Part Three: The Balance of Payments, Foreign
Exchange Markets, and Exchange Rates
Chapter 13
Balance of Payments
“Nothing, however, can be more absurd than this whole doctrine of the balance of trade, upon
which, not only these restraints, but almost all the other regulations of commerce are
founded.”
Adam Smith, Wealth of Nations, Book IV, Chapter III.
I. Chapter Outline
13.1 Introduction
13.2 Balance-of-Payments Accounting Principles
13.2a Credits and Debits
13.2b Double-Entry Bookkeeping
13.3 The International Transactions of the United States
13.4 Accounting Balances and the Balance of Payments
13.5 The Postwar Balance of Payments of the United States
13.6 The International Investment Position of the United States
II. Chapter Summary and Review
The balance of payments is a summary of all of the trade and financial
transactions between a country and its trading partners over some period of time.
Distinguishing between a purely domestic transaction and an international
transaction, however, can occasionally be difficult. For example, is a branch of the
U.S.-based Sears store in Mexico City exporting when it sells goods to residents of
Mexico City? Is the sale of a book in Cambridge, MA to a visitor from Mexico City an
export? For balance of payments purposes, an entity is classified as domestic or
foreign according to its normal and customary residence or location. According to
this definition, the Sears branch in Mexico is Mexican, despite being based in the
U.S., and its sales are not counted as U.S. exports. The visitor from Mexico, who
115
, normally lives in Mexico, is a foreigner and the sale of the book in Cambridge, MA
is an export, although such sales may be difficult to capture in the balance of
payments statistics.
If the United States exports goods, then buyers in other countries will have to
deliver dollars to the United States. Foreigners can acquire those dollars in a
number of ways. One way is to earn them by selling goods to the United States—
imports of the United States. Here, the outflow and inflow of dollars due to the
movement of goods are equal. Another possibility is that foreigners can sell U.S.
assets they have acquired in the past. In this case the outflow (from the U.S.) of
dollars from the sale of the asset matches the inflow of dollars due to U.S. exports.
Another possibility is to borrow U.S. funds. In this case the outflow due to foreign
borrowing matches the inflow of dollars due to the export.
The point is that every international transaction has a matching inflow and
outflow. If foreigners buy goods from the United States, there must be an outflow of
dollars to foreigners in order to fund the inflow of dollars to buy the goods. If U.S.
citizens import goods, then there must be an inflow of foreign currency in order for
an outflow to take place to fund imports.
This matching of inflows and outflows for every international transaction
means that every entry recording an inflow (outflow) in the balance of payments has
an accompanying entry that records an outflow (inflow). This is the nature of
double-entry bookkeeping. Transactions that give rise to an inflow are recorded
as credit transactions and carry a "+" sign. Transactions that give rise to an
outflow are recorded as debit transactions and carry a "-" sign.
Exports give rise to an inflow of funds so an export of a good or service is
recorded as a credit. Imports produce an outflow of funds so an import of a good or
service will be recorded as a debit. When financial assets are bought or sold, there
is a flow of financial capital, which is recorded as a financial outflow or a financial
inflow. A financial inflow for the U.S. occurs whenever a foreigner buys assets in
the U.S., or when a U.S. citizen liquidates a foreign asset. A financial outflow occurs
when a U.S. citizen buys a foreign asset, or when a foreigner sells a U.S. asset.
Consider a few examples. In each example, the recording of the transaction
is viewed from the U.S. balance of payments perspective.
Example 1: A U.S. exporter sells $1,000 in goods to a UK firm that pays for the
goods by liquidating a U.S. Treasury Bill. The export gives rise to an inflow and is
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Exchange Markets, and Exchange Rates
Chapter 13
Balance of Payments
“Nothing, however, can be more absurd than this whole doctrine of the balance of trade, upon
which, not only these restraints, but almost all the other regulations of commerce are
founded.”
Adam Smith, Wealth of Nations, Book IV, Chapter III.
I. Chapter Outline
13.1 Introduction
13.2 Balance-of-Payments Accounting Principles
13.2a Credits and Debits
13.2b Double-Entry Bookkeeping
13.3 The International Transactions of the United States
13.4 Accounting Balances and the Balance of Payments
13.5 The Postwar Balance of Payments of the United States
13.6 The International Investment Position of the United States
II. Chapter Summary and Review
The balance of payments is a summary of all of the trade and financial
transactions between a country and its trading partners over some period of time.
Distinguishing between a purely domestic transaction and an international
transaction, however, can occasionally be difficult. For example, is a branch of the
U.S.-based Sears store in Mexico City exporting when it sells goods to residents of
Mexico City? Is the sale of a book in Cambridge, MA to a visitor from Mexico City an
export? For balance of payments purposes, an entity is classified as domestic or
foreign according to its normal and customary residence or location. According to
this definition, the Sears branch in Mexico is Mexican, despite being based in the
U.S., and its sales are not counted as U.S. exports. The visitor from Mexico, who
115
, normally lives in Mexico, is a foreigner and the sale of the book in Cambridge, MA
is an export, although such sales may be difficult to capture in the balance of
payments statistics.
If the United States exports goods, then buyers in other countries will have to
deliver dollars to the United States. Foreigners can acquire those dollars in a
number of ways. One way is to earn them by selling goods to the United States—
imports of the United States. Here, the outflow and inflow of dollars due to the
movement of goods are equal. Another possibility is that foreigners can sell U.S.
assets they have acquired in the past. In this case the outflow (from the U.S.) of
dollars from the sale of the asset matches the inflow of dollars due to U.S. exports.
Another possibility is to borrow U.S. funds. In this case the outflow due to foreign
borrowing matches the inflow of dollars due to the export.
The point is that every international transaction has a matching inflow and
outflow. If foreigners buy goods from the United States, there must be an outflow of
dollars to foreigners in order to fund the inflow of dollars to buy the goods. If U.S.
citizens import goods, then there must be an inflow of foreign currency in order for
an outflow to take place to fund imports.
This matching of inflows and outflows for every international transaction
means that every entry recording an inflow (outflow) in the balance of payments has
an accompanying entry that records an outflow (inflow). This is the nature of
double-entry bookkeeping. Transactions that give rise to an inflow are recorded
as credit transactions and carry a "+" sign. Transactions that give rise to an
outflow are recorded as debit transactions and carry a "-" sign.
Exports give rise to an inflow of funds so an export of a good or service is
recorded as a credit. Imports produce an outflow of funds so an import of a good or
service will be recorded as a debit. When financial assets are bought or sold, there
is a flow of financial capital, which is recorded as a financial outflow or a financial
inflow. A financial inflow for the U.S. occurs whenever a foreigner buys assets in
the U.S., or when a U.S. citizen liquidates a foreign asset. A financial outflow occurs
when a U.S. citizen buys a foreign asset, or when a foreigner sells a U.S. asset.
Consider a few examples. In each example, the recording of the transaction
is viewed from the U.S. balance of payments perspective.
Example 1: A U.S. exporter sells $1,000 in goods to a UK firm that pays for the
goods by liquidating a U.S. Treasury Bill. The export gives rise to an inflow and is
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