THE BALANCE OF PAYMENTS (BP)
The balance of payments is the summary statement of the flow of economic transactions between the residents of one country and the rest of the world over a given period of time.
This summary statement comprises of such items as the export and import of all goods and services; all capital loans abroad and all borrowing from foreign countries; all gifts to and from foreign countries, including foreign aid; and all movements of gold and international reserves into and out of the country.
In this country, the Department of Commerce is responsible for calculating the balance of payments.
How are debits and credits defined in international transactions?
A debit represents the importing of an item such as a good, a service, a stock or a bond, a bank deposit, or gold. A debit adds to a nation’s demand for foreign currency. It receives a negative sign (-) in the balance of payments table.
A credit represents the exporting of an item such as a good, a service, a stock or a bond, a bank deposit, or gold. A credit item adds to a nation’s supply of foreign money. It receives a positive (+) in the balance of payments table.
Consider a few examples to aid in your understanding of the balance of payments:
Suppose a U.S. household purchases a car from Japan. The import of the car into the U.S. is recorded on the debit side (-) and creates a demand for Japanese currency (Yen). It adds to the supply of dollars.
Suppose a U.S. business sells a bond to a British household. The U.S. business, then, exports a bond. This would appear on the credit side (+) of the BP. It would increase the supply of British pounds. It adds to the demand for dollars.
Suppose the US gives wheat to Egypt. The exporting of the good, even as a gift, is recorded as a credit (+) and is called a unilateral transfer.
Assume a US citizen travels as a tourist to Germany. His expenditures in that country are classified as a debit (-) because he purchases (imports) a service (tourism) from that country. It also creates a demand for German marks.
The BP is often divided into three sections: current account, capital account, and financing method (deficit or surplus). A simplified table is as follows:
I. Current account
1. Exports (+)
2 Imports (-)
1. Military (net)
2. Travel and transportation (net)
3. Investment income (net)
Balance of goods and services = A + B
C. Unilateral transfers
1. Government grants (excluding military)
2. Remittances and pensions
Balance on current account = A + B + C
II. Capital account
D. Long-term capital movements or flows
E. Short-term capital movements or flows
Official reserve transactions balance = A + B + C + D + E
(There is some debate about where to draw the line to determine the balance of payments surplus or deficit. Some economists draw the line after long-term capital movements but before short-term capital movements, since short-term assets are temporary and can be withdrawn at a moments notice.)
III. Financing (deficit or surplus) method
F. U.S. official reserve assets (net)
G. U.S. liabilities to foreign official agencies
(Official reserve assets of the U.S. include (1) gold, (2) convertible foreign currencies,
(3) reserve position at the International Monetary Fund (IMF), and Special Drawing Rights (SDRs). An SDR created by the IMF in 1968 because of a shortage of international liquidity is the official unit of account used between the IMF, central banks, and governments. Foreign official agencies are central banks of other countries that lend to the U.S. when they experience a deficit.