D - Salvatore Ch13 Unedited

CHAPTER T H I R T E E N
13 International Economics
Twelfth Edition
Balance of Payments
Dominick Salvatore
John Wiley & Sons, Inc.
Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.
Learning Goals:
◼ Understand what the balance of payment is and
what it measures
◼ Describe the change in the U.S. balance of
payments over the years
◼ Understand the importance of the serious
deterioration of the trade balance and net
international investment position of the United
States in recent years.
13.1 Introduction
◼ The balance of payments provides a summary

statement of international transactions for a
nation for a specified period of time.
◼ An international transaction is the exchange of a
good, service or asset between residents of one
nation and residents of another nation.
◼ The main purpose of the balance of payments is
to help the government in formulation monetary,
fiscal and trade policies.
13.2 Balance of Payments Accounting
◼ In 2014, the Bureau of Economic Analysis BEA)

introduced a comprehensive restructuring of the
international economic accounts
◼ Credit transactions (+)

Transactions that involve receipt of payments
◼
from foreign sources.
◼ Debit transactions (-)
◼ Transactions that involve payment to foreign
sources.
◼ Credits
◼ Exports of goods and services
◼ Payments from abroad

◼ Income from investments in other countries
◼ Transfer payments from people or agencies abroad
◼ Financial inflows
▪ Increase in foreign assets in a nation
▪ Reduction in a nation’s assets abroad
◼ Debits
◼ Imports of goods and services
◼ Transfers to abroad
◼ Income paid on foreign investments
◼ Transfer payments to people or agencies abroad
◼ Financial outflows
▪ Increase in a nation’s assets abroad
▪ Reduction in foreign assets in a nation
◼ Current Account
◼ Imports and exports of currently produced goods
and services
◼ Primary income, investment income received
from and paid to foreign residents
◼ Secondary income, transfer payments sent and
received from abroad
◼ Capital Account
◼ Acquisition and disposal of nonproduced
financial assets and capital transfers received and
payable from abroad.
◼ Includes debt forgiveness and goods and financial
assets that migrants take with them as they leave
or enter the country.
◼ Usually very small as compared to the current and
financial accounts.
◼ Net lending (+) from current-and-capital-

account transactions
◼ Total credits exceed total debits in the country’s
current and capital accounts.
◼ The nation is extending credit to other countries.
◼ Net borrowing (-) from current-and-capital-

account transactions
◼ Total debits exceed total credits in the country’s
current and capital accounts.
◼ The nation is borrowing from other countries.
◼ Financial Account
◼ Net acquisition of financial assets, the net

incurrence of financial liabilities, and net financial
derivative transactions.
◼ Financial assets: direct investment, portfolio investment,
currency, bank deposits, loans, trade credit and advances
◼ Financial derivatives: assets whose value is based on the
value of other assets
◼ Net lending (+) from financial-account

transactions
◼ Net acquisition of financial assets exceeds net
incurrence of liabilities.
◼ Net borrowing (-) from financial-account

transactions
◼ Net incurrence of liabilities exceeds net acquisition
of financial assets.
◼ Official reserve assets
◼ Gold holdings of the nation’s monetary

authorities
◼ Special Drawing Rights (SDRs)
◼ The nation’s reserve position in the International
Monetary Fund (IMF)
◼ Foreign currency holdings of the nation’s
monetary authorities
◼ The International Monetary Fund (IMF)

◼ Discussed in detail in Chapter 21
◼ Special Drawing Rights (SDRs) are international
reserves created by the IMF ands distributed to
nations based on their importance in international
trade.
◼ The nation’s reserve position refers to the reserves
paid into the IMF when the nation joined, which
the nation can then borrow at any time.
◼ Membership in the IMF allows nations to borrow
additional reserves based on IMF conditions.
◼ Balance of payment accounting uses double-entry bookkeeping.

◼ Each transaction is entered twice, once as the sale or purchase of
something, and then as the equal payment received or made for
it.
◼ Example 1: $500 in exports to be paid in 3 months
time
Credit (+) Debit (-)
Goods export
$500
(current account)
Acquisition of
foreign asset $500
(financial account)
◼ Example 2: $200 spent by a U.S. tourist in London on

services
Import of travel services

$200
(current account)
Payment (of currency)

$200
(financial account)
◼ Example 3: The U.S. government give $100 in food aid

to the government of a poor nation
Export of food
$100
(current account)
Secondary income
$100
(current account)
◼ Example 4: $100 in foreign stock purchased by U.S.

resident and paid for by borrowing from a foreign
bank
Acquisition of stock
$100
(financial account)
Incurrence of loan liability

$100
(financial account)
◼ Example 5
◼ $200 of U.S. Treasury bills purchased by foreign
investor from his U.S. bank account

Incurrence of liability
(purchase of U.S. Treasury bills by $200
foreigner, financial account)
Acquisition of asset (reduction in
foreign bank balances in U.S., $200
financial account)
◼ Because of double-entry bookkeeping, it should be

true that:
Current account + capital account = financial account
◼ In the real world, there are errors and omissions,

and thus the difference between total debits and
total credits is recorded as the statistical
discrepancy.
13.3 The International Transactions of the
United States
United States
◼ In 2014, the U.S. current account showed credits for

exports of goods and services and income receipts
totaling $3,307 billion.
◼ $1,633 billion exports of goods: primary exports are petroleum
products, automobiles, agricultural products, and chemicals.
◼ $711 billion export of services: travel and transport services,
insurance, financial services.
◼ $823 billion primary income: largely, earnings from foreign
investments.
◼ $140 billion secondary income: mostly workers’ pensions and
emigrant remittances.
United States
◼ In 2014, the U.S. current account showed debits for

imports of goods and services and income payments
totaling $3,696 billion.
◼ $2,374 billion imports of goods
◼ $477 billion imports of services
◼ $585 billion primary income payments
◼ $259 billion secondary income payments
◼ The capital account shows no capital transfer receipts or

payments (rounded to zero billion).
United States
◼ In 2014, the U.S. financial account showed net acquisition

of financial assets excluding financial derivatives of $792
billion (net increase in assets/financial outflow).
◼ $357 billion direct investment
◼ $538 billion portfolio investment (stocks and bonds)
◼ -$100 billion reduction in other financial assets
◼ -$4 billion reduction in U.S. official reserve assets
United States
◼ In 2014, the U.S. financial account showed net incurrence

of financial liabilities excluding financial derivatives of
$977 billion (net increase in liabilities/financial inflow).
◼ $132 billion direct investment
◼ $705 billion portfolio investment (stocks and bonds)
◼ $141 billion other financial assets
◼ Net financial derivatives other than reserves were -$54
billion.
◼ The statistical discrepancy was $150 billion.
13.4 Accounting Balances and the Balance of
Payments
◼ In 2014, the U.S. had an overall current account

balance of -$390 billion.
◼ $508 billion deficit on trade in goods and services, from
deficit on trade in goods of $741 billion and surplus on
trade in services of $233 billion.
◼ $238 surplus on primary income
◼ $119 deficit on secondary income
◼ Since the capital account had a zero balance, this
means that the U.S. spent $390 billion more than
was earned abroad.
13.4 Accounting Balances and the Balance of
Payments
◼ In 2014, net borrowing on financial transactions

was -$240 billion.
◼ The U.S. borrowed $240 billion more it loaned
abroad.
◼ The statistical discrepancy equaled 150 billion.
◼ (Financial account – current account – capital account =
statistical discrepancy)
◼ (-240 billion - $390 billion = $150 billion)
◼ U.S. official reserve assets fell by $ 4 billion.
13. 5 The Postwar Balance of Payments of the
United States
◼ Table 13.3
United States
◼ Prior to the 1970s, the U.S. has a positive trade

balance on goods.
◼ The rising price of imported petroleum products plus the
high international value of the dollar in the 1980s, and the
relatively rapid growth of the U.S. in the 1990s and 2000s
meant that import growth outpaced export growth.
◼ The U.S. has a consistently positive balance on services.
◼ The current account balance was positive in the
1960s, but has been negative and growing.
◼ Average in the 1980s of -$78 billion, average in the 1990s of -
$116 billion, average in the 2000s of -$573 billion.
◼ Average from 2010-2014 of -$424 billion.
United States
◼ Points to keep in mind when examining balance of

payments:
1. Too much attention is usually placed the trade
balance, in part because the data is released
sooner than other measures.
◼ Dangerous to extrapolate for year based on quarterly
data.
◼ A trade deficit may not be a bad thing in the short run,
since it means that there are more goods available to be
consumed domestically.
◼ Can be unsustainable in the long run.
United States
◼ Points to keep in mind when examining balance of

payments:
2. Even the concept of the trade balance is suspect
because the nation exporting the product may
only have contributed to a part of its production.
◼ The entire value of Chinese iPads to the U.S. is counted
as a Chinese export, even though more than a third of
the components are produced in other countries.
13.5 The Postwar Balance of Payments of the
United States
◼ Points to keep in mind when examining

balance of payments:
3. International transactions are closely interrelated
rather than independent.
◼ For example, cutting U.S. foreign aid programs also
reduces ability of recipients to import U.S. goods, so
improvement in U.S. balance of payments may be much
less than reduction in aid.
13.5 The Postwar Balance of Payments of the
United States
◼ Points to keep in mind when examining

balance of payments:
4. An attempt to reduce the U.S. trade deficit with
respect to a nation such as Japan is likely to
reduce the U.S. surplus with respect to Brazil
because Brazil pays for U.S. goods partly
through natural resource exports to Japan.
13.6 The Importance of the Current Account
◼ Trade deficits are often blamed for the loss of U.S.

jobs and heavy U.S. borrowing from abroad.
◼ Not all borrowing is the result of settling trade deficits.
◼ Some results from the desire of foreigners to invest in the
U.S., where economic growth and the return on investment
has been relatively high.
◼ This in turn creates jobs in the U.S.
◼ Some borrowing results from the U.S. itself wanting to make

productive investments, which cannot be completely
financed by domestic savings.
◼ Some borrowing results from the U.S. government, which
may need to cover a budget deficit.
13.6 The Importance of the Current Account
◼ In accounting terms, the current account balance

can be regarded as the bottom line in the nation’s
income statement.
(M-X) = (G-T) + (I-S)
Current account Government Private investment
deficit deficit minus private savings
◼ In order to reduce borrowing from abroad, it is
necessary to reduce government borrowing or
private borrowing or both.
◼ In an interdependent world, this may have further
consequences as well.
13.7 The International Investment Position of
the United States
◼ Table 13.5
13.7 The International Investment Position of
the United States
◼ A nation’s BOP measures international flow of goods,

services and capital during a one- year period (flow
concept).
◼ A nation’s international investment position
measures total amount and distribution of assets
abroad and foreign assets in the nation at the end of
the year (stock concept).
◼ The international investment position can be used to
project the future flow of income from abroad and
payments on liabilities abroad.
The International Investment Position of the
United States
◼ Also known as balance of international indebtedness.
◼ Table 13.5 shows the position at the end of year for a

number of years.
◼ Position deteriorated from $360 billion at the end of 1980 to
-$7,020 billion at the end of 2014.
◼ U.S.-owned assets abroad increased from $930 billion to
$24,956 billion. (about 26 times)
◼ Foreign-owned assets in the U.S. increased from $569 billion
to $31,615 billion. (about 56 times)
◼ Result is that the U.S. became the largest debtor nation in
the world in the 1990s. (Figure 13-2)
FIGURE 13-2 The U.S. Current Account Balance and the Net Investment Position,
1980-2014
Case Study 13-1 The Major Goods Exports
and Imports of the United States
◼ Table 13.2
Case Study 13-2 The Exploding U.S. Trade
Deficit with China
FIGURE 13-1 U.S. Exports, Imports, and Net Trade Balance in Goods with China,
1985-2014 (billions of dollars).
Case Study 13-3 The Major Trade Partners of
the United States
◼ Table 13.4
Case Study 13-4 The United States as a Debtor
Nation
◼ On the positive side, large foreign investments

allowed the U.S. to finance about half of its budget
deficit in the 1980s without “crowding out”– driving
up interest rates, which would discourage private
investment.
◼ Direct foreign investment goes to a variety of sectors of the
economy, creating jobs and economic growth.
◼ New managerial and production techniques than increase
productivity.
◼ Greater growth means more funds to pay interest and
dividends on foreign investment. In other words, the
returns are likely to exceed the costs.
Case Study 13-4 The United States as a Debtor
Nation
◼ However, foreign investments that only increases

U.S. consumption leads to payments abroad both
now and in the future.
◼ U.S. debt is about 40% of Gross National Income (GNI),
relatively small, and could be repaid if required.
◼ But places a burden on future generations.
◼ Also diverts investment from poorer countries, which
reduces their potential growth.
◼ Some risk that foreigners might withdraw funds, leading to
a financial crisis and higher interest rates in the U.S.
Appendix: The IMF Method of Reporting
International Transactions
◼ Table 13.6
◼ Standardized reporting method that all nations must

use in reporting to the IMF.
◼ Ensures consistency in international comparisons.
◼ The major difference is the separation of reserves and
related items into a separate account.
◼ Current account + capital account - financial account
+ net errors and omissions = Balance of Payments
◼ If the BOP is not equal to zero, the reserve account
makes up the difference (“official settlements
balance”).
◼ Copyright 2016 John Wiley & Sons, Inc.
◼ All rights reserved. Reproduction or translation of this work beyond

that permitted in section 117 of the 1976 United States Copyright Act
without express permission of the copyright owner is unlawful.
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make back-up copies for his/her own use only and not for distribution
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information herein.

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CHAPTER T H I R T E E N

◼ The balance of payments provides a summary

◼ In 2014, the Bureau of Economic Analysis BEA)

◼ Credit transactions (+)

◼ Payments from abroad

◼ Transfer payments from people or agencies abroad

◼ Transfer payments to people or agencies abroad

◼ Net lending (+) from current-and-capital-

◼ Net borrowing (-) from current-and-capital-

◼ Net acquisition of financial assets, the net

◼ Net lending (+) from financial-account

◼ Net borrowing (-) from financial-account

◼ Official reserve assets

◼ Gold holdings of the nation’s monetary

◼ The International Monetary Fund (IMF)

◼ Balance of payment accounting uses double-entry bookkeeping.

◼ Example 2: $200 spent by a U.S. tourist in London on

Credit (+) Debit (-)

Import of travel services

Payment (of currency)

◼ Example 3: The U.S. government give $100 in food aid

Credit (+) Debit (-)

◼ Example 4: $100 in foreign stock purchased by U.S.

Credit (+) Debit (-)

Incurrence of loan liability

Credit (+) Debit (-)

◼ Because of double-entry bookkeeping, it should be

Current account + capital account = financial account

◼ In the real world, there are errors and omissions,

◼ In 2014, the U.S. current account showed credits for

◼ In 2014, the U.S. current account showed debits for

◼ The capital account shows no capital transfer receipts or

◼ In 2014, the U.S. financial account showed net acquisition

◼ In 2014, the U.S. financial account showed net incurrence

◼ In 2014, the U.S. had an overall current account

◼ In 2014, net borrowing on financial transactions

◼ Prior to the 1970s, the U.S. has a positive trade

◼ Points to keep in mind when examining balance of

◼ Points to keep in mind when examining balance of

◼ Points to keep in mind when examining

◼ Points to keep in mind when examining

◼ Trade deficits are often blamed for the loss of U.S.

◼ Some borrowing results from the U.S. itself wanting to make

◼ In accounting terms, the current account balance

◼ A nation’s BOP measures international flow of goods,

◼ Also known as balance of international indebtedness.

◼ Table 13.5 shows the position at the end of year for a

◼ On the positive side, large foreign investments

◼ However, foreign investments that only increases

◼ Standardized reporting method that all nations must

◼ All rights reserved. Reproduction or translation of this work beyond

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