INTERNATIONAL

FINANCIAL
MANAGEMENT

Fourth Edition

EUN / RESNICK

3-0 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 The Balance
of Payments 3
Chapter Three
INTERNATIONAL
Chapter Objective: FINANCIAL
MANAGEMENT
This chapter serves to introduce the student to the
balance of payments. How it is constructed and
Fourth Edition
how balance of payments data may be interpreted.
EUN / RESNICK

3-1 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 Chapter Three Outline
● Balance of Payments Accounting
● Balance of Payments Accounts
■ The Current Account
■ The Capital Account
■ Statistical Discrepancy
■ Official Reserves Account
● The Balance of Payments Identity
● Balance of Payments Trends in Major
Countries
3-2 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 Balance of Payments Accounting
● The Balance of Payments is the statistical record
of a country’s international transactions over a
certain period of time presented in the form of
double-entry bookkeeping.

N.B. when we say “a country’s balance of

payments” we are referring to the transactions of
its citizens and government.

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 Balance of Payments Example
● Suppose that Maplewood Bicycle in
Maplewood, Missouri, USA imports
$100,000 worth of bicycle frames from
Mercian Bicycles in Darby England.
● There will exist a $100,000 credit recorded
by Mercian that offsets a $100,000 debit at
Maplewood’s bank account.
● This will lead to a rise in the supply of dollars
and the demand for British pounds.

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 Balance of Payments Accounts
● The balance of payments accounts are those that
record all transactions between the residents of a
country and residents of all foreign nations.
● They are composed of the following:
■ The Current Account
■ The Capital Account
■ The Official Reserves Account
■ Statistical Discrepancy

3-5 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 The Current Account
● Includes all imports and exports of goods and
services.
● Includes unilateral transfers of foreign aid.
● If the debits exceed the credits, then a country is
running a trade deficit.
● If the credits exceed the debits, then a country is
running a trade surplus.

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 The Capital Account
● The capital account measures the difference
between U.S. sales of assets to foreigners and U.S.
purchases of foreign assets.
● In 2004, the U.S. enjoyed a $611.2 billion capital
account surplus—absent of U.S. borrowing from
foreigners, this “finances” our trade deficit.
● The capital account is composed of Foreign Direct
Investment (FDI), portfolio investments and other
investments.
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 Statistical Discrepancy
● There’s going to be some omissions and
misrecorded transactions—so we use a “plug”
figure to get things to balance.
● Exhibit 3.1 shows a discrepancy of $51.9 billion
in 2004.

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 The Official Reserves Account
● Official reserves assets include gold, foreign
currencies, SDRs, reserve positions in the IMF.

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 The Balance of Payments Identity
BCA + BKA + BRA = 0
where
BCA = balance on current account
BKA = balance on capital account
BRA = balance on the reserves account

Under a pure flexible exchange rate regime,

BCA + BKA = 0

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 U.S. Balance of Payments Data
Credits Debits
Current Account
1 Exports $1,516.2
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)
Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
7 Statistical Discrepancies 51.9
Overall Balance $2.8
Official Reserve Account $2.8

3-11 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 U.S. Balance of Payments Data
Credits Debits
Current Account In 2004, the
1 Exports $1,516.2
U.S. imported
2 Imports ($2,109.1)
more than it
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9) exported, thus
Capital Account
running a
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8) current account
6 Other Investments $524.3 ($483.7) deficit of
Balance on Capital Account $611.2
7 Statistical Discrepancies 51.9 $665.9 billion.
Overall Balance $2.8
Official Reserve Account $2.8

3-12 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 U.S. Balance of Payments Data
Credits Debits During the same
Current Account
year, the U.S.
1 Exports $1,516.2
2 Imports ($2,109.1)
attracted net
3 Unilateral Transfers $16.4 ($89.4)
investment of
Balance on Current Account ($665.9) $611.2
Capital Account
4 Direct Investment $115.5 ($248.5)
billion—clearly
5 Portfolio Investment $794.4 ($90.8) the rest of the
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
world found the
7 Statistical Discrepancies 51.9 U.S. to be a
Overall Balance
Official Reserve Account
$2.8 good place to
$2.8
invest.
3-13 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 U.S. Balance of Payments Data
Credits Debits
Current Account
1 Exports $1,516.2
Under a pure
2 Imports ($2,109.1)
flexible
3 Unilateral Transfers $16.4 ($89.4) exchange rate
Balance on Current Account ($665.9) regime, these
Capital Account
4 Direct Investment $115.5 ($248.5)
numbers would
5 Portfolio Investment $794.4 ($90.8) balance each
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
other out.
7 Statistical Discrepancies 51.9
Overall Balance $2.8
Official Reserve Account $2.8

3-14 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 U.S. Balance of Payments Data
Credits Debits
Current Account
1 Exports $1,516.2
In the real
2 Imports ($2,109.1)
world, there
3 Unilateral Transfers $16.4 ($89.4) is a statistical
Balance on Current Account ($665.9) discrepancy.
Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
7 Statistical Discrepancies 51.9
Overall Balance $2.8
Official Reserve Account $2.8

3-15 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 U.S. Balance of Payments Data
Credits Debits
Current Account
1 Exports $1,516.2
Including that,
2 Imports ($2,109.1)
the balance of
3 Unilateral Transfers $16.4 ($89.4) payments identity
Balance on Current Account ($665.9) should hold:
Capital Account
4 Direct Investment $115.5 ($248.5) BCA + BKA = – BRA
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
7 Statistical Discrepancies 51.9
Overall Balance $2.8
Official Reserve Account $2.8
($665.9) + $611.2 + $51.9 = ($2.8)
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 Balance of Payments and the
Exchange Rate
Credits Debits Exchange rate $
Current Account
1 Exports $1,516.2 P S
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)
Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7) D
Balance on Capital Account $611.2
7 Statistical Discrepancies 51.9
Overall Balance $2.8 Q
Official Reserve Account $2.8

3-17 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 Balance of Payments and the
Exchange Rate
Credits Debits Exchange rate $
Current Account
1 Exports $1,516.2 P S
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)
Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7) D
Balance on Capital Account $611.2
7 Statistical Discrepancies 51.9
Overall Balance $2.8 Q
Official Reserve Account $2.8
As U.S. citizens import, they are supply dollars to the FOREX market.
3-18 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 Balance of Payments and the
Exchange Rate
Credits Debits Exchange rate $
Current Account
1 Exports $1,516.2 P S
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)
Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7) D
Balance on Capital Account $611.2
7 Statistical Discrepancies 51.9
Overall Balance $2.8 Q
Official Reserve Account $2.8
As U.S. citizens export, others demand dollars at the FOREX market.
3-19 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 Balance of Payments and the
Exchange Rate
Credits Debits Exchange rate $
Current Account
1 Exports $1,516.2 P S
2 Imports ($2,109.1)
S1
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)
Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7) D
Balance on Capital Account $611.2
7 Statistical Discrepancies 51.9
Overall Balance $2.8 Q
Official Reserve Account $2.8
As the U.S. government sells dollars, the supply of dollars increases.
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 Balance of Payments Trends
● Since 1982 the U.S. has experienced continuous
deficits on the current account and continuous
surpluses on the capital account.
● During the same period, Japan has experienced the
opposite.

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Balances on the Current (BCA) and Capital
(BKA) Accounts of the United States

Source: IMF International Financial Statistics Yearbook, various issues

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Balances on the Current (BCA) and Capital
(BKA) Accounts of United Kingdom

Source: IMF International Financial Statistics Yearbook, various issues

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Balances on the Current (BCA) and Capital
(BKA) Accounts of Japan

Source: IMF International Financial Statistics Yearbook, various issues

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Balances on the Current (BCA) and Capital
(BKA) Accounts of Germany

Source: IMF International Financial Statistics Yearbook, various issues

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Balances on the Current (BCA) and Capital
(BKA) Accounts of China

Source: IMF International Financial Statistics Yearbook, various issues

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 Balance of Payments Trends
● Germany traditionally had current account
surpluses.
■ From 1991 to 2001Germany experienced current
account deficits.
■ This was largely due to German reunification and the
resultant need to absorb more output domestically to
rebuild the former East Germany.
■ Since 2001 Germany returned to its earlier pattern.
● What matters is the nature and causes of the
disequilibrium.
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Balances on the Current (BCA) and Capital
(BKA) Accounts of Five Major Countries

Source: IMF International Financial Statistics Yearbook, 2000

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 End Chapter Three

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