IV. Financing International Trade

Balance of Payments Accounts

• A country’s balance of payments accounts records its international trading, borrowing, and lending. There are three balance of payments accounts:

· The current account records payments for imports of goods and services from abroad, receipts for exports of goods and services sold abroad, net interest income paid abroad, and net transfers (such as foreign aid payment). The current account balance equals exports plus net interest income plus net transfers minus imports.

· The capital account records foreign investment in the United States minus U.S. investment abroad. Any statistical discrepancy is included in this account.

· The official settlements account records the change in U.S. official reserves, which are the government’s holdings of foreign currency. An increase in foreign reserves corresponds to a negative official settlements account balance. This occurs because holding foreign currency is like (but not the same as) investing abroad, which is a negative entry in the capital account.

• The sum of the balances always equals zero:

current account + capital account + official settlements account = 0.

• In 2010, the U.S. current account balance was negative and entirely offset by a positive capital account balance. Over time, the current account balance tends to mirror the capital account balance because the official settlements account balance is small.

Borrowers and Lenders, Debtors and Creditors

Because of current account deficits and surpluses, countries, like individuals, can be borrowers or lenders.

• A country that is borrowing more from the rest of the world than it is lending to it is a net borrower. A net lender is a country that is lending more to the rest of the world than it is borrowing from the rest of the world. The United States currently is net borrower. Being a net borrower is not a problem provided the borrowed funds are used to finance capital accumulation that increases income. Being a net borrower is a problem if the borrowed funds are used to finance consumption.
• A debtor nation is a country that during its entire history has borrowed more from the rest of the world than it has lent to it. A creditor nation is a country that during its entire history has invested more in the rest of the world than other countries have invested in it. The United States currently is debtor nation.

· The net borrower/net lender difference refers to the current flow of borrowing or lending over a period of time. The debtor nation/creditor nation refers to the stock of debt or foreign assets that exists at a moment in time.

Current Account Balance and Net Exports

• The current account balance (CAB) is:

CAB = X − M + Net interest income + Net transfers

• The main item in the current account balance is net exports (X − M). The other two items are much smaller and don’t fluctuate much.
• The national accounts show that Y = C + I + G + X - M and also that Y = C + S + T. These two relationships can be equated and rearranged to give (X - M) = (S - I) + (T - G). In this formula,

· (X - M) is net exports, exports of goods and services minus imports of goods and services.

· (S - I) is the private sector balance, saving minus investment.

· (T - G) is the government sector balance, net taxes minus government expenditures on goods and services.

• The formula shows that net exports equal the sum of the private sector balance and the government sector balance. There is a strong tendency for the private sector balance and the government sector balance to move in opposite directions, which means that the relationship between net exports and the other two sectors taken individually is not a strong one.

Where Is the Exchange Rate?

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