.O.P
• When there is a B.O.P deficit the Fed depletes its reserves of foreign currency and credits the B.O.P

Active vs. Passive Official Reserves

• US is passive in its use of official reserves; does not seek to manipulate the dollar exchange rate
• China is active in its use of official reserves; actively buys and sells dollars in order to maintain a steady exchange rate with the US