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AP Macroeconomics: 6.1 Balance of Payments Accounts

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APMac U6 L1 balance of payments accounts

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Includes Quizzes, and has videos relating to the entire unit.

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Uploaded by Marginal Revolution University on 2014-08-27.

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Student-recommended

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Foreign exchange and trade | Macroeconomics | Khan Academy

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Learn for free about math, art, computer programming, economics, physics, chemistry, biology, medicine, finance, history, and more. Khan Academy is a nonprofit with the mission of providing a free, world-class education for anyone, anywhere.

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This Year 12 Recap video covers the basics around the topic of the balance of payments.

The balance of payments is a collection of individual trading accounts which measure how dependent an economy is on the rest of the world to satisfy its needs and wants. The accounts can be used to assess the external competitiveness of a country with the rest of the world. In an exam situation, students need to understand the basic structure of the balance of payments accounts to be able to appreciate that there is an inverse link between the performance on the current account and the financial account. By understanding the basic principles of this trading account, a student can start to analyse in more detail the impact of an exchange rate, interest rate and inflation rate change on the performance n competitiveness of an economy.

Here Jack guides you around the topic of the balance of payments:

Our Year 12 recap is supported by our new awesome revision mindmaps. Find out more about them and how teachers and students can access them by clicking here.
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This Year 12 Recap video covers the basics around the topic of the balance of payments. The balance of payments is a collection of individual trading accounts which measure how dependent an economy is on the rest of the world to satisfy its needs and wants.

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New York Fed Explains Balance of Payments

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New York Fed Explains Balance of Payments

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Balance of Payments - FEDERAL RESERVE BANK of NEW YORK

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Working within the Federal Reserve System, the New York Fed implements monetary policy, supervises and regulates financial institutions and helps maintain the nation's payment systems.

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Define the current account (CA), the capital and financial account (CFA), and the balance of payments (BOP).

Explain how changes in the components of the CA and CFA affect a country’s BOP.

Calculate the CA, the CFA, and the BOP.

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Foreign trade accounting measures the flow of goods, services, and financial capital between countries.

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The current account (CA) records net exports, net income from abroad, and net unilateral transfers.

The CA is not always balanced; it may show a surplus or a deficit. A nation’s balance of trade (i.e., net exports) is part of the current account and may also show a surplus or a deficit.

The capital and financial account (CFA) records financial capital transfers and purchases and sales of assets between countries.

The CFA is not always balanced; it may show a surplus (financial capital inflow) or a deficit (financial capital outflow).

The balance of payments (BOP) is an accounting system that records a country’s international transactions for a particular time period. It consists of the CA and the CFA.

Any transaction that causes money to flow into a country is a credit to its BOP account, and any transaction that causes money to flow out is a debit. The sum of all credit entries should match the sum of all debit entries (CA+CFA=0).

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APMac Unit 6 Lesson 1 - Balance of Payments Accounts

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Start studying APMac Unit 6 Lesson 1 - Balance of Payments Accounts. Learn vocabulary, terms, and more with flashcards, games, and other study tools.

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A waiter serves glasses of red wine at the counter of a bar in Paris. - FRED DUFOUR/AFP/Getty Images

We're doing a series of explainers of economic concepts to mark Marketplace's 25th anniversary, and today we take a look at the Trade Deficit.

The United States has been running one one every year since oh... 1974 . Currently, it's about $40 billion or so a month, give or take a few billion.

A trade deficit, you've probably heard, is when a country is buying more from the rest of the world than it's selling to the rest of the world-importing more than it's exporting. That may sound bad. If I personally ran a trade deficit for forty years like the U.S. has, I would be broke. But I am not a country - and the rules are different for countries.

"There's actually nothing necessarily wrong about a trade deficit," says Doug Irwin, professor of economics at Dartmouth. "In fact, here's where economists always have a definitive answer to the question is a trade deficit good or bad and that definitive answer is, it depends!"

Depends on what, exactly?

Well, before we can answer that we have to explain why it's so neutral-ish in the first place. The reason is that trade deficits have this whole other side to them that is not obvious at all.

Trade deficits actually have as much to do with international investment and debt as they do with importing and exporting. It's invisible unless you look at the money, so let's look at the money.

Let's say the U.S. and Europe have a trade deficit (which they do)-meaning America imports tons of French wine, let's say, but exports almost nothing to Europe.

Wine stores across the U.S. will place their orders with wineries in Europe for massive quantities of Beaujolais and Chardonnay. And they will, of course, need to pay in Euros. French wineries don't want a stack of Benjamins any more than you want that damn Turkish lira that somehow always ends up in your bag of change when you are trying to pay a toll on the freeway.

So the wine stores-or the bank or the credit card company the wine stores use-will have to take their U.S. dollars to an international currency market and convert them into Euros to give to the French vineyard to buy the wine. Since the U.S. is buying massive amounts of French wine, that bank is going to have to convert massive amounts of dollars into Euros.

Here's the problem: We have a trade deficit. We aren't exporting much to Europe-As in, Europe isn't buying our stuff, which means they don't need dollars. Why would they need dollars? To use as paper weights?

Now, you can imagine one way out of this. American banks might have to lower the price of the dollar. They might say 'Fine, world! What if I give you $110 for $100 euros? $120? $150?,' until finally someone in Europe decided that was a really good deal and they could use some dollars to maybe buy some American goods. It's a kind of auto correct feature that trade deficits can have.

"When the dollar falls, that stimulates U.S. exports, it discourages U.S. imports, and that fall in the value of the dollar will naturally begin to close the trade deficit," says Irwin.
This can happen with trade deficits-they can push down a currency's value.

But that's not happening with the U.S., nor is it happening with a lot of countries. The dollar is doing great. And yet we continue to import much more than they export. Somehow we are finding another way to deal with the problem that we can't get Europeans to exchange our dollars so we can buy European wine.

The fact is, there ARE people abroad who want to give us Euros in exchange for dollars. These are not people who want to buy our stuff, though. These are people who need dollars...because....drum roll.... they want to INVEST in America. They're investors.

Investors need U.S. dollars to buy U.S. assets: treasury bills, real estate, stocks, bonds, etc. After all, the NASDAQ doesn't take Euros, so foreign investors need dollars to park their money in the U.S. and make a profit just like we need euros to buy wine.

That's how the U.S. economy finds the euros go import crazy. So if we are having a trade deficit, it is a sign that someone abroad is investing in some part of our economy. A trade deficit and investment are like two sides of a strange coin. We buy goods from the world, the world invests in us.

This invisible connection between trade deficits and foreign investments is why a trade deficit can be good or bad-all it means for sure is that other countries are coming to you to invest their money. That can be great if it's growing your economy or it can be bad if it's not-you can't tell what's going on just from having a trade deficit.

An example of a trade deficit that was happening for good reasons was the U.S. during the 19 th century, says Robert Lawrence, who teaches international trade at Harvard's Kennedy School. The U.S. had increasing trade deficits, which were made possible by investors pouring in money from abroad. "The United States used the money to build rail roads and build the U.S. economy-so you can look in retrospect and say that was a pretty healthy deficit."

An example of a trade deficit that was happening for less good reasons is Greece, he says. During the financial crisis, Greece was running a trade deficit made possible by investors who were pouring money in to purchase government debt. "During the global financial crisis, in Greece the government accumulated large debts-so large, in fact, that they couldn't repay them."

Sometimes it can be ok to finance government debt, but if something scares investors and they all take their money out at once (like happened in Southeast Asia in the late 90s) that can spark a crisis. In cases like those, a trade deficit can be a sign of vulnerability.

So a trade deficit strictly speaking means investors are parking their money with you. Whether it's good or bad depends on what you (or they) are doing with the money.

The U.S. is lucky because investors keep coming back. As long as they do, we can import more than we export.

"I think the best compliment I can give is not to say how much your programs have taught me (a ton), but how much Marketplace has motivated me to go out and teach myself." - Michael in Arlington, VA

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Trade deficits aren't good or bad, just weird

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We're doing a series of explainers of economic concepts to mark Marketplace's 25th anniversary, and today we take a look at the Trade Deficit. The United States has been running one one every year since oh... 1974 . Currently, it's about $40 billion or so a month, give or take a few billion.

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Getty/MalcolmFife

Running a trade deficit is not new for the U.S. It's been mostly running trade deficits since the 1970s. However, this trade imbalance has recently become hotly scrutinized. Much of the concern stems from a fear that trade deficits lead to declines in manufacturing sector employment.

In a recent Regional Economist article, Assistant Vice President and Economist Yi Wen and Research Associate Brian Reinbold explored why the U.S. runs a trade deficit, why manufacturing employment is declining and how these two are related. They also looked at the trade relationship with China, which is the largest supplier of goods to the U.S.-and by extension, its biggest creditor.

The long-running U.S. trade deficits and the emergence of China as a major creditor nation are largely the result of two economic forces, they wrote:

1. The rise of the U.S. currency and U.S. government debts to become the world currency and a global form of liquidity and store of value following the collapse of the Bretton Woods system

2. The comparative advantage shift in goods production, which caused labor-intensive manufacturing to move from the U.S. to nations with cheaper labor

The Bretton Woods System
After World War II, a new international monetary system, referred to as Bretton Woods, established the U.S. dollar as an international reserve currency. The dollar would be backed by gold, and any country could exchange dollars for gold. "This new system facilitated and stabilized global trade, especially trade among the industrialized nations," Wen and Reinbold wrote.

However, after years of U.S. aggregate-demand growth, countries running trade surpluses with the U.S. sought to exchange their dollars for gold, rapidly shrinking U.S. gold reserves, the authors noted. The Bretton Woods system effectively ended in 1971 when the U.S. ended dollar convertibility to gold.

Subsequently, because of the historical strength of the U.S. dollar, it became the global currency, and U.S. government securities became the most-demanded foreign reserve in the world, the authors pointed out.

When the U.S. can purchase goods from the world market simply by issuing debt, it is likely to run persistent trade deficits, they said. Indeed, since the mid-1970s, the U.S. has seen persistent and growing trade deficits.

"[T]he current international monetary system-based on the U.S. dollar as the dominant world reserve currency and U.S. government securities as the most-sought-after store of value-is the root cause of persistent trade deficits in the U.S.," Wen and Reinbold wrote.

Deficits and Manufacturing Employment

The next question the authors addressed is: Do trade deficits lead to a decline in employment in the manufacturing sector? Not necessarily, they explained. The more likely causes are rapid technology growth and improved labor productivity, similar to what happened in the U.S. agricultural sector.

Manufacturing employment in the U.S. started to decline in the 1960s as labor productivity rose. The authors pointed to research by Timothy Kehoe, Kim Ruhl and Joseph Steinberg that showed that about 85 percent of the drop in employment in the goods manufacturing sector from 1992 to 2012 was due to the rising labor productivity. Only 15 percent was due to rising U.S. trade deficits.

"When workers get pushed out of agriculture and goods-producing sectors, they enter the service sector," Wen and Reinbold wrote. "This phenomenon of structural change (caused by technology growth) is observed across all successfully industrialized nations."

China's Role?

Manufacturing employment in the U.S. declined nearly 20 percent from 2000 to 2007, even before the Great Recession, the authors pointed out. They added that this sharp decline correlated with a worsening U.S. trade balance and a growing trade deficit with China.

However, the global comparative advantage in manufacturing has been shifting away from the U.S. since World War II, they noted. Following the war, it shifted to recovering countries such as Germany and Japan. It gradually shifted to the so-called Asian Tigers in the 1970s and 1980s, and then to China.

But while the total U.S. goods trade deficit with Asia has been increasing, its share of the U.S. deficit has been declining, the authors noted. In 1991, the East Asian and Pacific region (which includes China) accounted for more than 80 percent of the total U.S. goods trade deficit. That now stands at around 65 percent, despite China's rise as the largest supplier of goods to the U.S.

"In other words, the rise of China since the late 1980s-especially after joining the WTO [World Trade Organization] in 2001-has not increased the total share of Asia's contribution to the U.S. trade imbalance; China simply substituted out other Asian economies by taking their positions," Wen and Reinbold wrote.

So, even though China's share in total U.S. trade deficits increased from around 15 percent in 1991 to 45 percent around 2016, it has not increased the total share of Asia's trade position with the U.S., they pointed out.

The rise of the U.S. dollar as an international reserve currency and a shift in comparative advantage in manufacturing are key economic changes driving the large U.S. trade deficit.

"Given this perspective, a trade war with China may not necessarily solve the U.S. trade imbalance problem," the authors said. They identified three likely outcomes from an extended trade conflict with China, none of which are likely to increase U.S. exports and reduce its trade deficits:

1. Chinese imports becoming more expensive

2. U.S. trade deficits shifting to other countries with similar comparative advantages in producing labor-intensive goods

3. U.S. exports to China becoming more expensive as a result of China's retaliation

Notes and References
¹ Kehoe, Timothy J.; Ruhl, Kim J.; Steinberg, Joseph B. " Global Imbalances and Structural Change in the United States." Journal of Political Economy, April 2018, Vol. 126, No. 2, pp. 761-96.

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Behind the U.S. Trade Deficit | St. Louis Fed

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Getty/MalcolmFife Running a trade deficit is not new for the U.S. It's been mostly running trade deficits since the 1970s. However, this trade imbalance has recently become hotly scrutinized. Much of the concern stems from a fear that trade deficits lead to declines in manufacturing sector employment.

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The Debate on Trade Deficits Is Littered with Misconceptions

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Misconception No. 1: Trade Deficits Are for Losers

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1. How does a decrease in tariffs affect the current account balance for the country lowering the tariff?

2. What is the current account and what does it measure?

3. What is the capital (financial) account and what does it measure?

4. What is the balance of trade, and how is it different than the balance of payments

5. What happens when a country, like the US, consistently runs a current account deficit?

6. Is there a connection between the capital (financial) account balance, the strength of the country's currency, and demand for that country's exports? For example, if a country has a current account deficit, what type of pressure does this put on the foreign exchange rate for that country’s currency.

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[Rebroadcast] Daniel Griswold on the Basics of Trade by Macro Musings

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Daniel Griswold is a Mercatus Center Senior Research Fellow and Co-Director of the Program on the American Economy and Globalization at the Mercatus Center at George Mason University. He joins the show to discuss the theory of trade, dating back to Adam Smith, and his work on current US trade policy.

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20 - Douglas Irwin on Free Trade, the Gold Standard, and American Economic History by Macro Musings

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Douglas Irwin, professor of economics at Dartmouth College and author of Free Trade Under Fire (Princeton University Press, 2015), joins the show to discuss the economic arguments for free trade and the reasons for the heated politics surrounding trade. He describes the history of U.S.