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.

Bank of International Settlements

The Bank of International Settlements (BIS) is an interna­tional organization supporting cooperation among central banks and other agencies. The Bank’s mission is to ensure international monetary and financial stability. The BIS functions as:

a forum for international central bankers,
a provider of financial services for central banks,
a center for monetary and economic research,

• an agent or trustee for implementation of international financial agreements.
Recently the BIS coordinated antiterrorism financial monitoring.
One of the major activities of the BIS is operating the Financial Stability Institute (FSI). The FSI, created in 1998, provides seminars and information programs train­ing central bank personnel from around the world. As demonstrated in the CIRCULAR FLOW MODEL of an eco­nomic system, monetary flows are needed to facilitate the flow of resources and goods and services. Monetary authorities must provide the needed amount of funds to facilitate exchanges, savings, and INVESTMENT. Excessive or “tight” monetary policies impair economic perform­ance. Financial stability is necessary for sustained ECO­NOMIC GROWTH. The FSI trains central bank personnel in areas concerning promotion of adequate CAPITAL stan­dards, effective risk management, and transparency (openness) in financial markets. The best-known BIS agreement is the 1988 Basel Capital Accord. (The BIS is headquartered in Basel, Switzerland.) The accord strives for international convergence in the measurement of the adequacy of banks’ capital and to establish minimum capital standards.
The BIS was created in 1930 as part of the Young Plan from the Treaty of Versailles ending World War I. The BIS took over responsibility for reparations payments imposed on Germany and was directed to promote cooperation among central banks. Responsibility for war reparations ended with the financial chaos in Germany during the 1930s, focusing BIS efforts toward central bank coopera­tion. The BIS supported the BRETTON WOODS system, with a gold standard and the dollar as the international reserve currency until the early 1970s, and it managed capital flows during the oil crises in the 1970s. The organization also assisted with the international debt crisis in the 1980s and with financial management associated with GLOBALIZA­TION in the 1990s.

In addition to providing training and a forum for cen­tral bank officials’ discussion, the BIS provides banking services, such as reserve management and gold transac­tions for central banks and international organizations. At various times it has acted as the agent for EXCHANGE RATE agreements among European countries. It also hosts G10 (Group of 10, previously G7) central bank governors meetings. The G10 leaders attempt to coordinate monetary polices to stabilize world ECONOMIC CONDITIONS. The G10 includes Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, the United Kingdom, and the United States.