Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-0 INTERNATIONAL...

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-1

INTERNATIONALFINANCIAL

MANAGEMENT

EUN / RESNICK

Fourth Edition


INTERNATIONALFINANCIAL

MANAGEMENT

EUN / RESNICK

Fourth Edition

Chapter 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 Three

The Balance of Payments


Chapter Three 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

Countries


Balance 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.


Balance 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.


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 Discrepancy

Balance of Payments Accounts


The 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.


The Capital Account

The capital account measures the difference between U.S. sales of assets to foreigners and U.S. purchases of foreign assets.

In 2004, the U.S. enjoyed a $611.2 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.


Statistical 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 $51.9 billion in 2004.


The Official Reserves Account

Official reserves assets include gold, foreign currencies, SDRs, reserve positions in the IMF.


The Balance of Payments Identity

BCA + BKA + BRA = 0where

BCA = balance on current account

BKA = balance on capital account

BRA = balance on the reserves account

Under a pure flexible exchange rate regime,

BCA + BKA = 0


U.S. Balance of Payments Data

Credits DebitsCurrent Account

1 Exports $1,516.2

2 Imports ($2,109.1)

3 Unilateral Transfers $16.4 ($89.4)

Balance on Current Account ($665.9)Capital Account

4 Direct Investment $115.5 ($248.5)

5 Portfolio Investment $794.4 ($90.8)

6 Other Investments $524.3 ($483.7)

Balance on Capital Account $611.2

7 Statistical Discrepancies

Overall Balance $2.8 Official Reserve Account $2.8

51.9



In 2004, the U.S. imported more than it exported, thus running a current account deficit of $665.9 billion.


1 Exports $1,516.2

2 Imports ($2,109.1)









51.9



During the same year, the U.S. attracted net investment of $611.2 billion—clearly the rest of the world found the U.S. to be a good place to invest.


1 Exports $1,516.2

2 Imports ($2,109.1)









51.9



Under a pure flexible exchange rate regime, these numbers would balance each other out.


1 Exports $1,516.2

2 Imports ($2,109.1)









51.9



In the real world, there is a statistical discrepancy.


1 Exports $1,516.2

2 Imports ($2,109.1)









51.9



Including that, the balance of payments identity should hold:

BCA + BKA = – BRA

($665.9) + $611.2 + $51.9 = ($2.8)


1 Exports $1,516.2

2 Imports ($2,109.1)









51.9


Balance of Payments and the Exchange Rate

Q

P

Exchange rate $

S

D


1 Exports $1,516.2

2 Imports ($2,109.1)









51.9



Q

P

As U.S. citizens import, they are supply dollars to the FOREX market.

Exchange rate $

S

D


1 Exports $1,516.2

2 Imports ($2,109.1)









51.9



Q

P

As U.S. citizens export, others demand dollars at the FOREX market.

Exchange rate $

S

D


1 Exports $1,516.2

2 Imports ($2,109.1)









51.9



Q

P S

D

As the U.S. government sells dollars, the supply of dollars increases.

S1

Exchange rate $ Credits DebitsCurrent Account

1 Exports $1,516.2

2 Imports ($2,109.1)









51.9


Balance of Payments Trends

Since 1982 the U.S. has experienced continuous deficits on the current account and continuous surpluses on the capital account.

During the same period, Japan has experienced the opposite.


Balances on the Current (BCA) and Capital (BKA) Accounts of the United States

Source: IMF International Financial Statistics Yearbook, various issues

U.S. Balance of Payments Trend: 1982-2004

-800

-600

-400

-200

0

200

400

600

800

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Year

Bal

ance

of

Pay

men

ts (

$B)

U.S. BCA

U.S. BKA


Balances on the Current (BCA) and Capital (BKA) Accounts of United Kingdom

-50

-40

-30

-20

-10

0

10

20

30

40

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

UK BCA

UK BKA



Balances on the Current (BCA) and Capital (BKA) Accounts of Japan


-150

-100

-50

0

50

100

150

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

Japan BCA

Japan BKA


Balances on the Current (BCA) and Capital (BKA) Accounts of Germany


-100

-80

-60

-40

-20

0

20

40

60

80

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

Germany BCA

Germany BKA


Balances on the Current (BCA) and Capital (BKA) Accounts of China


-20

-10

0

10

20

30

40

50

60

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

China BCA

China BKA


Balance of Payments Trends

Germany traditionally had current account surpluses. From 1991 to 2001Germany experienced current

account deficits. This was largely due to German reunification and the

resultant need to absorb more output domestically to rebuild the former East Germany.

Since 2001 Germany returned to its earlier pattern. What matters is the nature and causes of the

disequilibrium.


Balances on the Current (BCA) and Capital (BKA) Accounts of Five Major Countries

Source: IMF International Financial Statistics Yearbook, 2000

-600

-400

-200

0

200

400

600

800

1980 1985 1990 1995 2000 2005

China BCA

China BKA

Japan BCA

Japan BKA

Germany BCA

Germany BKA

UK BCA

UK BKA

U.S. BCA

U.S. BKA


End Chapter Three

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-0 INTERNATIONAL...

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Transcript of Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-0 INTERNATIONAL...