Balance of payments

Balance of payments is a summary of a country’s economic exchanges with the rest of the world for a given period of time. Typically, countries trade goods, services, and finan­cial ASSETS. The balance of payments shows whether a country is accruing debits or credits in its trade with other countries. For a country, exports of goods and services and investment INCOME from other countries represent credits against foreigners, while IMPORTS and investment income paid to foreigners are debits. Debits result in demand for FOREIGN EXCHANGE; credits generate supply of foreign exchange. Without offsetting activities, net trade balances influence foreign EXCHANGE RATES.

There are also unilateral transfers, gifts, and retirement pensions sent to and from countries for which there is no exchange of goods or services. Many foreign-born workers in the United States send money back to their families in other countries. For the United States there are more uni­lateral transfers out of the country than coming into the country.

Balance of payments, by definition, must balance or be equal, but different components of the balance of payments can have net positive or negative balances. The three most important components of a country’s balance of payments are the merchandise account, current account, and capital account. The merchandise account records all interna­tional transactions involving goods. For decades the United States has run a negative net trade in merchandise. The merchandise account is also called the balance of trade. The current account is the sum of a country’s trade in merchandise, services, investment income, and unilat­eral transfers. While the United States has a negative bal­ance in merchandise trade, it has a positive balance of trade in services, and INVESTMENT income going out of the coun­try is almost equal to investment income coming into the country. The United States has had a current account deficit for many years. In 2000, the U.S. current account was approximately $435 billion.

When a country like the United States has a current-account deficit, three things can occur. First, foreigners can exchange the excess dollars for their own currency. This increases the supply of dollars as well as the DEMAND for other currencies, causing the value of the dollar to fall in world currency markets. A decreasing dollar will make imports more expensive and exports cheaper to foreigners, reducing the current account deficit. Second, foreigners can use the excess dollars to make DIRECT INVESTMENTs in the United States. For example, dur­ing the early 1990s foreign investors bought many visible symbols of Americana, including the Empire State build­ing and the Pebble Beach Resort. In both cases they paid too much for these assets and subsequently sold them at a loss.

Third, foreigners can use the excess dollars to purchase financial assets, stocks, and BONDS in U.S. companies and U.S. TREASURY SECURITIES. These are known as portfolio investments. For decades foreigners have invested heavily in U.S. securities. Foreign investors hold almost 20 percent of U.S. Treasury securities. Alarmists fear this could lead to economic blackmail, where foreigners threaten to pull their funds out of the United States if the federal govern­ment does not follow policies they support. But foreigners, not foreign governments, are buying U.S. securities, and foreigners are buying these securities primarily because of the relative safety of financial investments in the United States. To try to undermine the authority of the U.S. gov­ernment would be counter to their investment objective.

Because foreigners have primarily used excess dollars to purchase U.S. investments and securities, the value of the dollar has remained stable and even increased, and the capital account—net investment in the United States ver­sus outside the country by U.S. investors—has been posi­tive. This means the United States (businesses and the government) is selling more bonds and other financial assets to foreigners than it is purchasing from abroad. The media therefore portrays the United States as a “net debtor” nation. Since 1985 the U.S. net debtor status has grown annually. These financial assets represent claims against future income and output from the United States.