Why can't all the balance of payments accounts be in surplus? What factors determine the demand for British pounds in foreign exchange markets?

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Ashley Kannan | Middle School Teacher | (Level 3) Distinguished Educator

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In any economics question, basic terms need to be defined. The critical element in a nation's balance of payments is the concept of "balance."  In this understanding, economic transactions of a nation must "balance" out.  What is spent should be balanced out by what it made.  Money is a finite resource.  It must be balanced and not pushed to extremes because of its limited nature.

The idea of balance is an essential concept in understanding the concepts of surplus and deficit.  A nation's surplus is reflective of revenues generated by a nation, while deficits reflect the expenditures or money owed that a nation must bear.  This is where the balance of payments resides, as it represents "the record of all economic transactions between the residents of a country and the rest of the world."  In a balance of payments configuration, there has to be an understanding that a nation's current account, reflective of the nation's assets and liability in real time, and its capital account, investments in and through other nations that will come to immediately bear on a nation's current account in due time, will balance out.  International economies demand that there is a balance.  There cannot be solely surplus.  Nations invest money, borrow money, and recognize the need for investments and expenditures.  It is inconceivable that an international economy would be consisting of solely surplus.  Certainly, there can be a surplus in a balance of payments.  Economies fluctuate all the time and sometimes, there is a surplus. However, it is unlikely that all the balance of payments accounts be in surplus because of the limited nature of money.  It is not infinite.  When a nation spends money or develops in foreign assets, it creates the conditions for expenditures that have to be reflected in its balance of payments.  It is in here that all surplus is unlikely.  At the same time, other factors will play into the capital account, such as a country's currency exchange rate.  These elements change and vary, thus making it unlikely that all the balance of payments account be in surplus.

In examining the factors that determine the demand for currency in foreign exchange markets, some are more dominant than others.   One of the largest factors that determines the demand for British pounds in foreign exchange markets would be the amount of exports Britain can generate.  The demand for foreign exports, in this case British exports, helps to drive the demand for the pound.  The greater the demand for British exports, the more people will pay in terms relative to the British pound.  With this, the demand for the British pound increases.  Demand for exports can drive up the the call for British pounds in foreign exchange markets.  At the same time, if Britain imports from other nations, it must pay these nations in their respective currencies.  This means that the presence of the British pound will increase in the marketplace, thereby reducing the demand for it.  Since there would be sufficient presence of the pound, there would not be a great demand and thus its rate would decrease.  In this light, one of the most dominant factors that determine the demand for the British pound in foreign exchange markets is the demand for a country's exports.  Another aspect that plays a role in determining a nation's demand for its currency in foreign exchange markets would be financial indicators or reflections of a nation's balance of payments.  If a nation possesses financial indicators that show a propensity to import more and develop the potential for a trade imbalance, then it might experience change in the demand for its currency in a foreign exchange markets.  This becomes another factor that would determine the demand for a currency in a foreign exchange market, in this case, the British pound.

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