Double Entry Accounting Lecture

INTERNATIONAL ECONOMICS Ch Chapt apt apter er Outline Double Entry Accounting Balance-of-Payments Structure U.S. Balance of Payments What Does a Current Account Deficit (Surplus) Mean? Balance of International Indebtedness The Dollar as the World’s Reserve Currency The Balance of Payments • The Balance of Payments is a record of the economic transactions between the residents of one country and the rest of the world • Records are kept annually and quarterly • An international transaction is an exchange of goods, services, or assets between residents of one country and those of another • Residents include businesses, individuals, and government agencies that make the country their legal domicile Double-Entry Accounting • Arranging international transactions into a balance-of-payments account requires that each transaction be entered as credit or debit (Double-Entry Accounting). • A credit transaction results in a receipt of a payment from foreigners; recorded with a + • A debit transaction is one that leads to a payment to foreigners; recorded with a − Double-Entry Accounting • Examples of credits • Merchandise exports • Transportation and travel receipts • Income received from investments abroad • Gifts received from foreign residents • Aid received from foreign governments • Investments in U.S. by overseas residents Double-Entry Accounting • Examples of debits • Merchandise imports • Transportation and travel expenditures • Income paid on the investments of foreigners • Gifts to foreign residents • Aid given by the U.S. government • Overseas investment by U.S. residents Balance-of-Payments Structure • Current Account • The monetary value of international flows associated with transactions in goods, services, income flows, and unilateral transfers • Merchandise trade balance includes all goods U.S. exports or imports; exports minus imports gives merchandise trade balance • When balance is negative, trade deficit • When balance is positive, trade surplus Balance-of-Payments Structure • To calculate a goods-and-services balance, add services to the merchandise trade account • When balance +, surplus of goods-andservices transactions • When balance −, deficit of goods-andservices transactions • Goods-and-services balance is part of a nation’s GDP Balance-of-Payments Structure Figure 10.1 Balance-of-Payments Structure • Capital and Financial Account • Transactions include all international purchases or sales of assets, including private sector and central bank transactions • Assets broadly defined to include titles to real estate, corporate stocks & bonds, government securities, and ordinary commercial bank deposits Balance-of-Payments Structure • Capital and Financial Account (cont’d) • Major types of capital transfers are debt forgiveness and migrants’ goods and financial assets accompanying them as they leave or enter country • Acquisition and disposal of nonfinancial assets include sale and purchase of rights to natural resources, patents, copyrights, and trademarks Balance-of-Payments Structure • Private Sector Financial Transactions • Vast majority of transactions in capital and financial account come from private financial transactions; include • Direct investment: residents of one country acquire controlling interest (stock ownership of 10 percent or more) in business of another country • Securities: private-sector purchases of debt issued by governments and private companies • Bank claims and liabilities: loans, overseas deposits, acceptances, foreign commercial paper, and foreign government obligations Balance-of-Payments Structure • Private Sector Financial Transactions • Capital and financial transactions recorded in balance-of-payments statement by applying + (credit) to capital and financial inflows and − sign (debit) to capital and financial outflows Balance-of-Payments Structure • Private Sector Financial Transactions • Financial inflow (credit entry) might occur when (1) U.S. liabilities to foreigners rise (French resident purchases securities of IBM); (2) U.S. claims on foreigners decrease (Citibank receives repayment of loan to Mexican firm); (3) foreign-held assets in U.S. rise (Toyota builds plant in U.S.); or (4) U.S. assets overseas decrease (Coca-Cola sells Japanese bottling plant to Japanese buyer). • Financial outflows imply opposite movements Balance-of-Payments Structure • Official Settlement Transactions • Movement of financial assets among official holders such as U.S. Fed and Bank of England • Official reserve assets (U.S. government assets abroad) • Liabilities to foreign official agencies (foreign official assets in the U.S.) Balance-of-Payments Structure • Official Settlements Transactions (cont’d) • Official holdings of reserves used for two purposes • Provide a country sufficient international liquidity to finance short-run trade deficits, currency crises, etc. • Central banks sometimes buy or sell official reserve assets in the private sector to stabilize their currencies’ exchange rates Balance-of-Payments Structure • Official reserve assets • Stock of gold reserves held by U.S. government • Convertible currencies such as Japanese yen, readily acceptable as payment in international transactions • Reserve position of U.S. in International Monetary Fund (IMF) Balance-of-Payments Structure Table 10.1 Selected Foreign Holders of U.S. Securities as of 2016 Country Billions of Dollars Percentage of World Total Japan 1,959 11.4 China 1,630 9.5 Cayman Islands 1,524 8.9 United Kingdom 1,427 8.3 Luxembourg 1,349 7.9 Canada 950 5.5 Ireland 931 5.4 Switzerland 742 4.3 World Total 17,139 Source: U.S. Treasury Department, Report on Foreign Portfolio Holdings of U.S. Securities as of June 30, 2016. Balance-of-Payments Structure • Special drawing rights, new reserve asset created by the IMF as a supplement to the existing reserves of member countries. • Can be transferred among nations in settlement of balance-of-payments deficits or stabilization of exchange rates • Basket of currencies that includes U.S. dollar, Japanese yen, UK pound, and euro Balance-of-Payments Structure • Statistical Discrepancy: Errors & Omissions • Data collection process for balance-of-payments figures imperfect • Government statisticians base figures partly on information collected & partly on estimates • When statisticians sum credits & debits, rarely match • Since debits must equal credits, residual is inserted to make them equal • This correcting entry is statistical discrepancy, or errors and omissions U.S. Balance of Payments • Merchandise trade balance commonly referred to as trade balance • In 2016, U.S. had merchandise trade deficit of -$749.9 billion —U.S. merchandise exports minus imports • Trade deficits not popular with U.S. residents & policymakers • Negatively affect terms of trade, employment levels, stability of international money markets U.S. Balance of Payments Table 10.3 U.S. Balance of Payments, 1980–2016 (Billions of Dollars) Year Merchandise Trade-Balance Services Balance Goods and Services-Balance Income Receipts and Payments-Balance Unilateral Transfers-Balance Current Account-Balance 1980 −25.5 6.1 −19.4 30.1 −8.3 2.4 1984 −112.5 3.3 −109.2 30.0 −20.6 −99.8 1988 −127.0 12.2 −114.8 11.6 −25.0 −128.2 1992 −96.1 55.7 −40.4 4.5 −32.0 −67.9 1996 −191.3 87.0 −104.3 17.2 −42.1 −129.2 2000 −452.2 76.5 −375.7 −14.9 −54.1 −444.7 2004 −665.4 47.8 −617.6 30.4 −80.9 −668.1 2008 −820.8 139.7 −681.1 127.6 −119.7 −673.2 2012 −735.3 195.8 −539.5 198.6 −134.1 −475.0 2016 −749.9 249.3 −500.6 180.6 −161.2 −481.2 Source: From U.S. Department of Commerce, Survey of Current Business, various issues. U.S. Balance of Payments • Taken as a whole, U.S. international transactions always balance • Any force causing increase or decrease in one balance-of-payments account leads to exactly offsetting changes in balances of other accounts • U.S.: Deficit of -$481.2 billion in 2016 (Table 10.3) • Offsetting this deficit was a combined surplus of $481.2 billion in remaining capital & financial accounts (this includes statistical discrepancy) What Does a Current Account Deficit (Surplus) Mean? • Net Foreign Investment & Current Account Balance • Current account balance synonymous with net foreign investment in national income accounting • Current account surplus means an excess of exports over imports; nation becomes lender to rest of world • Current account deficit means an excess of imports over exports; nation becomes borrower from rest of world What Does a Current Account Deficit (Surplus) Mean? • Impact of Capital Flows on the Current Account • Capital and financial flows can initiate changes in the current account • In 1980s, massive financial inflow caused current account deficit for U.S. — resulted from increase in U.S. interest rates relative to interest rates abroad • Higher interest rates caused by growing budget deficit and decline in private savings • Current account deficit may be driven by capital flows: capital inflows keep dollar stronger than it otherwise would be, boosting imports and suppressing exports