Payments Among Nations

1
Payments Among Nations

• Pugel Chapter 15
• Mankiw Chapter 5, Section 1

2
Accounting in Open Economies

• National Income and Product Accounts (NIPA)
• Balance of Payments
• International Investment Position

3
Accounting in Open Economies

• Balance of Payments
• International Investment Position

4
Questions

• Why does the USA have a Trade Deficit?
• Is this Bad?

5
Answers

• Why does the USA have a Trade Deficit?
• - Because Savings is Less than Investment
• Is this Bad?
• - Yes, if the Saving Rate is Too Low

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Wrong Answers

• Why does the USA have a Trade Deficit?
• Foreign Trade Barriers
• US Goods Arent Competitive
• Is this Bad?
• - Yes, Trade Deficits Cause Unemployment

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Trade Deficit and UnemploymentUSA 1973 - 2003
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NIPA-1Gross Domestic Product

• Closed GDP C I G
• Open GDP C I G NX

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NIPA-2Gross National Product (Income)

• Closed GNP GDP
• Open GNP GDP
• Net Factor Income Received
• Net Transfers Received

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NIPA - 3

• Net Factor Income Income Received from Domestic
  Factors Employed Abroad, Minus
• Income Paid to Foreign-Owned Factors Employed in
  Domestic Production
• Example Profits of Volkswagen factory in China
  are part of China GDP but part of German GNP

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NIPA - 4

• Net Transfers Transfer Payments Received from
  Abroad, Minus
• Transfer Payments Paid to Foreigners
• Transfers Not an Exchange or Sale Example 1
  Resident Workers in US Send Income to Families
  in Other Countries.
• Example 2 Foreign Aid

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Balance of Payments - 1

• Record of International Payments
• Payments to Domestic (firms, individuals, or
  governments) from Foreigners are a plus ()
• Payments from Domestic (firms, individuals, or
  governments) to Foreigners are a minus (-)

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Balance of Payments 2

• Current Account (CA)
• Exports Imports
• Net Factor Income Received
• Net Transfers Received
• GNP C I G CA
• GDP C I G NX

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USA Current Account(2004, Billions)
IMF, International Financial Statistics,
February, 2004
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CHN Current Account(2002, Billions)
IMF, International Financial Statistics,
February, 2004. Estimate for 12 months to Oct,
06 CA161 The Economist
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Balance of Payments - 3

• Capital Account now refers ONLY to transfers
  NOT sales of capital assets.
• Example USA forgives debt owed to it by a
  developing country gt transfer to developing
  country gt minus for USA and plus for developing
  country
• Usually small, but Argentina ...

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Balance of Payments - 4

• Capital Account (Financial Account)
• Sales of Assets to Foreigners () minus
  Purchases of Assets from Foreigners (-)
• Sale to Capital Inflow
• Purchase from Capital Outflow

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Balance of Payments - 5

• Three types of capital flows
• Foreign Direct Investment (Ownership gt 10)
• Portfolio Investment (Financial Assets such as
  stocks and bonds)
• Other (Bank loans deposits, other)

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USA Financial Account(2004, Billions)
IMF, International Financial Statistics,
February, 2004
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CHN Financial Account(2002, Billions)
Foreigners reduced holdings of Chinese other
assets.
IMF, International Financial Statistics,
February, 2004
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Official Reserve Transactions - 1

• Domestic Monetary Authority Holds Reserves of
  Foreign Currencies
• Many Countries hold US, Euros, Yen
• Often, Short-term Government Debt
• Note When Peoples Bank buys US, it enters as a
  debit (negative) for China

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Official Reserve Transactions - 2

• Net Purchases (-) or Sales() of Official
  Reserves during 2002
• USA -4 billion CHN -75 billion
• Stock of Foreign Currency Reserves (End of 2002)
• USA 68 billion CHN 291 billion
• The Economist estimate (Oct, 06) CHN 988
  billion

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Official Reserve Transactions - 3

• Why keep foreign currency reserves?
• Attempt to stabilize exchange rate by filling the
  gap between supply and demand in the foreign
  exchange market.
• More later.

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Official Reserve Transactions - 4

• Why does the USA have so few reserves?
• Currency floats.
• US dollar is the primary reserve currency of
  other countries.

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Balance of Payments - 6

• In principle, Current Account Financial Account
  ORT 0
• gt Current Account -(Financial Account ORT)
• Net Purchases of Foreign Assets
• Household Income Expenditure Saving
  (Foreign) Investment

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Balance of Payments - 7

• But reported data are estimates, so in the
  accounts
• Current Account Financial Account ORT
  Statistical Discrepancy 0

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The Balance of Payments
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CA (FA ORT) 0

• CA lt 0 if and only if (FA ORT) gt 0
• Two Equivalent Questions
• Why does the USA have a Current Account deficit?
• Why does the USA have a (Financial Account ORT)
  surplus?

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NIPA - 5Savings and Investment

• Three uses of income GNP C Sp T,
• where Sp Private Saving
• Government Saving Sg T G
• National Saving Private Government Sp Sg

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NIPA - 6

• Closed GNP C I G gt
• S I
• Open GNP C I G CA gt
• S I CA
• Domestic Savings can be used either for domestic
  I or to buy foreign assets.

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S I CA

• A Country has a Current Account Deficit if and
  only if Domestic Saving lt Investment
• Why does the USA have a CA Deficit?
• Because S lt I

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CA S - I

• How Can the USA end the CA deficit?
• Reduce I
• Increase S
• Recall S Y C T (T G)
• Reduce C
• Reduce G
• Increase T (Unless Ricardian Equiv)

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CA S - I

• Is a CA Deficit Bad?
• Better to Invest Less?
• Better to Save More?
• What is Done with the Capital Inflow?
• 19th Century USA I
• 21st Century USA G and C

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International Investment Position

• Balance of Payments records Flows per period
  (usually a year).
• International Investment Position (IIP) records
  Stocks at a point in time.
• IIP is the Cumulative result of Flows.
• US Financial Account Surplus for 20 years gt IIP
  declining.

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Worlds Largest Debtor CountryInternational
Investment Position USA
Includes 352 of US Currency
http//www.bea.gov/bea/newsrelarchive/2006/intinv0
5.xls
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Is This Bad?

• When China receives FDI, Chinas IIP
  decreases/becomes negative. Bad?
• When the USA was developing in the 19th Century,
  it was also a huge debtor.

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Is this Bad?

• If the US stock market goes up, US IIP goes down
  (since foreigners own US stocks).
• If I sell my house in Montana to a Chinese, is
  the USA worse off? Is China better off?

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IIP is NOT a Balance Sheet

• Includes USA-owned Assets Abroad
• Does NOT include USA-owned Assets in USA
• Includes Foreign-owned Assets located in USA
• Some are Liabilities for USA (e.g. US Government
  Bonds)
• Some are Not Liabilities (Toyota plant in
  California)

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Net Worth US Households and Nonprofits End of
2001
http//www.federalreserve.gov/releases/z1/current/
z1r-5.pdf
40
US Household Net Worth(Constant 2001)
2006Q2 NW 48T or 160,000 per person
http//www.federalreserve.gov/releases/z1/current/
z1r-5.pdf
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Notes on USA Net Worth

• Does NOT Include
• Government Assets (27 of USA Land)
• Government Promises Implied by Social Security,
  Medicare and Medicaid Laws
• Present Value (Expend - Revenues) 50-70T
• Somethings got to give.
• NOT (Primarily) an International Issue
• IS Domestic Saving/Expenditure Issue

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For Next Class

• Read Chapter 15
• Do Problems 1,2,4,5,7,8,9,10