Caves2002.Cap15 BoP Accounts

8/2/2019 Caves2002.Cap15 BoP Accounts

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TueBnnrucror PnymENTsccouNrsarts through II of his book concentratedn the behvior f "real" vari-ables n the nternational conomy-on the quantities f goodsprocluced,consunted,nd raded. rices'ere ruc ialn secLrr ingqui l ibr iurn,ut onlvas he elative rices f goods th e erms f t rde)or of factors f product ion.hefocusnow urns o the "monetary"sideof international conourics.lhis requiresan examinat ionf thebehavior f nronetary agni tudes-the uant i ty f rnoneyirself ndvarious ricesha tar cmeasuredn curreno' rni ts .hcsenclude veri r l lprice evels, age ates, nd he oreign xchangeate, vhich s thepriceat whrch

curenciesexchanee olone auotherTh esubject f nternationr l oneti lry conomicsas rou'n lpicl ly n nterestand nrportancever he ast30 vears.,luchhls happened ver his period n thes'orld econony. n 1973 the major industrial izedountr iesmoved ronr aslstemunder vhich xchangeateswere ixedb,v overnments-rsystemhat hadheld ss'avsinceVorld War II-to rr ne*,,unfamiliarsvsren n rvhichexchangerates redeterminedn them:rrketplirce.Venoir 'hve 0 vears [ experic.nce'iththis svstemron rvhich o clrrv essons.lv leanrvhi le,ot h goodsmirrkets nd financialmarkets r i rve econre ighlvintegrated,orcing ve n rev ious lynsularAmericanmlcror'cononristso recog-nize he rnportancef th e oreign ector: i l price' hangt-sr,c nduced cono-mists o buildback nto heirvierv f the racr oeconr)mvonre f the eal ectorshath d .ecn eft behind; levelopingountrics irve e conrentegrrrtednro heglobl l econonrl ' ;uropeanountr ies:rve ndcrtkcn l lonetrvntcgretionit heachother;and l ; rrge ew macrocconomicoii. . . l istrrrl .ncls.nl[ec('de]rtcdt rade mbalances,nd currency risesn sornc ountl irs rrvecstedhe imitsofth enloderninanc ir l vstenr. t th esme ime, hinking n th c subjecr as beenstiniul irted 1, nerv developmentsn the macroccononticht 'orv of ckrsedecononries:ntellectualevolutionshrt in fervshort r ' i l rssJw nronct:rrisnradopteds a standard escript ionf ong-run qui l ibr iurnif not of short-runel -i t1'), rat ronrl -xpectations"dopted s tandrrdnethodologv,nt l relbusinesscvclc" heor-rdopted sa represent : r tionf supplv hocks.

l-fhe iekl s also nownas he "macroeconomicsf openeconomies."he erm intcrnrtionlf inrnce"s ppl icables rvel i , art icul :rr l r,rohenterial overedn PrtsV nclVL


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282 Cxnerrn5 THE ALANcEoFAYMENTSACCoUNTSThis half of the book rvill ntroduce ightor ten actors, r variables,hat re-ceivedittlc or no attention n the irst half of the book.The variablesncludeheexchangeate,output and employmentemphasizinghe cyclical omponents feach),he nterestate,stocks f moneyand eserves,he aggregaterice evel, herelative riceof non-traded oods,nternationallowsof portfoliocapital, nd ex-pectations. nderstandingolv hemacroeconomicystemvorks anbequitedif-ficult if one ries o consider ll ten variables imultaneously.hese ariables ill

be ntroduced neat a time, so hateach anbe assimilated-understoodn termsof its nteractionvith he othervariables-beforehe next s ntroduced. hus, veneed ot discardvhat ve haveused t each tage s vemoveon to the next stageand the next variable.Rather, vecan considervhatcamebefore o be he rightansrver 'hen he variable n question s held constant;ves'ill thenexamine hecorrespondinghangen theresults'hen thevariables allou'ed o change.Beforeproceeding, ou'ever,ve briefly explain he sequencef the differentvariables. hapter 6 will introduce hc exchangeate,and vill shol how t helpsdetermine country's alance f trade.The effect f the exchangeateon the rade' balance ill be examinedirst n the mostcontrolled nvironment'n whichpricelevels, ncome evels, nd all othervariables re held constant. hen Chapter17rvill allorv or cyclical luctrationsn income.Unlikechangesn outputconsideredpreviousl hese lucnrationsvill represent hangeselatiue o potentialoutput,changesssociatedvith unemplo.vmentf laborand unutilized apacity. he,v rethe consequencef rvages ndpriceshat are igid,or at east stickl"-that resistmoving o equilibratehe aborandgoodsmarkets. his representssharpdepar-rure rom he irsrhalf of the book, n s4richall prices 'ereassumedo be lexibleenough hat tlrey acljmted o ensurethat stpply ahvaysequaleddemend.Ssse ofthe results, uch s theexistence f unemployrnentnd excess apacitare amil-ia r from standardmacroecononricsextbooks.Horvver, luchwill be nerv nddifferentn the openeconomy.-ore-xample,'henprices renot free o adjust,heexchangcatecansometirneseused o restore quilibrium.In the as t an of Chapter8 themonev upply nd he ntcrestate vi l lmaketheirappearance.t thispoint vc 'i l l -. ,-. . "shorr i l t vrial. les-trade alance,exchangeate, elel of income,monel' suppl-r',nd interest ate-all interrehte.Here,and hroughouthe asthalfof the bo-ok, keyquestion oncernshe eftectsof monetar.vnd iscal olicvon theopeneionom.u.n Chapter19 nvo more sc-torsareadded.The irst half of the chapter ntroduceshe stockof internationrlreservese.g., old) hat s heldby thecentral ank.The second ilf of thechapterexarnines,or the first tinte, he overirllprice evel.Chapter20 distinguishese-tween racled nd non-traded oods,providinga partictrlarll' sefulmodel orLDCsan dother ountricsha tar e mall n world rade.The coreof PartV concernshe nternationalloiv of capital, hemostporver-ful nerv actor n themodcrnworld macroeconomy'.e simplifv:Parts through IIconcentratedn the ntcrnarionallorv o goods,t'ith the rde balance enerallyconstrainedo zero;Prrt lV introduceshe nternationallorv tti money, llos'ingnonzero ayments alances; ndPartV introduceshe nternationallow of port'

l5.l BnroowruorrHAccoursfolio capital-assetsuchasstocks nd bonds.Becausen assets a claim o futureconsumption'nternationalrade n assetsswhat allorvs ountrieso spendmorethan heyearn n some eriods,henmakeup for it by spendingess han heyearnin otherperiods. inall Pan VI examineshe determination f exchaneeares ninternationalssetmarkets, hereexpectationslsoariseasa key variale.ve rvill see hat lvo particular spects f rhesrrucrure f the worrd economyas t evolved ver he 1970s,-1980s,nd 1990s-rhe grearease f internationalcapitalmovements nd the systemof market-determinedxchange ates-havecompletelyltered orvpolicychanges nd orhermacroeconomicisturbancesp-erate. hese spects f the moderneconomyhave mportant mplicationsor theresolution f iremationalpaymentsmbalances nd other policy problems hattheworld faces.Before vebegin xploringhe operation f the nternationalmacroeconomy,ris necessaryo go rhrough hemechanicsf balance-of-paymenrsccounringn rhepresenthapter. his ool wouldbe necessaryven f the subjectwereas edious smatters f accountingometimesppear. alance-of-paymentsccounts, owevehaveattained nerv ascinarionn recent ears.Somemeasuresf the balance fpaymentsreclosely atched y thepress nd policymakers.considerablensight nto present nternational avmentsmbalances an begained imply rom the accountingdentities, venbefore he discussionurs rothe nore nterestinguestions f economic ausality. n accountingdentity s rneq.ation hat must hold precisel,v,s a marterof definitionor arithmetic,as op-posedo behavioralquations,vhich epresentheories f econornic ehavior hatarenote.\pectedo hold precisely.

15 . BRelxoowr.FTHE ccouNrsA nation's alance-of-payrnentsccounts s the statistical ecorcl f all economictransactionsakingplace enveents residents nd he restof the world.These remost onvenientlvroken p nto threeaccounrs,s shorvnn Table1.5.1. irs,lhe current tccol.tttCA i s he ecordof trade n goodsandservicesnd othecur-rent ransactions,s opposedo rrade n assels,vhichare obligations egardingthe future.Trade n assets ppears n the capitalaccounrs,f the asser s tradedamong rivate itizens f the countries,hen t appears n the priuatecapitalac-count KAl. l f th ebuyer r seller f rheassets a cenrral ank-that is, he mone-taryauthority f either he domestic r foreigngovernment-then he transactroappearsn theofficial eserueransaciozsccount ORT).Breakdown ofthe Current AccountEachof these hreeaccounrss in turn divided nro subaccounrs.irhin the cur-rentaccounr he irst subaccounts merchandiserade,consisting f exportsandimportsof goods,vhich ncludes ll movable oodseithersold,bought,or orher-wise ransferredetween omestic nd oreignowners.


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284 CHprn 15 " THEBALANCEr PvNEr'irsAccourrs

Table 5. lSchematicRepresentationof the Balanceof PaymentsAccountsndSubaccounts

CURRENTccouNr (CA)lv lerchandise .. . .NlerchandisebalanceServiceso Trnsport.r ion Touism. Business nd professional ervices . Balance f goods ndserylcesInvestrent income ... . . . . Balance fgoods,serv ices,and ncomeUnilateral ransfers Government rants. Private emittances . . . . Currentaccount rrlancePRrv,lrC,rrrrr Accornr (KA)Direct nvestmentPortfolio nvestmentssecuritiesnd banking lorvs). Long-term ...Baslcbalance. Shot-term. . . Oveallbalance f paymentsOrrrcrai-Rsrvc TBANlAcinoNlORT)Changesn foreign entralbanks'holdingof dornestic ssetsChangesn the domestic entralbnkt holdingof foreignassets' Gold l l r lF crcdrtsrn. l DR >. Foreign xchangeeserves

Each balance t the right s he sun of the prer ous balance nd rh e ddi t ional tems is red etore he doned ine

The seconclubaccount'i thin he curreut lccoLlnts scrvicesalso nou,n nthe UnitcdKingdom s "invisibles,"sopposedo "visrbles,"vhich efer o mer-chandise).onle f the rnportantnternationalerviceransactionsreas ollorvs:l. Trrrnsport lt ioncrvicesnclLrdereight nd insurencehelgcsor he ntcrnrt ionlmovnlcnt f goorls nd also heexpendituresn rntcrnationalrar,el f t()Lrrists

nd nthe. nrcqenoPrqr_ " -"b'_" '2. Touristservicesncludeall expendituresv a countr,v'sitizensn foreign or-rntnes(on ood, odging, ocal ransportation,rc.).3, Bus inessandprofess ionalerv icesmakcupadjvesec lassof internat ionlr: rnsrc-t ions. nternationalade n heservicesf cngineeringirrns,mirnagcmentoltstt lr:ing irms, o mputer rogrammersnd so orth s a rapidly rowing omponentftrade.Royalties nd icenseees aid or the useof l work or inr,ention, 'henhecopyright or patent is held by a resident itizen of rnotherountrv,are alsocounted spa,ymentsor a sevrce,A third subaccountvithin he currentaccounts nyestmentncomc.nrerest ay-ments or dividendsappearhere becausehev are considercd avmentsor theservicesfcapital hat is "working" abroad. he profitsearned y a factorv rvnedby a foreign esident,or example, repaymentsor theservicesf theclpitll em-

l5.l ' BnaroowNrluAccour.rrs 28 5bodied n that actory. t is mportant o distinguishheseyearly aymentsor theseruicesf capital, vhichappear n the currentaccount,rom the original nvest-ment tself,whichappearsn the capital ccounr.Unilateralransfers re a fourth subaccount.his subaccountonsists f gov-ernment rants foreignaid) and private eminancesfronl emigrant .vorkersotheir amilies,rom pensionso rerired eopleivingabroad, tc.). ransfers ppearin thecurrent ccount ather han n the capital ccount ecauseheydo not createanvobligationor repaymentn fhe uture, sa loandocs.Breakdown of the Capital AccountVithin the capitalaccounr,2he key distincrions benveen irecr nvestment ndportfoliocrpital.Portfolio nvesrmenfn fun crn be diviclednro long-rernr nrlshort-term.Foreign irect nuestmentccurswhen he esidentsf onecountry rcquire ontrolovera businessnterprisen another ountry. he acquisition ay nvolvebuvingenough tock n an eristingenterpriseo become controlling hareholderdefinedfor this purpose s 10 percent wnership),4'n&".tg the enterpiseurlght* ortuilding anew actoryor enterpriserom scrachincluding,swell, hepurchasefrealestate). hen an nvestor uysonly a small ractionof the shaes f a foreigncompan)',orvever,t is anexample f long-term ortfolio rvestnlent.Long-term ortfolio nuestntentnvolvesnternationalransactionsn financialas-sets vithan original erm o maturitygreaterhanoneyear.Such nvestnent on-sists f purchasesf securit iesstocks, ls o alled hares r equit ies,nd bonds)and ong-term ank oans.Often he distincrion etr,veenong-term ndshort-rcrnrcapital lorvssarbitrar. ',swhenan nvestor uvs 10-.vearovernrnenrond n-tendingo resellt i n a short ime,or huys bond ht has lrea,lybeen eld or9l/2years nd s about o mature.Short-tenn Ltpitllotus nvolveassesvithoriginal enns o marurityof less hrnon e 'ear. ramplesre reasurv il ls, ommcrcialrrper,nc l ert i f icatesf depositlshort-tenllainrs n hegovernmerrt,orporsrions.rnd anks,espectivcly).ls oincluded sshort-termapital lorvs reany ntcmationalhifts n the ox'nershrpof liquid unds, uchas an nrerest-earningeposit, r even checkor cash vhichdoes ol pav nterest. or example, ri t ish oundnotes, r depositsn a Birishbank, reassetsiving clim n futureBrit ish oocls nd sen'ices,us t s surclyas Brit ish reasury i l ls.Th edist inction enveenhort-term ncl ong crnr s st i l lreportedn Japen,Gerrnanl',nd sonle thercounrries, r:t not in thc U.S.ac -counts,mainlv ecauset i s dif i iculr o disentanglehe u'o ypes f porrfol io n-vestmentn thedata.

2"Cpital account" r,i l l generallvbe used o efir to the privarecrpitrl accoLlnr, rs clistinct rorrrthc trnsctions oi central bauks. (l t does nclude.horvevcr. nv infcrniltionrl tansactjonsunder-taken bv governmenr gencies ther rhan rhe cenlrl bank-for erample, creclits o U.S. rrmedfocesstationedaboad.)

Cumulative lances

1.

)

3.

!'i:.'=-,:it:i:'r=:

s-ii,::i=:::r;ai::F


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256 CHprn 5 . THE ALANcEFPvrnrsAccouNtsFinall the ORT account onsists f central ank ransactionsn internationale-serveassets: old, foreign exchange eserves, redits ssuedby the InternationalMonetaryFund IivfF), nd Special rarvingRights SDRs).3 entralbanksholdthese eserve ssets o back up the liab ilities they issue domestic urrency andotherassetshat add up to the monetary ase),much as commercial anksholdreserveso back up the liabilities hat they ssue checking ccount eposits ndotherassetshataddup to the otal money upply).

15.2 How lnovrouALTRANsAcnoNsRERrcoRoroThe key rule for recording ransactionss as ollows: Slhateverenters he countr),,suchasan mport, s recorded s a debir; vhatevereaveshe country, uchas anexport, s recorded sa credit. he exampleshat irstcome o mind concernradein merchandisegoods). n import of an autontobile ppears s a debit n themerchandiseccount ecauseomethings enteringhe country; he export of je tenginesppears sa creditbecauseomethings eavinghe country.Of course,hecountry hatexports he automobile arns crediton rsmerchandiseccount; ndthe country hat irnports he et engines eceives debit.Therearemanyotherexamplesor exportsand mportsof various ervices,and for each of the other subaccounts s rvell.Vhen an American mporterarrangesransportation.vitha Greekshipping ompanl', r American ouristscoss he Atlanricon a foreignairline, he mport of the services recorded sadebit n heU.S. ransportationervice ccount.lhen foreign irmshireAmericanships o carrygoods, r when oreign ourists ome o theUnitedStates,he exportof thesevices recorded sa credit.The spending f Anierican ouristsn Europeir r. .*d.d rt, d.bit,again n theservice ccount, nd hespendingfJcpanesetourists n the UnitedStates s a credit.Vhen an American elevision roducercontracrs ut to Koreans he rvork of filling n frames n an animated artoon,aservicemportof the UnitedStates gainappears.lhen a foreign tudent omesoan Americanuniversity o stud.vor a foreignmedical patient comes o rnAnierican ospitalor surgerv,t appears sa U.S. en,icexport.The conventions that giftsand other ransfers re recorded nderunilaterltransfers.ven hougha transfer rom another ountrydoesnot create nl' obli-gation or futuremonetary epayment, sdoes loan,a device or rememberinghatit appearssa creditmightbe o think of the ransfer s he exportof a politicalormoral OU. n 1991,heUnitedStateseceivedarge aymentsromJapan ndotherallies o finance peration esert torm n Kurvait. hese redits id notappear nthe servicesccountbecausehey were not literally exports f nlilitar v services urappearednstead s ransfers. rnigrants'emittancesre an importantsource lcreditsor Mexico, he Philippines,nd countries round he Nfediterranean;hecorrespondingebits re ncurred n the UnitedStates, orthernEuropean ountrles,andPersian ulf stateshat host he mmisran vorkers.

sSpecial ra*'ingRights, onetimes escribeds paper old,"arean asset reated ,v he lrlF'Their aluesdefinedn ernls f four curencies:hedollar,'en, ound, ndeuro.

15.2 HovxovlouLTmscrroxsAnEconoeo Zg7Credits and Debits on the Capital Account

oThe cquisition f a foreignasset ounts s a debiton the capitalaccount, ecausethe asset, r at leasr he claim o the asser,s entering he homecountry.As a de-vice or rememberinghat an nvestment broadcounrsas a debit, hink of ir asthe "import" of an asset.Theequivalent erm-"capital outflow',-rnay be esshelpfulhere,n rhat t maynot sound ike an mporr,even hoLrght is one.)VhenGeneralElectricbuilds a factory n Europe,an ourflorvof direct nvestrlent,adebit,equal o the valueof rheequity hat GE acquiresn the factor is recordedin the U.S.balance f payments.n thissensehepurchase f machineoolsbolteddown o a factory loo n Scotlands similar ro rhe purchase f Scotrishmachinetools mported ntothe UnitedStates, ut in the formecase he debirappears nthe capitll rccounrand n the artercase t appears n the merchandiseradeac-count. n American urchasefthe bonds fa Canadianrovincial overnnlentsrecoded s a porrfoliocapitaloutflorv,a debiton the ongterm portfoliocapitalaccount.The Americanacquisition f a short-rermasset n anther count;y-.,vhethert is a treasur,v ill, corporareOU, cerrificate f deposit, heck,or cur-rency-countsas a debit on rheshort-term ortfolio capitalaccount.This pointshouldbeemphasizedecauser rv,ill e nrportanr or understandinghe lccour"rr-ing to follorv.Rememberhat he reason his acquisition ounrs s a debit s thatan American as ncreasedndividualholdingsof a foreignasser, ven f rhe assetis onl-voreign urrenc!'.Eversince1982, he U.S.capitalaccounrhasshorvnmanymore credits hrndebits.Foreign itizenshave beenacquiring assets f evervsort in the UniredStates: nrrenc,r',reasury ills, bank oirns,.bonds,tocks, nd direct nvestnent.The rEnn "cre# maffilikc a goodthrngffirrecaiving cornrr{r-onesensehis s true: t crn evierved s a voteof confidencevhen oreisners e-cide o investn the UniredSrrtes. he dorvrside.f course,s rh; U.Slcirizcnsrvi l lhave o servicehe debt i.e., ay nteresr, nd eventuallyepry heprincipal)in the uture;or, n the cases f sales f stocksrndnrvarddirect nvestnrent,lii,i-dends nd profits r,illhave o be reparriatedbroad n rhe Lrture.If American it izenscsell o a ioreign esiclent bondoriginall,vssued v afoleigncorporation, r an1' ther oreignassetheyacquiredn the pirst, hat roocountsas a credit.There s no economic ifference etrveen n increrrsen yourobligationso a fbreigner r a decreasen a foreigner'sbligationso you.Both aredescribedsa deceasen the net foreign nvestment osrtion f the UnitedStates,r,vhichssimply nemorewa yof saying capital nf lorv"or "credrt n rh ecrpitrlaccount."Siurilarly,f an American uys backa U.S.Treasury ill fronl a foreignresident hoacquiredt in thepast, rcounrs sa debir n theU.S. apital ccountin thesame vayas vhen he asserhe Americirn urchasesrom the foreign csi-dent s one hatu,as riginallyssued y sonreoreign o\rernmentr institut ion.alAs matter f fct, ncreasesn U.S.-heldssetsssued broad nddecreasesn ioreiqn-heldssetsin the UnitedStates re eported eparatelyn the detailed alancef-prynrentsrccuLrnt,ub-lished very uarter v heDepartmentf commerce. conomiciscussionsf thebrrlancef par,-nents :sually'ocus nlyon henct capital lorvs, orvever


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288 Cspren 5 . TEBrrucorPvlrrsAccouxrsThe final placewhere ceditsand debitscan appear s the OfficialReserveTransactions ccount.Vhen the domestic entralbank buys oreign urrency r

- gold, ts purchaseourts sa debit, us tas t does vhen private nvestormakeshepurchase, ut here t appears n the ORT account ather han heprivate apitalaccount.As a dei,iceor rememberinghat t counts sa debit, hepurchaseanbethoughtof asan mport of goldor foreign urrency y hecentral ank. n thissenseit is ike the mport of gold ewelryor sharesn a foreign old mine,excepthat nthe ewelrycase he debit appearsn the merchandiseradeaccount nd n thegoldmine case n the capitalaccount.Only rvhen he central ankmakes he purchasedoes t appear n the ORT account._ Another examplearises f the country n question s one rvhose urrency susedby othercentralbanksas a reserve sset asare he dollar and several thercurrencresr).he n a foreign entral ankbuys ome f th edonlesticurrenc tspurchase ounts sa credi t n th edomestic alance-of-payrrentsccounts,us tasit doeswhen a private oreigner uyssome.

15.3 DouaLe-El.rRY BooKKEEPTNGNote a criticalpoint: As a matterof accolntiqg,everyqornplete conomrcra$-actrons recordFd*ice, onas a debit and onceasa credit.The easons ha t neverr orrrpleteransaction here s somethingeaving he countrv n erchangeorsomerhing ntering he country. f therewere not, then one party or the otherrvouldbe givingup somethingor nothing.6 necase vherehis s easy o se esbarter. f, for crample,Arsentinrexports vheat o Russian exchangeor tractors,then both thecredit or the rvheat xportand he debit or the ractorsmport rp -pearon the merchandiseradeaccount. imilarlv,f Russie cceptedheclaim osonreArgentinearmland n pavm ent or th e ractors,he Argentine ahncc-of-payments tatisticsvoLrki horva debit o the tradeaccount nd a corresponclilgcreditunder oreien irect nvestment.Paying or lmportsUsully, orvevet ral lsactions re paid for in an inlnecl irte ensehrough hebankingsystem.: rgcntina a,vsor the ractors y rvri ting check n a bnk'5Only contertible foreign currencies are held as foreign erchange e serves. entrl banks do no rhold Tajikistani rubles as resen'es,because erther he governmenr r)or privirre hnks u'i l l frcelvconvert them irto gold, dollars, or other internatjonl reserve ssets.6The unique case vhere on e prrt,v does n fact give up sornething or nothing ls the unrlterl ltrnsier. When the United Statesdonatesgrain to an Africrn country, fo r errnrple, r debit s s -signed o the trde acco unt of the African countrt ' (o r to its capitrl account f the donrion con-sistsof monev) because omething s entering he countr,y.A credit s assigncd o the United Sttesbecarse omething s eaving he countr ; ' .As rvasal readvnored, he uni lter l r r rs f r rs ecounr swherc accountants.bv convention, also assigna corresponding redit to the recipient ountry rn d.r debi t ro the donor e^unru.7l n a type of intcrnxtional transaction calle,J ountertrde, he exporter of goods o a counlypromises ro import a corrcsponding value of goods from that country. Horvever, ost counrer-

| 5.1" Douer-ErR'rooxrprNc 289The credit hat correspondso the debit on the trade accountappears n rheshort-term apitalaccount. ecall hat any imea foreign esident cquires n as-set or a claimon the domestic ounrryeven f it is a bank deposit ather han amore angiblenvestment,t countsas a crediton the domestic apitalaccounr.tis quite ikely hat he Russianracformanufacturer ill quicklycash n its check,rvhich s a claimon an Argentine ank, o buy something oredirectlyuseful o tthan Argentine esos perhapsha t Argentinewheat), ut this would countas anentirely eparateransaction nd would appearn the accounts s a new credit-debitpair.Other han paying or transactionsy cashor check, he only othercommonmethod s trade credit:The tractor manufadurerextends o the Argentine m-porter he ceditneededo buy rhe actors i.e., he mporterdoes ot have o payutii a l;rr date) r else bankextendshe credit o rhe mporter.n this cse hecredit temagain ppearsn the short-term apitalaccounr: foreign esidcnt asacquired short-term laim against n Argentineesident.n thissense aying oran mport on short,term redit ooks us t ike paying ash; oth appear s ceditsin the sameine of the balance f oavments.Payln g for Asset PurchasesAs a finl se tof examples, onsider ow the purchase f an assers paid for. f aJapaneseompany uysan officebuilding n LosAngeles nd paysby chcck, heU.S.balance f paymentsegisters creditunderdirect nvestmentl foreign om-panvhas ncreasedts holdings f U.S. ealestate) nda debitundebanking lows(anAmerican ompanv as ncreasedts holdings f short-tcrm lairns n foreign-ers-it has heJapaneseheck). f an American irm buysa Canadian ond andpavsby check,he U.S.balance f payments ho.rvs debir o porrfoliocapital rhefirnr has ncreasedts holdingsof foreignsecurities)nd a creditunderbankingflorvs a oreign inn has ncreasedts holdings f shot-term laims n Americans).If n American uysa 90-da,v ertificare f Deposit n the UnitedKingdomandpavsbl check. oth he credir nd he debirappear nderbanking lorvs rrvoshort- termssetsav cbeen xchanged).n some asesr is difi icuk o sr v rvhichsideof the transactions paying or the other.There s nothing vrong vith this;bothparties ave o ge tsomething ut of it.It rlay be clearer orv rvhy it makesaccoullting enseo enter a paynrentabroadasa credit o thecapitalaccount r hesameime hat a debit s enteredotheotheihalfof the ransactione.g., n the radeaccountn thecase f an mportof merchlndise). ake he case f an American ompany aying or an import nclollarseither ash r a check n ts bankaccounr).f the oreign ompanywere ohold on to the dollars ather than cashing hem in, in exchangeor its olvn

rrade ransactionsre.still ai d or hrough hebanking vstem. elativelyinleof it is outrightbarter orgoods, s hi s s arvkrvard.Dalia \4anin, Tyingn lnrenationalrade: videncenCountertrade,"he Xlorld conom1.,3,no.3,Scpt. 990,145-467.J


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29 0 CHprer 5 . THe lrucr r PvmrxrsAccoulrscurrency-that is, if the re rvereno second ransaction ndoing he capital low-this uouldhave o mean hat the foreigncompanyhad madea deliberate ecisionto increasets holdings f dollars.Thisshould ountasa capital-accountredit; tconsritutesoreign nvestmentn U.S. assets,ust as f the foreigncompanyhad n-creasedts holdings f U.S.stocks r bonds. gain,normally he oreign ompanywould be expectedo cash n the dollars or somethingmore useful,but doing sowould countas a separateransaction.f the foreign ompany ells he dollars othe central ank, he secondransactiononsists f a debit o the U.S.short-termcapitalaccounta oreign rivate ompany asnorv educedts holdings f short-termU.S. ssets)nl credit o the ORT account theFederal eservease-xportedsome oreigncurrency eserves).What if the lmporter Pays n ForcignCurrency?It hasbeen ssumedo ar hat heU.S. mporter anmakepaymentn dollars. hestory ssimilar, orvever,f it pays n foreign urrency. ssumeist hat heU.S. m-porterhason handa stockof foreign urrencyust or suchpurposes.nitially hecurrentaccount ebit s paid for by a short-term apital-accountredit:A U.S.company as educedts holdings f foreign ssets,vhich epresentscapital n-florv ust as i it had soldoff a securitl'.Recallhat rvhen he U.S.company e-creasests creditposition is-)-vis oreign ompanies,t is as f foreign ompanieshad increasedhei creditpositionvis-i-visU.S.companies.)orvever,f the m-porterobtainedhe oreign urrency v drawingdol'n some ranstctions alancesthat'rvere epton hand or thepurpose, ubsequentlyt ivill probably vant o re-plenishtsstock f foreign urency by bu,vingome n the oreign xch."g.rytk.r.If the mporter oes ot have stockof fbreign urrencyo begin 'ith, henagainthas ogo nto he oreign xchange arket o obtain ome. itherwaJ',he rnponerneedsoreign urrenil',and herewill be a secondrirsactionn rvhich t is ob-tained.f the mporter btainshe oreign urrencyrom ts central ank, hesecondtransactiononsistsf a debit o theshort-termapiral ccount nda credit o th eORT accounq xactly s n the irst exanple.On the otherhand, f the rnporter llorvs ts stockof foreign urrencyo re-main owerat he endof the period han t wasat the beginningor goesnto debtin foreign urrency),hen t must havedecided eliberatelyo decreasets (net)holdings f foreign ssets.he net credit hen emains n the capitalaccount-aswhen oreign ompaniesncreaseheirclaims n domestic ompanies-ratherhanbeingransferredo the ORT account.

15.4 Tn EBnlaNcesEvery ear,hecountryadds p the debits ndcredits risingrom he nternadonaltransactionshat have akenplace. or mostpurposesn economics,he onll'con-

;:.:

15.4. THBALANCES29 1

cen szt lows,or total creditsminus otal debits.Within anygiven ine of the bal-ance [ payments,herewill be manycredits nddebits hat cancel achotherout.For example, hort-term anking lows are rypicallyvery high in gross erms,asbanks buy and sell short-termpositions n foreign currency and send checksbackand oth for collection.But the net flow is much smaller.The country then adds ogether he net flows, or subtotals, om different inesin the accountso detemineariousbalances, uchas he tradebalance.f creditsoutrveigh ebits, hen the balance n question s positive.A positivebalance scommonly eferred o as "favorable." f debits ourweighcredits, he balance snegative,r "unfavorable.'Noe the gravitational ull of rhe semantics. he export side owns all thepositive vords-and has done so ever since he eighteenth-centulyercantilistsmadea national irtueof selling broadmore han one bought n order o "storeup treasure."Although economistsrom Adam Smith on haveproclaimed hateconomicwelfareultimatelydepends n the goodsavailable or the nation'suseand not on the moneyeaned rom exporting, hey havenever onqueredhis in-guistic emnant fmercantilism.hen the erm "un{avorable" s used n re{erenceto a negativerade balance, emember hat it may be perfectlyappropriate or acountry o run a tradedeficit,depending n the circumstanccs.or example, evel-oping countries sometimes un large trade deficits. This practice can beperfectly ppropriatef they aregrorving apidly and need, or example,o importcapitalgoods n orde o invest n plant and equipment. uch ountries re neces-sarilyborrorving rom abroad o finance heir current-accounteficits. f they arespendinghe funds well, they will in the future have he levelof capital stock,paleulycxport ca@ort earningswith which rorepay har ebr.Th e Adding-Up e onstraintBecause verydebit has an offsetting redit somewhere, A + KA + ORT = 0.(Three arsare usedn the equaliry ign o indicatehat his s an accountingden-t i r t . )Becu.ct . al i l lys ; . i lo, he hrre-rccorntum snot a verv nterest ine.rr t rr-tic! Trvo nterestingtatistics re 1) he current-accountalance nd (2) he sumof

_ the currentand capitalaccounts,vhich s what is generallymeant by the overallbalance f paymentsBP):BP = CA + KA. Thesestatistics evealwhether hecountry s spending eyond ts means, nd whether hee s a net supplyof, or de-mand or, ts currncy. country hat is runninga current-accounteficit-for ex-anrple,he UnitedStates ince1982-is borrowing rom abroad o do so, unningdorvn ts net oreign sset osition.Eversince1.91.7,thenitedStates ad been c-cumulating laims n the estof theworld, but in a fer.v ears he enormous cficitsof the 1980s viped ut that accumulatednvestment osition.The official statistrcsshou"+hathe countrypassedrom net creditstatus o netdebtorstatusn 1988.


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292 Cuprn 5 . TueBrce r Pwrrs ccourrsA country hat is running a current-accounrurplus-Japan,or example-isaccumulating laimson foreigners nd buildingup a positive et oreign sset o-sition.s f the foreignassets re acquired y the private esidents f the domesticcountry, hen the capital-accounteficit offsets he current-accounturplusandthe overallbalance f paymentss zero. n thiscase, A = -CA, soORT = 0.On the otherhand, f a country s runninga cuent-accounturplus nd tsprivate esidents e not acquiring oreignassets,hen t mustbe hecentralbankthat is acquiring oreignassets:n this case,KA = 0, so ORT = -CA. Sucha

country s runninga surplus, ot juston its currentaccount, ut alsoon ts overallBP. BP ssometimesalled heofficialsettlementsalance.Note hat t is he reg-atiueof the sumof the temson the ORT account:ORT = -BP.) The overallbal-anceof paymentss thenetsupplyof foreign urrency or he netdemand or do-nrestic urrenc), hich s the sarne hing),after he private ector asnlade ll itsdesired urrent-accoulltnd capital-accountransactions.f it is apositive untber,the ORT is negative, hich means rat he central ank s adding o ts foreign .v-change eservesor is supplying he domestic urrency hat private gentsn theforeignexchangemarket vant, vhich s the same hing). f BP s a negative um-ber, henORT is positive, vhichmeans hat he central ank s selling oreign x-d+aagereserdar is brying tfrrdonresticcnrrency tharprivate agems n the Rlr-ket rvlnt to sell..Where to Draw the Line?Thereuseclo be apresurnption f causrrlityunning rom ters eported igher ntheaccounts horvn n Table 5.l to items eported,.lvcr. rade, or example,og-icllly came irst.Suppose line s dra*'n under he entriesor trade n goodsandservices.hen, f the balnces n deficit, t couldbe inanced y transfers, y bor-rowing KA),or by reserveos s ORT).Al l i tenrs trovehe ine'areconsideredtobe autontnnous-the1'crusehe tenisbelorv he ine, vhich re inancing r lc-cornntod:rting. here rvas mucl-r ebateas to where o drrv he ine. OblittLspl,rces re he CA balance,vith KA nd ORT:rs ccomtrodt ing,r rr tBP ,uithOR T alonc rs cc


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294 CHpren,5 . TUEBur.corPryeNrsAccoururswirh other formsof foreigndirect nvestment nd sales f longterm assets,houldcounr above he ine-as do exports f goods. hus, he basicbalance dds heselong-term apitalnflows o thecurrent ccount. heaccountinghoivshat hisbal-ancemustbe inanced, accommodated,itherby shorttermprivate apital lowsor by official reserveransactions. he basicbalances no longer eporred or theUnitedStates.ndeed,t cannoteven ecomputed ecausehesradsricsollectedolongerdistinguishbenveenong-termand short-termporrfolio nvesrmenr. he bal-ance sstill eportedor Japan ndsome thercountries.Are There ReallyAccommodating Transactions!originall rhe reason or drarving he line-rvhetherat the merchandiseradebalance; oodsand se^,ices; oods, e^'ices, nd income; urrentaccount; asicbalance; r overallbalance f payments-wasso that ransactionselorv he inecouldbe houghtof as inancing r accommodatingbeing aused y) rransacionsabove he ine.This reasonings now somervharur of dare.A lnore modernview of causalityn the balance-of-paymentsccounts asevo.lvcdrt of the rrnrirri r o i lorring xchangeates n thepartof mosrmajorindustrializedountriesn 1973.t1 he definitionof (pure) loating s ORT = 0:Thecentral ank doesnot buy or sell oreignexchange,o hereareno official e-serve ransactionso record.obviousl in thiscaseBp is not an nterestinqtatis-tic, as r is norvahvays qual o zero.Currcntly,nlosrcenrralbanksat tinlesdo participaten foreignexchangenrarkets o try ro inluencehe exchangeare.This is ntanagedloating, rarherthan pure loating.rr er here s no clearsensen rvhich enral an ksales rpurchasesf international eservesectssarily ccommodate'r.e., reczrsety)pri 'are radcan dcapiral lol 's, rarhe h n he other ,ayaround. ore_rample,in the ate 1960s, nde ixed exchangeates, t made ome enseo sa y ha tlargeu.s. balance-of-paymentseficits ausedo.eign entral anks o buv upunrvntcclol lars.n rh ecase f rh edeficirsun b1' heunitedstatesn some e-centycrs,horvever,t n,s rs oncct o say hat rhe voluntarv lecisionl.for-eigncentrl l bankerso buy dollars l lot,ed, r even caused,"'the.s. deficirs.This point s evenmore applicablevhenassets re sold o foreign rivareresidentsather rhan to foreigncentralbanks.A surplus n the private apitalaccourlt s rvhatallorvs, r even auses, country o run a deficiton the currentaccount,as much so as fhe deficit in the current accountgiving rise to thesurrlnsn thecapital ccouut. he mostprominent xamples he arge urrent-account eficir hat he united States cgan o nr n afrer1982.To sa,vha r hedecision v privare oreigners o incrcaseheir holdines f u.s. assers scausedhe u.s. currenr-accounteficitss ascorrect ssayingha t he cecision

rrRohertstern, The Presentationf he u.s. Ilalance f parments: Sr.nrposium,,,ssaysnIntcrntionali lrcc, I2i. lrinceron Iniversitv.,\ugust971.rrln he ate1990s,heUnitecl tatesndMexicowere wo countrieshat loared ith very ittlelntcrvention.

15.5 Snrrslcr ERnonsNrsepyNeNrsAccouNrs zgsby Americanso import more goodsan d services aused he current-accounrdeticits, vhich hen had to be inancedby borro,,ving rom abrqrd.The rmpor-tantpoint s ha tno clear resumption xists s o rh edirection f causaliry.nrealiry, he variousacc.ountsre generallydeterminedsimultaneously. or thisreason,hedist inction enveenutonomous nd accommodaringransactionssno longerobserved.In fact,even he iguresor the overallbarance f payments re no longerex-plicitly eported or the united srares, scan be seenom rhe actualbalance fpaymenrstatisricseproducedn Table1j.2. The ner capital-accounralance asbeencomputed.otice hat n 1983 t turnedsharply rm deficit nro surplus, sforeignersegan o acquire .S. assersn recordamounrs.we rustadd tlie capi-tal-accountumber o thebalance n currentaccount a argecleficit ince19C3,to find heoverallbalance f payments. t first, he private apitl inflorvwassuf-ficient o finance heu.S.currenr-accounteficit. n t9g6-200, horvever,he pri-vate apital nflorvusuallyell fa r shortof thecurrent-accounrleficit, n oreigncentralbanksmadeup rhe difference, sevidencedn Table1i.2 urider ,forei[nofficialassets." heuniredstaresan a deficir,not just on ifs currentaccount,b-utalsoon ts overallbalance f payments.Nlaking hese alculationsan be nstructive ven hough vehaveabancloneclthe presumptionhat he U.S.balance-of-pal'menrseficit vas necessarih',tusittgcenrral anks obuv up unrvrnted ollars, ather hc n heorher vrl. rrond.

15.5 Srnsrrcal EnnonsNTH E AyMENTsAccouNTsWhen governnlent tatisticiulsssernblehe record of rnrion's internationrrltransactions,hevdo norobseive iiectly hervides of every ransacion. rorlcreep n for trvo reasolis: ome ransactions re valued ncorrectly. o that thequantityecordedor on e id e f rhc ranst.t i , , l t:ri lso eqLr,rlh:rt or it scorrren_-satingransaction,r one id e f a transactionsontit ted ntirelv.While hestatis-t icinmeasuresc h lrssf transrctionrs rccur.rr(l \ 'rr possible,rec,rusef these1nd thererrors he suns i creditan d delrit terrs lo nu t a,r,na ut eoual.Therefbre,he statist icianirnpl,vncludes n re mcalled strist ical l iscrepancy,"or "errosandomissions,"qual o this difference. hesenleasure,llantrro.r r. .no small roLrlem.he errorsn th eu.S.sratisricsegan o run rvrld n the 19g0s,indicating n unmeasureder nflorvof monel',ascan beseen n Table15.2.Thisinf]oiv*'as due n pa.r-co llnrest n some oreigncountrieshat impelled nds toseek safe rven n th eunited tates. he:rcquisit ionfsuchclaimiby forergners,called capital l ight,"ofren s clandesrinend goes nrecorded.n the 1990s hi sne t lo*' re'ersed, uggesringht his l ightcapital va s erurning onre. he ab -solutemagnitude f the discrepirncys still arge.Anothernrajordiscrepancyppears hen he ner current-accountosrtions fal l countries re added ogether. ecause veryexport is somecou.t.y's import,thcre ccouiirsvould un tr. ero f all countries oi thcirn,.,.,r,,ranl.,lr,ight. Thediscrepancyan as argeas $100 billion in the 1990s. t irppears s thoi.rghheworld .vereunninga deficit vithorherplaners.


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,3,5!=;+a23F

: i

! $. , r EF:ill i i: y = ; 9i5 i*r:=ii

i2-; Yr.:-

t = i:

E i: :;v.-:. : i zz

c

296

Table 5.2U.S.Balance f Payments tatisticsn Summary orm

\:aaq :na ^l \ n q f i : : .9q 91+: :+** F X * =--.s S+ ?+ + frt l t t t t t t t t I l t t t t l

e 91 \ r\q q ", t . . : 9 : "1 q 1.!n \ 9 999oaaNn6-OSqNdFhde-


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298 CHprn 5 - TrB-ucrorPnyrrrsAccourrs

8. U.S. irm buildsa factory n Mexico,pays or land, ocal abor,and so on,in pesos. ,9. U.S. o!'emmentendsoreign id o Pakistan,vhichPakistanis old n theform of dollars.10. Chinabu's uclear eactors rom the U.S.government,ays n gold. (Nocentral ank s nvolved.)- lL Portuguesemmigrant endsmoneyback o family n Lisbon n the orm ofa 10-year .S.savings ond.12, U.S. im receivesrofits n the orm of pesosrom he actory t previouslybuilt in Mexico.13. Dutch holdingcompanybuysa controlling nterestn an Anierican irnr,pays n dollars.14. U.S.ship s easedo carry beef rom Australia o Britain. Paymentor freightchargess n dollars.15. Federal eserveells old o support he valueof the dollar.

2, Ve heaof financialransfeso "launder" llegally cquiredunds.For example,SouhAmerican mugglermight deposit ncome rom illegalexports n a lvliamibank,and arrangeor the bank o re-lend t to the smugglero invest n a legiti-mate activit)'.a. Horv voutelhis ransaction ppear n the U.S.balance-of-paymenrsc-countsfitrvere recorded orrectly? orv would t appearn rheaccountsof hr SouthAmerican ountry?b, llhat error vill t createn the accountsf rheexporter's arnings ndclaimon heNliamibank arenot ecordedn the exporter's omecountrftrnsactlonsare recorded n tcasef thecommodity xported s egal, ut the exportereaveshe dollarproceedsn the Miami bank o evade axes.)fhat rvill his do to thervorldwide urrent-accountiscrepanc,vc. What emor vill becreatedn thenvo countries' ccountsf the exportertclaimon he bank s not recordedn either ountr)', ut the export s e-portedn both? Tominimizehc -l;.,iies f getting aught, he exporrer

simply ails o infom he vfiamibank hat heor she snot a U.S.citizen.)Vhat would hiserror do to the rvorldwide urrent-accountiscrepancy?

Tur FonncNExcHnNGEARKETAND nnorEnsrcrlEsFFh. foreign xchange arket swheredomesticmoney for example, ollars)

I is traded or foreignmoney for example,poundssterling).The exchange-E- mte susually efined s he priceof the oreigncurrency n termsof the do-mestic urrency',hough t couid as easily ave been he reverse,l nd his conven-tion will be ollorvedhere.Note that a deprecintion,a decreasen the value of thedomestic urrency,s an ncreasen the exchangeate,becauset is an increasenthe priceof foreign urrenc)'. ome ind it counteintuitivehat a deceasen thevalueof the currencys calledan ncreasen the exchangeate.Yet ust as econo-mistsoften alk about an ncreasen the pricesof commodities inflation) athertha the equivalent epreciation f money's urchasing ower over commodities,so t is often ntuitive o talk aboutan increasen the price of foreign currencyrather han heequivalent ecreasen the valueof thedomestic urrency.Ve aresimplif ng vhenu'e speak f //reexchangeate or a country. n real-it1', achcountryhas many exchange ates,one for every other currency n thervorld.The UnitedStates,or example, as he dolla/yen ate, he dollar/poundof the movementsn the homecountry's urrency epends n rvhichexchangeateis used. o'geta good deaof the value of the currencyoverall, t is necessaryouse n exchangeate ndcx,knorvnas rbeeffectiue xchangeate, whtchcomputesa rveighted verage f the exchangeatesagainst ch f the ndividual countries.Typicallvhe veightssed re he countries' haresn trrde.

!. Tse Flow oF Supply AND DEHAND FoR FoREtcN ExcxaHceIn the oreign xchange arket, s n othermarkets. ,,ppl1'. , i1 ernand recen-tral.The proceedsrom exports, nd othercredit tems n the balance f payrnents,generatehe supplyof foreignexchange r foreigncurrency.mport spenclingndothedebit temsgeneratehe demand or foreignexchange.n Figure 16.1 rvemeasurehe quantities f foreignexchange uppliedand demanded n the hori-zontalaxis,and hepriceof ioreignexchange-theexchangeate E-on theverti-cal axis.Wecan hink of the supplyand demand or foreignexchange s unctionsof the currency'srice-the exchangeate-just as he supplyand demand or anvlln the United ingdom,or example,he practices o speakn termsof the dollar/poundate,anexceptiono thegeneralulebecausehepouncls he domestic urretrcy.

Caves2002.Cap15 BoP Accounts

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