International Balance of Payments (BOP)

The international balance of payments (BOP) is an accounting of the international transactions of a country that has its own currency over a certain time period, typically a calendar quarter or year. It shows the sum of all economic transactions between individuals, businesses, and government agencies in the country and those in the rest of the world.

Every international transaction involving different currencies results in a credit and a debit in the BOP. Credits are transactions that increase the amount of money to domestic residents from foreigners, and debits are transactions that increase the money paid to foreigners. For instance, if someone in England buys a South Korean stereo, the purchase is a debit to the British account and a credit to the South Korean account. If a Brazilian company sends an interest payment on a loan to a bank in the United States, the transaction represents a debit to the Brazilian BOP account and a credit to the United States BOP account.

The BOP for the United States international transactions is divided into 2 accounts: the current account and the capital account. The current account deals with international trade in goods and services and with earnings on investments. The capital account consists of capital transfers and the acquisition and disposal of non-produced, non-financial assets. A subdivision of the capital account, the financial account records transfers of financial capital and non-financial capital. The official reserves account, which is part of the financial account, is the foreign currency held by central banks, and is used to pay balance-of-payment deficits.

Each account is further divided into sub-accounts.

The Current Account

When a trade deficit or surplus is reported, this is usually the account that is being referred to. It is an indication of the desirability of a country's products and services by the rest of the world, and therefore, its competitiveness in the world marketplace. The current account is composed of 4 sub-accounts:

Merchandise trade consists of all raw materials and manufactured goods bought, sold, or given away. Until mid-1993, this was the figure that was used when the balance of trade was reported in the media. Since then, the merchandise trade account has been combined with a second sub-account, services, to determine the total for the balance of trade.
Services include tourism, transportation, engineering, and business services, such as law, management consulting, and accounting. Fees from patents and copyrights on new technology, software, books, and movies also are recorded in the service category. Most outsourcing of labor is a debit to the services account.
Income receipts include income derived from ownership of assets, such as dividends on holdings of stock and interest on securities.
Unilateral transfers represent one-way transfers of assets, such as worker remittances from abroad and direct foreign aid. In the case of aid or gifts, a debit is assigned to the capital account of the donor nation.

The amount of goods and services imported compared to the amount exported is known as the balance of trade. A trade surplus exists when exports exceeds imports over a measured period and a trade deficit exists when imports exceeds exports.

U.S. Merchandise Trade Deficit 1970-2001.

Graph of the U.S. merchandise trade deficit from 1970-2001.

Source: New York Federal Reserve Bank.

The Capital Account

The capital account is equal to capital transfers, and the sale of natural and intangible assets to foreigners minus the capital transfers, and the purchase of foreign natural and intangible assets by U.S. residents.

Capital transfers include debt forgiveness and migrants’ transfers (goods and financial assets accompanying migrants as they leave or enter the country). In addition, capital transfers include the transfer of title to fixed assets and the transfer of funds linked to the sale or acquisition of fixed assets, gift and inheritance taxes, death duties, uninsured damage to fixed assets, and legacies.
Acquisition and disposal of non-produced, non-financial assets represent the sales and purchases of non-produced assets, such as the rights to natural resources, and the sales and purchases of intangible assets, such as patents, copyrights, trademarks, franchises, and leases.

The Financial Account

The financial account, a subdivision of the capital account, consists of 2 categories, which lists trade in assets such as business firms, bonds, stocks, and real estate:

U.S.-owned assets abroad are divided into official reserve assets, government assets, and private assets. These assets include gold, foreign currencies, foreign securities, reserve position in the International Monetary Fund, U.S. credits and other long-term assets, direct foreign investment, and U.S. claims reported by U.S. banks.
Foreign-owned assets in the United States are divided into foreign official assets and other foreign assets in the United States. These assets include U.S. government, agency, and corporate securities, direct investment, U.S. currency, and U.S. liabilities reported by U.S. banks.

Balance of Payments Deficit and Surplus

The current account should balance with the capital account, because every transaction is recorded as both a credit and a debit (double-entry accounting), and since credits must equal debits and the balance of payments is equal to credits minus debits, the sum of the balance of payments statements should be zero. For practical reasons, however, it deviates slightly from zero.

BOP = Current Account + Capital Account = Credits - Debits ≈ 0

For example, when the United States buys more goods and services than it sells—a current account deficit—it must finance the difference by borrowing, or by selling more capital assets than it buys—a capital account surplus. A country with a persistent current account deficit is, therefore, effectively exchanging capital assets for goods and services. Large trade deficits mean that the country is borrowing from abroad or selling assets to foreigners. In the balance of payments, this appears as an inflow of foreign capital. In reality, the accounts do not exactly offset each other, because of statistical discrepancies, accounting conventions, and exchange rate movements that change the recorded value of transactions.

However, the specific accounts can, and almost always do, have surpluses and deficits. Surpluses are in one account are counterbalanced by deficits in the other.

The Official Reserve Account

The official reserve account, a subdivision of the capital account, is the foreign currency and securities held by the government, usually by its central bank, and is used to balance the payments from year to year. In the United States, the New York Federal Reserve serves as the Treasury's fiscal agent. The official reserves increases when there is a trade surplus and decreases when there is a deficit. Sometimes the central bank will use it to attempt to change the exchange rate to what the government perceives as more favorable.

The 2003 U.S. Balance of Payments

In 2003, the United States exported $714 billion of merchandise and imported $1,263 billion, for a merchandise trade deficit of $549 billion. However, service exports were $305 billion and service imports were $246 billion, for a surplus of approximately $59 billion. The trade deficit on goods and services, therefore, was $490 billion. U.S. interest payments to other countries and U.S. interest income from abroad were $250 and $272, respectively, and there was a net outflow of $68 billion in unilateral transfers. Therefore, the current account showed an overall deficit of $536 billion.

Capital account transactions yielded a net outflow of $3.1 billion. For the financial account, U.S. investors acquired $277 billion of assets abroad and foreign investors acquired $857 billion of assets in the United States, yielding a net financial and capital account surplus of $580 billion. That surplus, minus a statistical discrepancy of $34 billion, balanced the $536-billion current account deficit.

Dollarization

There are some smaller countries and independent territories in the world that do not have their own currency, but use the currency of another country. Although it is known as dollarization, the currency can be any currency, although it usually is the United States dollar. Therefore, such countries and regions have no balance of payments nor can they effect monetary policy. Countries that are territories or commonwealths of other countries generally use the currency of the main country. For instance, Puerto Rico, a commonwealth of the United States, and the U.S. Virgin Islands, a quasi-independent territory of the United States, use the United States dollar for their currency. Sometimes a country will adopt a foreign currency because the domestic currency has little or no value. For instance, in March, 2000, the government of Ecuador changed the official currency from the sucre to the United States dollar to stabilize the economy and to greatly reduce the high inflation that plaqued the country in the 1980's and 90's.