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Lesson 12 Balance of Payments: 2015 Data is in or is it?
Export Doldrums: The Little Engines that Couldn’t
Lesson 9 US Exports of Goods and Services to the World
Inversions and Globalization

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All transactions between the US and the rest of the world during a given year (or quarter) are reported in the balance of payments of the US, which is prepared and published by the BEA, see the link http://www.bea.gov/international/index.htm#bop. Balance of payments statistics are produced under international conventions to make them comparable and these conventions have changed recently. Here, we need a little detail to understand the relevant concepts.  

The following table shows the US balance for the year 2010. It consists of three main parts, the current account, the capital account, and the financial account. Of these three, the current account and the financial account are the most important ones. The current account reports all international transactions related to trade in goods and services and income payments between the US and the rest of the world. The financial account relates to the flow of payments generated by trade in goods and services and to the trade in financial instruments and assets between the US and the rest of the world. The capital account relates to changes in US international assets and liabilities which are not linked to trade in goods, services, and financial assets. Examples are changes in the valuation of assets, e.g., stock price movements, international debt forgiveness benefitting poor countries, or bequests. Since the capital account is typically very small for the US, we will neglect it from now on. Note that, in previous terminology, which you still find in older books and reports, the financial account was called the capital account.

The current account

Positive entries in the current account relate to exports of goods and services and incomes earned abroad, negative entries to imports of goods and services and incomes paid. The current account has four sub-categories: Trade in goods, trade in services, income payments, and the unilateral transfers. Royalties and license fees relating to the use of intellectual property are reported under trade in services. Unilateral transfers are payments for which there is no compensation in terms of goods or services, such as income remittances paid by foreign workers to their families in their home countries or official aid to developing countries. The income account reports labor incomes and earnings on financial assets earned abroad and paid to foreign countries. The table shows that exports and imports in goods account for the largest part of the current account.

The bottom of the table reports various concepts of balances from the balance of payments. It shows that the US balance of goods trade was in deficit in 2010 while the balance of services was in surplus. The balance of trade in goods and services is commonly referred to as the US trade balance. Line 74 indicates that the US had a trade deficit of USD 500 billion in 2010, while the current account balance had a deficit of USD 470 billion.

The financial account

The first broad category of transactions in the financial account is changes in US owned assets abroad (excluding financial derivatives).  We call these financial outflows (capital outflows in older terminology). Negative entries relate to purchases or foreign assets by US residents, positive entries to sales. The financial account distinguishes between three types of US residents doing this:  The Federal Reserve System, the remainder of the US government sector, and the private sector. Foreign assets owned by the Federal Reserve are called US official reserve assets. They include gold reserves, claims on the International Monetary Fund, and foreign currency reserves. The Fed can use these to influence the value of the dollar in terms of other currencies. US government assets other than official reserve assets are foreign assets held by other branches of the US government.  US private assets include foreign direct investment, i.e., the purchase of a share in a foreign business exceeding ten percent of its capital, and various types of portfolio investments.

The second broad category of transactions is changes in foreign-owned assets in the US. We call these financial inflows (capital inflows in older terminology).  If the assets are purchased by foreign governments or their central banks, they are called “foreign official assets in the US.” An example is US Treasury securities bought by the People’s Bank of China. Otherwise, they are called “other foreign assets in the US.” These include foreign direct investment and various types of portfolio investments.

The third broad category is trade in financial derivatives.

By the principles of double-entry book keeping, the balance of payments must always be zero. That is, the sum of the current account balance, the capital account balance and the financial balance must be zero. In practice, this is rarely the case. To account for any difference, the balance of payments contains an entry called “statistical discrepancy”. It is calculated in order to achieve overall balance. Accountants note that only governments can get away with a statistical discrepancy of USD 200 billion in their accounts!! Sources of statistical discrepancy are differences in timing between trade flows and financial flows and underreporting of financial incomes and transactions with other countries.

Neglecting the statistical discrepancy and the capital account, it must be true that

The balance of the current account = – the balance of the financial account.

What does that mean? A country with a current account deficit like the US must have a surplus on the financial account. This means that foreigners have acquired more US assets and claims on the US economy than US residents have acquired foreign assets and claims on foreign economies. In other words, US net foreign assets have decreased and the US has borrowed from the rest of the world. A country with a current account surplus, like China, must have a financial account deficit, indicating that Chinese residents have acquired more foreign assets than foreigners have acquired Chinese assets. China has increased its net foreign wealth.

For a view of recent developments in financial accounts internationally, look here: http://www.imf.org/external/pubs/ft/weo/2011/01/pdf/tblpartb.pdf Then scroll down to Table B18. Summary of Balance of Payments, Financial Flows, and External Financing.  Emerging and developing countries in 2010 had a deficit in C&F of about $295 billion. Despite large inflows of direct and portfolio investment, these countries lost large amounts of reserve assets (probably the result of selling domestic assets as a means for currency depreciation). IMF projects this deficit to get much larger in 2011 and 2012. The C&F negative balance (-$295 billion) roughly matched the surplus in the current account ($378 billion) plus the error….

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The U.S. government issues quarterly press releases on international transactions. They offer a good source of the most current U.S. data and it provides an excellent way to see how experts write about international trade changes and trends. It provides more detail on some of the topics introduced briefly below.

The link to these releases is:http://www.bea.gov/newsreleases/international/transactions/2009/trans109.htm

The following quote came from the BEA trade release (see one of the links above) for the first quarter of 2009

“The deficit on goods and services decreased to $91.2 billion in the first quarter from $144.5 billion in the fourth.”

There are a few things to note about this one quote.

First, it implies that in both quarters mentioned, the U.S. imports of goods and services were greater than exports of goods and services.

Second, this measure of the trade deficit is narrower than the full current account (see below).

Third, the deficit shrank from the fourth quarter 2008 to the first quarter 2009 by a little more than $53 billion.

Finally, the first quarter number is for just one quarter. But if we multiply the number by 4 we get $578 billion. That is the annualized figure for 2009:Q1. It tells you how much the trade deficit would be for the entire year – if the $144.5 kept up for all four quarters. Most people would say—that’s a large trade deficit.

This next short reading is meant to show you how international transactions are discussed in the media.  Notice the discussion is organized around the current account and the financial account. These accounts are used frequently to describe international trade changes and issues. For example, the following quote from this article of 2005 is saying a lot about international trade.

Saying that the current account deficit cannot rise indefinitely is equivalent

to saying that the financial account surplus cannot rise indefinitely, since

they are tautologically equal. The surplus in the first two quarters of 2003

was financed by accumulating foreign-owned assets in the U.S. that exceeded

the outflow of U.S.-owned assets abroad. In the third quarter, foreign

claims on domestic assets fell, particularly in foreign direct investment

and non-Treasury securities.

Here’s a chart on the current account balance from the U.S. Bureau of Economic Analysis —  http://bea.gov/newsreleases/international/transactions/trans_large.gif

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Some things to note here: This shows that a Current Account has four main parts – balance on goods, balance on services, and balance on income, and net unilateral transfers. The chart shows that the US Current Account deficit is largely the results of a deficit in goods plus a net outflow of unilateral transfers. Balances on services and income are positive. The current account has generally been in deficit and you can see the improvement in 2009 was temporary and the deficit was moving toward $200 billion in 2011.

The U.S. dollar is a unique currency in the global economy in that the largest part of the coins and bills issued by the US Treasury and the Federal Reserve System are located outside the USA. Recent estimates place the share of dollar currency circulating outside the country at 60 percent. (See Treasury Department, “The use and counterfeiting of US currency abroad, part 3” Washington DC 2006.) This share was probably even larger at the end of 1999, when many people abroad held dollars in cash to protect themselves against the “millennium bug”. This is just an extreme example of a broader tendency, namely that people living in countries where political and economic conditions are highly unstable and uncertain use the dollar as a reliable store of value and medium of transaction. Several countries around the world even use the US dollar as their official currency, a phenomenon called “dollarization.” Ecuador, El Salvador, and Panama are three examples. In addition, dollar currency is also used in smuggling and other criminal activity. Nevertheless, apart from currency, U.S. dollar-denominated money including bank deposits still has its highest use at home.

As you can see from the balance of payments table, much of what we call international financial account transactions involves such things as cross border transactions in:

  • bank accounts
  • corporate bonds and stocks
  • government bonds and stocks
  • real estate and other “capital” transactions.

The discussion in the press release in BEA press release link http://www.bea.gov/newsreleases/international/transactions/2010/trans110.htm. The current account deficit was $109 billion in 2010:Q1. So think of there being that much money sitting around overseas. Now go to the discussion under the financial account. We learn there that U.S. assets owned abroad increased $300.8 billion, US residents bought more assets abroad. Now look at the foreign-owned assets in the U.S. – the narrative says that foreigners increased their ownership of U.S. assets by $332.1 billion in the first quarter of 2010, i.e., foreigners bought more assets in the US. The financial account balance was $31.3 (=$332.1 billion – 300.8 billion). As a result, the statistical discrepancy was $109 billion – $31.3 billion =  $77.7 billion including the unreported net financial derivatives transactions.

All of this asset trade activity has implications for a country’s asset/debt profile. We have two measures that capture this – the net foreign debt position of a country and the net international investment position. These two things measure the same thing but are mirror images of each other. The following link shows information on the US international investment position at the end of 2008 as reported by the BEA: http://www.bea.gov/newsreleases/international/intinv/2009/pdf/intinv08.pdf

At the end of 2008, US residents owned foreign assets worth USD 19.9 trillion, while foreigners owned US assets worth USD 23.4 trillion. As a result the US net international investment position was USD -3.5 trillion, or US net international debt was USD 3.5 trillion, 24.3 percent of US GDP in 2008. However, it is interesting to observe from the balance of payments table above that US earns more on its foreign assets than it pays on its foreign debt. In other words, the rate of return on US foreign assets is higher than the rate of interest paid on foreign-owned US assets. Foreigners were willing to hold relatively low-yielding US assets because they value the relative safety of the US economy, while US investors were willing to invest in relatively risky and high-yielding assets abroad.

The Net international investment position becomes negative for a country when foreign-owned assets in a country exceed its assets owned abroad. At that point it becomes a net international debtor.

International Application

Not all countries have current account deficits – in fact, if some countries have deficits, other countries must have surpluses. The below link from the St. Louis Fed shows current account deficits for many countries from 1988 to 2010. There are several points to make.

First, the numbers show the current account balance as a percentage of national GDP. In that way it is easier to compare across countries – because the country sizes can be so different.

Second, we can see that the U.S. current account deficit was about 4.7% of nominal GDP in 2008. It decreased to 3.2 % by 2010.

Third, two other countries had larger deficits than the U.S. (as a percent of nominal GDP): Turkey, Spain, Italy, and  Greece. The chart shows that none of these four was new to trade deficits in 2010. Twelve of these 34 countries had deficits in 2010. Countries with large current account surpluses as a percent of nominal GDP were: Norway, Malaysia, Singapore, Switzerland, and Venezuela. Singapore’s surplus was 22.2% of nominal GDP. Singapore and Switzerland have perennial surpluses. http://research.stlouisfed.org/publications/aiet/page8.pdf

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Another view of current accounts worldwide can be found here: http://stats.oecd.org/index.aspx?queryid=21760   (Note: you may have to select the right table by looking at the options on the left “Key Short-term Economic Indicators). Interesting that most surplus countries fall into northern Europe or Scandinavia.

Deficit countries were led by Greece, Ireland, Slovak Republic, Spain and Turkey.