International Issues in
Individuals, businesses and governments in a country may interact
with individuals, businesses and governments in another country.
In this sense, we say residents of different countries interact.
As you know, in the US the money we carry around and use in our
day to day transactions is called the dollar. But, other countries
may call their money something else. For example, there is the
British Pound, the Japanese Yen, the Canadian Dollar and the
Note that typically one US dollar does not equal 1 unit of the other
country’s money (not even the Canadian Dollar).
Recently I was able to travel to another country for the first time in
my life. I only had dollars in my pocket because when I earn
money I get paid in dollars. But when I went to buy something the
folks there didn’t want dollars, they wanted their own currency.
Luckily for me, a big bank there was willing to take my dollars and
give me the money (often called foreign exchange) of the country I
was in (I was charged a fee, of course). I was also able to use my
credit card and debit card and the banks involved paid in the money
of the country I was visiting.
Say some folks in Nebraska want to sell beef in Columbia. This
would be a US export. The folks in Columbia do not have dollars.
The Nebraska sellers want dollars.
1) Demand US dollars, while at the same time
2) Increasing the supply of foreign currency in the US.
This is an example of a good being exported, but a similar result
holds if we export a service (like engineering knowledge of
building a bridge), or if we make a financial investment in a
foreign country and we are going to get paid interest or dividends.
Say in Nebraska someone wants to roast coffee beans to sell to the
public in the form of coffee. The Nebraskan would import the
coffee beans from Columbia, perhaps. The folks in Columbia do
not want dollars. They want their own currency. The Nebraska
importer has dollars.
1) Demands units of foreign currency, while at the same time
2) Reducing the supply of foreign currency in the US.
This is an example of a good being imported, but a similar result
holds if we import a service (like insurance for a foreign
company), or if foreigners make a financial investment in the US
and we are going to pay them interest or dividends.
Balance of Payments
A nation’s balance of payments, BOP, is a system to keep track of
the international transactions of the residents for a particular period
of time. The focus is on the money flows.
Any transaction that causes money to flow into a country is a
credit to its BOP account and will have a plus sign attached to it.
Any transaction that causes money to flow out of a country is a
debit to its BOP account and will have a minus sign attached to it.
From our previous examples, the export of Nebraska beef is a
credit and the import of Columbian coffee beans is a debit.
The BOP is made up of the CURRENT ACCOUT and the
CAPITAL AND FINANCIAL ACCOUNT.
The Current Account
The current account is one part of the BOP. The types of
transactions kept track of in the current account include
a) export of goods,
b) import of goods,
c) export of services,
d) import of services,
e) net investment income, and
f) net transfers.
More Current Account
Remember a credit is a money inflow and will have a plus sign and
a debit is a money outflow and will have a minus sign. For the
items in the current account we have
Recall exports bring
a) export of goods + money in and imports
have money go out. The
b) import of goods - signs we see here for
imports and exports will
c) export of services + always be the case. But
the signs on net
d) import of services - investment income and
net transfers will not
e) net investment income + always be as shown.
Let’s explore this and
f) net transfers - other ideas next.
Even more Current Account info
Folks talk about balance on goods, balance on services, and
balance on goods and services. The point here is the combining
of exports and imports. Note in a recent year the balance on
goods was negative, the balance on services was positive and the
balance on goods and services was negative meaning the goods
negative was bigger than the services positive.
When the balance on goods and services is negative we talk of a
trade deficit, and when positive we talk of a trade surplus.
Net investment income is made up of i) interest and dividends
paid by foreigners to us (an inflow - a credit or plus sign) and ii)
interest and dividend paid by us to foreigners (an outflow - a
debit or minus sign). It just so happens in a recent year this was
a net positive.
Still more current account info
Net transfers is made up of i) foreigners making payments to us
for things like aid after a disaster (hurricane Katrina, an inflow - a
credit or plus sign), and ii) US making similar payments abroad (an
outflow - a debit or minus sign). In the US this term has been a net
minus for many years.
A current account deficit means when looking at the whole set of
accounts the debits are larger than the credits. This also means the
outflow is larger than the inflow.
Capital and Financial Account
The capital and financial account is the second part of the BOP.
The types of transactions kept track of here are
a) The balance on the capital account,
b) Foreign purchases of assets in the US, and
c) US purchases of assets abroad.
The balance on the capital account is a net amount measuring debt
forgiveness. Analogy: say I owe you 10 bucks. When you forgive
the debt it is like you give me 10 bucks. Did you give me 10
bucks? NO, but it feels like it because you had it coming to you and
then cancelled it. From your perspective you had an outflow of 10
bucks – a debit! So, when a debt owed to the US is forgiven it is a
debit. When foreigners forgive debt we owe it is a credit. Note in 11
a recent year this balance is a debit – we forgave more than they.
More Capital and Financial Account
The foreign purchase of assets in the US (like US exporting
assets such as real estate or US government securities) will
always be a credit or inflow and the US purchase of assets abroad
(like US importing assets such as common stock in a foreign firm
or buying a foreign hotel chain) will always be a debit or outflow.
The balance on these two accounts is called the balance on
financial account and in the US has been positive lately.
BOP = 0
The BOP then really is made up of the combination of the current
account, the capital and financial account.
If you are like me, then it is not obvious that the balance on all
these accounts must add up to 0. But, these accounts add up to
zero during a period of time. No kidding!
Note I am not saying the current account balance must be zero, or
the capital account must be zero, or the financial account must be
zero. Any one of these may be in deficit or surplus, but in total
the accounts must add to zero.
This means a current account deficit must be accompanied by a
capital and financial account surplus, and vice versa.
In this story we want to think in the perspective of the
foreigners want to pay for stuff using their currency (what we
call foreign exchange) and wanting to be paid in their
currency (have I mentioned we call their currency foreign
On the next slide you see a big table and on it we will put on
and take off foreign exchange. For example, when we
export goods and services foreigners bring foreign exchange
to the table. When we import we take foreign exchange off
The big foreign exchange table in
- + Exports
Imports Net Investment
Net transfers income
Account purchase of
assets in US
More of the story
Now you see in the slide with the table a dashed line. All the
accounts above that line make up the current account. What is
below is called the capital and financial account. (Remember what
is above and what is below must balance out to zero.)
It is very useful to separate what private citizens do in the capital
and financial account and what the government or the Federal
Scenario 1 Say on the current account we have a deficit – this
means less foreign exchange is coming to the table than going out.
Also say privately on the capital and financial account we also have
a deficit (or a surplus smaller in absolute size than the current
account deficit). 16
The rest of the story
Scenario 1 so far would be called a balance of payments deficit.
More foreign exchange is leaving the country than coming in. AT
this point the FED makes an inpayment of foreign exchange to the
table. This would be like the foreigners are purchasing assets in the
US and the asset is their own currency that we have been holding.
Scenario 2 Say we have a current account surplus and a private
capital and financial account surplus (or deficit smaller than current
account surplus). Then we would have foreign exchange piling up
on the table. The FED will make an outpayment of foreign
exchange. This is like the US purchasing assets abroad. This
balance of payments surplus results in the FED accumulating foreign
When the FED is making inpayments or outpayments it is working
with what are called OFFICIAL RESERVES.