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Balance of Payments is the difference between the money coming into a country and the money leaving the same country. In economics, the balance of payments, (or BOP) measures the payments that flow between any individual country and all other countries. It is used to summarize all international economic transactions for that country during a specific time period, usually a year. The BOP is determined by the country's exports and imports of goods, services, and financial capital, as well as financial transfers. It reflects all payments and liabilities to foreigners (debits) and all payments and obligations received from foreigners (credits). Balance of payments is one of the major indicators of a country's status in international trade, with net capital outflow.^{[citation needed]}

The balance, like other accounting statements, is prepared in a single currency, usually the domestic. Foreign assets and flows are valued at the exchange rate of the time of transaction.

[edit] IMF definition

The IMF definition: "Balance of Payments is a statistical statement that summarizes transactions between residents and nonresidents during a period."^[1] The balance of payments comprises the current account and the capital account (or the financial account). "Together, these accounts balance in the sense that the sum of the entries is conceptually zero."^[1]

The current account consists of the goods and services account, the primary income account and the secondary income account.
The capital account is much smaller than the other two and consists primarily of debt forgiveness and assets from migrants coming to or leaving the country.
The financial account consists of asset inflows and outflows, such as international purchases of stocks, bonds and real estate.

[edit] Balance of payments identity

The balance of payments identity states that:

Current Account = Capital Account + Financial Account + Statistical Discrepancy

This is a convention of double entry accounting, where all debit entries must be booked along with corresponding credit entries such that the net of the Current Account will have a corresponding net of the Capital and Financial Accounts:

$X + K_i = M + K_o \,$

where:

X = exports
M = imports
K_i = capital inflows
K_o = capital outflows

Rearranging, we have:

$(X - M) = K_o - K_i \,$ ,

yielding the BOP identity.

The basic principle behind the identity is that a country can only consume more than it can produce (a current account deficit) if it is supplied capital from abroad (a capital account surplus).^[2]

Mercantile thought prefers a so-called balance of payments surplus where the net current account is in surplus or, more specifically, a positive balance of trade.

A balance of payments equilibrium is defined as a condition where the sum of debits and credits from the current account and the capital and financial accounts equal to zero; in other words, equilibrium is where

$\mbox{Current account} + (\mbox{Capital and financial accounts}) = 0 \,$

This is a condition where there are no changes in Official Reserves.^[3] When there is no change in Official Reserves, the balance of payments may also be stated as follows:

$\mbox{Current account} = - (\mbox{Capital and financial accounts}) \,$

or:

$\mbox{Current account deficit (or surplus)} = \mbox{Capital and financial account surplus (or deficit}) \,$

Canada's Balance of Payments currently satisfies this criterion. It is the only large monetary authority with no Changes in Reserves.^[4]

[edit] History

Historically these flows simply were not carefully measured due to difficulty in measurement, and the flow proceeded in many commodities and currencies without restriction, clearing being a matter of judgment by individual private banks and the governments that licensed them to operate. Mercantilism was a theory that took special notice of the balance of payments and sought simply to monopolize gold, in part to keep it out of the hands of potential military opponents (a large "war chest" being a prerequisite to start a war, whereupon much trade would be embargoed) but mostly upon the theory that large domestic gold supplies will provide lower interest rates. This theory has not withstood the test of facts.^{[citation needed]}

As mercantilism gave way to classical economics, and private currencies were taxed out of existence, the market systems were later regulated in the 19th century by the gold standard which linked central banks by a convention to redeem "hard currency" in gold. After World War II this system was replaced by the Bretton Woods institutions (the International Monetary Fund and Bank for International Settlements) which pegged currency of participating nations to the US dollar and German mark, which was redeemable nominally in gold. In the 1970s this redemption ceased, leaving the system with respect to the United States without a formal base, yet the peg to the Mark somewhat remained. Strangely, since leaving the gold standard and abandoning interference with Dollar foreign exchange, the surplus in the Income Account has decayed exponentially, and has remained negligible as a percentage of total debits or credits for decades. Some^[who?] consider the system today to be based on oil, a universally desirable commodity due to the dependence of so much infrastructural capital on oil supply; however, no central bank stocks reserves of crude oil. Since OPEC oil transacts in US dollars, and most major currencies are subject to sudden large changes in price due to unstable central banks, the US dollar remains a reserve currency, but is increasingly challenged by the euro, and to a small degree the pound.

Economists favouring macro economic intervention by government suggest Devaluation as a possible solution to an adverse balance of payments, while those favouring a free market suggest that its best if the currency is allowed to Depreciate on a freely floating exchange system. In both cases the currency of the nation with the adverse balance looses value, making it more expensive for its citizens to buy imports but also making its exports cheaper for foreign buyers. The solution often doesnt have a positive impact immediately due to the Marshall–Lerner Condition. ^[5]

The United States has been running a current account deficit since the early 1980s. The U.S. current account deficit has grown considerably in recent years, reaching record high levels in 2006 both in absolute terms ($758 billion) and as a fraction of GDP (6%).

[edit] Criticism

According to Murray Rothbard:

“

Fortunately, the absurdity of worrying about the balance of payments is made evident by focusing on inter-state trade. For nobody worries about the balance of payments between New York and New Jersey, or, for that matter, between Manhattan and Brooklyn, because there are no customs officials recording such trade and such balances.^[6]

”

[edit] See also

[edit] References

^ ^a ^b IMF Balance of Payments Manual, Chapter 2 "Overview of the Framework", Paragraph 2.15 [1]
^ http://www.econlib.org/library/Enc/BalanceofPayments.html Herbert Stein, "The Balance of Payments" in The Concise Encyclopedia of Economics.
^ http://www-personal.umich.edu/~alandear/glossary/b.html Glossery of International Economics
^ "Bank of Canada - Intervention in the Exchange Market - Fact Sheet - The Bank in Brief". http://www.bankofcanada.ca/en/backgrounders/bg-e2.html.
^ Paul Davidson (2009). The Keynes Solution: The Path to Global Economic Prosperity. Palgrave Macmillan. p. 125. ISBN 978-0230619203.
^ Protectionism and the Destruction of Prosperity, Murray Rothbard

Economics 8th Edition by David Begg, Stanley Fischer and Rudiger Dornbusch, McGraw-Hill
Economics Third Edition by Alain Anderton, Causeway Press
AS and A Level Economics, Cambridge University Press

[edit] External links

[edit] Data

IMF
- [2] (See "External Sector")
Balance of Payments in Hong Kong

You can also download historical balance of payments information from 1960 under the "All Tables" link of the following page:

BEA Balance of Payments Section

[edit] Analysis

Where Do U.S. Dollars Go When the United States Runs a Trade Deficit? from Dollars & Sense magazine

[BOP_Overview-0] IMF Balance of Payments Manual, Chapter 2 "Overview of the Framework", Paragraph 2.15 [1]

[Stein-1] ttp://www.econlib.org/library/Enc/BalanceofPayments.html Herbert Stein, "The Balance of Payments" in The Concise Encyclopedia of Economics.

[2] ttp://www-personal.umich.edu/~alandear/glossary/b.html Glossery of International Economics

[BoC-3] "Bank of Canada - Intervention in the Exchange Market - Fact Sheet - The Bank in Brief". http://www.bankofcanada.ca/en/backgrounders/bg-e2.html.

[solution-4] Paul Davidson (2009). The Keynes Solution: The Path to Global Economic Prosperity. Palgrave Macmillan. p. 125. ISBN 978-0230619203.

[5] Protectionism and the Destruction of Prosperity, Murray Rothbard

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