Balance of Payments
This article focuses on balance of payments. It provides an overview of the main categories of balance of payments accounts including current accounts, capital accounts, and financial accounts. The double-entry bookkeeping method used for balance of payments accounting is described. The article provides a close look at the United States' balance of payments accounts and practices. The connections between trade liberalization, economic globalization, and balance of payments are addressed.
Keywords Balance of Payments; Capital Account; Current Account; Deficit; Developing Countries; Double-Entry Bookkeeping; Economic Globalization; Exchange Rate; Financial Account; Globalization; Markets; Nations; Trade Liberalization; World Bank
International Business: Balance of Payments
Balance of payments (BOP) is a method used by countries to monitor and record international financial activities and transactions. The Federal Reserve Bank of New York defines balance of payments as “an accounting of a country's international transactions for a particular time period.” The balance of payments records all private and public sector trade activity and records the total of all money moving into and out of a country during a particular time period. The balance of payments may be recorded on a quarterly or annual basis. The balance of payments includes credits and debits.
- Credit refers to the money or payments a country has received during the balance of payments time period. Balance of payments credits include any transaction that causes money to flow into a country.
- Debit refers to the payments a country has made during a balance of payments time period. Balance of payments debits include any transaction that causes money to flow out.
A nation's balance of payments includes three separate accounts: The current account, the capital account, and the financial account, related to different types of international financial activity or transactions. The balance of payments should ideally or theoretically stand at zero. In practice, the balance of payments of most countries usually includes a trade surplus or deficit (Fieleke, 1996).
The following sections provide an overview of the three main categories in the balance of payments accounts and balance of payments record keeping practices. These sections serve as the foundation for later discussion of the United States' balance of payments accounts and practices. The issues associated with international governance of balance of payments practices are addressed.
Balance of Payment Accounts
Balance of payments includes three categories of accounts. These three accounts: Current accounts, capital accounts, and financial accounts, are described and analyzed below.
The Current Account
The current account reflects a country's inflow and outflow of goods, services, income, and current transfers. The current account includes a summary of a country's balance of trade. Revenue produced from investments and income-generating assets are included in the current account. The current account is considered to be a measure of a country's economic health and strength. Countries tend to have either a balance of trade surplus or deficit depending on the health and scale of their import and export programs. The current account includes four sub-categories: Merchandise trade, services, income receipts, and unilateral transfers.
- Merchandise trade refers to all raw materials and manufactured goods bought, sold, or given away.
- Services refer to activities such as tourism, transportation, engineering, and business services, such as law, management consulting, accounting, and fees from patents and copyrights.
- Income receipts refer to income derived from ownership of assets including dividends on holdings of stock and interest on securities.
- Unilateral transfers refer to one-way transfers of assets including worker remittances from abroad and direct foreign aid (Federal Reserve Bank of New York, 2004).
The Capital Account
The capital account reflects all of a country's international transfers. Examples of international capital transfers include the acquisition or disposal of non-financial assets. Capital transfers include debt forgiveness, migrants' transfers, the transfer of title to fixed assets, the transfer of funds connected to the sale or purchase of fixed assets, gift and inheritance taxes, death duties, and uninsured damage to fixed assets. In addition, capital accounts include transfers of non-produced, non-financial assets. Non-produced, non-financial assets refer to the sales and purchases of the rights to natural resources, leases, patents, copyrights, and trademarks (Federal Reserve Bank of New York, 2004).
The Financial Account
The financial account reflects all international monetary flows related to investment, business, real estate, bonds, stocks, foreign reserves, and direct foreign investments and assets. Foreign-owned assets include official reserve assets, government assets, and private assets. Examples of these assets include gold, foreign currencies, foreign securities, foreign credits, direct foreign investment, corporate securities, and direct investments (Federal Reserve Bank of New York, 2004).
Countries work to balance their capital and financial accounts. In practice, the goal of balanced accounts is not possible due to factors such as record keeping practices and exchange rate fluctuations, described in the next section.
Balance of Payments Record Keeping
Balance of payments record keeping follows double-entry bookkeeping accounting practices. For example, the amounts and figures involved are recorded on each of the two sides of the balance-of-payments accounts. While the two sides of the account would ideally be equal, this is rarely the case. The imbalances reflect surpluses or deficits in the national economy.
Balance of payments accounting practices and records include three main categories:
- Accounts dealing with goods, services, and income.
- Accounts recording gifts or unilateral transfers.
- Accounts on financial claims including bank deposits and stocks and bonds (Fieleke, 1996).
Common transactions recorded in the balance of payments record include the following:
- Commercial exports.
- Payment for commercial exports.
- Receipt of income from investment abroad.
- Commercial imports.
- Expenditures on travel abroad.
- Gifts to foreign residents.
- Loans to borrowers abroad.
Challenges to Balance of Payments Data Collection
Challenges, errors, and omissions are common in balance of payments data collection. For example, some international financial transactions go unreported. Purchases and sales of short-term financial claims are often underreported. Some transactions are consistently estimated rather than measured. There is often a difference in the value stated in accounting records and the value actually paid for a good or service. This difference in valuation can lead to disparity between debits and credits. In response to this problem, a residual account for statistical discrepancies has become standard practice in balance of payment accounting practices. This residual account gives strategy for satisfying the rule of double entry bookkeeping so that total debits must equal total credits (Fieleke, 1996).
In addition to statistical discrepancies, fluctuating exchange rates and the change in the value of money, can add to balance of payments discrepancies by changing the recorded value of transactions. An exchange rate is a comparison between a national currency and a foreign currency. Exchange rates and the global or macroeconomy are closely related. A country's exchange rate influences exports, imports, job rates, working conditions, external purchasing power of residents abroad, and trade balances. For example, a rising exchange rate depresses exports, boosts imports, and depresses the trade balance (Piana, 2001). International capital markets respond to exchange rate fluctuations and exchange rate volatility. Exchange rate variability and volatility depress trade and the economy in general. In an effort to limit exchange rate variability, international governance organizations, such as Group of Seven (G-7) industrialized countries and the European Union (EU), have explored the possibility of establishing informal target ranges for exchange rates. Currently, there is no international consensus on how currency relations among major regions should be approached or governed (Obstfeld, 1995). Ultimately, statistical discrepancies, accounting conventions, and exchange rate movements may combine to create significant discrepancies in balance of payments accounts. International governance organizations promote shared or standardized balance of payments record keeping in an effort to facilitate comparable accounting records and balanced trade relations....
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