Slide 0Slide 1Chapter OutlineBalance of Payments AccountingBalance of Payments ExampleBalance of Payments AccountsThe Current AccountThe Capital AccountStatistical DiscrepancyThe Official Reserves AccountThe Balance of Payments IdentityU.S. Balance of Payments Data 2006Slide 13Slide 14Slide 15Slide 16Slide 17Balance of Payments and the Exchange RateSlide 19Slide 20Slide 21Sovereign Wealth FundsThe J-Curve EffectBalance of Payments TrendsSlide 24Slide 25Slide 27Slide 27Mercantilism and the Balance of PaymentsEnd Chapter ThreeRelationship between Balance of Payments and National Income AccountingSlide 32Slide 33Slide 34Slide 35INTERNATIONALFINANCIALMANAGEMENTEUN / RESNICKFifth EditionCopyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/IrwinChapter Objective:This chapter serves to introduce the student to the balance of payments. How it is constructed and how balance of payments data may be interpreted.3Chapter ThreeBalance of Payments3-2Chapter OutlineBalance of Payments AccountingBalance of Payments AccountsThe Current AccountThe Capital AccountStatistical DiscrepancyOfficial Reserves AccountThe Balance of Payments IdentityBalance of Payments Trends in Major Countries3-3Balance of Payments AccountingThe Balance of Payments is the statistical record of a country’s international transactions over a certain period of time presented in the form of double-entry bookkeeping.N.B. when we say “a country’s balance of payments” we are referring to the transactions of its citizens and government.3-4Balance of Payments ExampleSuppose that Maplewood Bicycle in Maplewood, Missouri, USA imports $100,000 worth of bicycle frames from Mercian Bicycles in Darby England. There will exist a $100,000 credit recorded by Mercian that offsets a $100,000 debit at Maplewood’s bank account.This will lead to a rise in the supply of dollars and the demand for British pounds.3-5The balance of payments accounts are those that record all transactions between the residents of a country and residents of all foreign nations.They are composed of the following:The Current AccountThe Capital AccountThe Official Reserves AccountStatistical DiscrepancyBalance of Payments Accounts3-6The Current AccountIncludes all imports and exports of goods and services.Includes unilateral transfers of foreign aid.If the debits exceed the credits, then a country is running a trade deficit.If the credits exceed the debits, then a country is running a trade surplus.3-7The Capital AccountThe capital account measures the difference between U.S. sales of assets to foreigners and U.S. purchases of foreign assets.In 2006, the U.S. enjoyed a $826 billion capital account surplus—absent of U.S. borrowing from foreigners, this “finances” our trade deficit.The capital account is composed of Foreign Direct Investment (FDI), portfolio investments and other investments.3-8Statistical DiscrepancyThere’s going to be some omissions and misrecorded transactions—so we use a “plug” figure to get things to balance.Exhibit 3.1 shows a discrepancy of $18 billion in 2006.3-9The Official Reserves AccountOfficial reserves assets include gold, foreign currencies, SDRs, reserve positions in the IMF.3-10The Balance of Payments IdentityBCA + BKA + BRA = 0whereBCA = balance on current accountBKA = balance on capital accountBRA = balance on the reserves accountUnder a pure flexible exchange rate regime, BCA + BKA = 03-11U.S. Balance of Payments Data 2006 Credits DebitsCurrent Account 1 Exports $2,096.3 2 Imports ($2,818.0)3 Unilateral Transfers $24.4 ($114.0) Balance on Current Account($811.3)Capital Account 4 Direct Investment $180.6 ($235.4)5 Portfolio Investment $1,017.4 ($426.1)6 Other Investments $690.4 ($400) Balance on Capital Account$826.9 7 Statistical Discrepancies Overall Balance($2.4) Official Reserve Account$2.4($18)3-12U.S. Balance of Payments Data 2006In 2004, the U.S. imported more than it exported, thus running a current account deficit of $811.3 billion. Credits DebitsCurrent Account 1 Exports $2,096.3 2 Imports ($2,818.0)3 Unilateral Transfers $24.4 ($114.0) Balance on Current Account($811.3)Capital Account 4 Direct Investment $180.6 ($235.4)5 Portfolio Investment $1,017.4 ($426.1)6 Other Investments $690.4 ($400) Balance on Capital Account$826.9 7 Statistical Discrepancies Overall Balance($2.4) Official Reserve Account$2.4($18)3-13U.S. Balance of Payments Data 2006During the same year, the U.S. attracted net investment of $826.9 billion—clearly the rest of the world found the U.S. to be a good place to invest. Credits DebitsCurrent Account 1 Exports $2,096.3 2 Imports ($2,818.0)3 Unilateral Transfers $24.4 ($114.0) Balance on Current Account($811.3)Capital Account 4 Direct Investment $180.6 ($235.4)5 Portfolio Investment $1,017.4 ($426.1)6 Other Investments $690.4 ($400) Balance on Capital Account$826.9 7 Statistical Discrepancies Overall Balance($2.4) Official Reserve Account$2.4($18)3-14U.S. Balance of Payments Data 2006Under a pure flexible exchange rate regime, these numbers would balance each other out. Credits DebitsCurrent Account 1 Exports $2,096.3 2 Imports ($2,818.0)3 Unilateral Transfers $24.4 ($114.0) Balance on Current Account($811.3)Capital Account 4 Direct Investment $180.6 ($235.4)5 Portfolio Investment $1,017.4 ($426.1)6 Other Investments $690.4 ($400) Balance on Capital Account$826.9 7 Statistical Discrepancies Overall Balance($2.4) Official Reserve Account$2.4($18)3-15U.S. Balance of Payments Data 2006In the real world, there is a statistical discrepancy. Credits DebitsCurrent Account 1 Exports $2,096.3 2 Imports ($2,818.0)3 Unilateral Transfers $24.4 ($114.0) Balance on Current Account($811.3)Capital Account 4 Direct Investment $180.6 ($235.4)5 Portfolio Investment $1,017.4 ($426.1)6 Other Investments $690.4 ($400) Balance on Capital Account$826.9 7 Statistical Discrepancies Overall Balance($2.4) Official Reserve Account$2.4($18)3-16U.S. Balance of Payments Data 2006Including that, the balance of payments identity should hold:BCA + BKA = – BRA($811.3) + $826.9 + ($18) = ($2.4) Credits DebitsCurrent Account 1 Exports $2,096.3 2 Imports ($2,818.0)3 Unilateral Transfers $24.4 ($114.0) Balance on Current Account($811.3)Capital Account 4 Direct Investment $180.6 ($235.4)5 Portfolio Investment $1,017.4 ($426.1)6 Other