Balance of payments

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The balance of payments budget deficit has always been a popular topic of casual discussion at dinner parties among friends. The figures are a watched and followed closely by stockbrokers, fund managers, bonds and currency traders as well as investors. While business leaders, economists and policy makers spend the weekend debating the relevance of these newly acquired numbers on the Sunday business show. Even movie star Arnold Schwarzenegger who is running for governor of California was quoted in the Courier-Mail (0 August. 00, p.) saying that he was disgusted at the massive budget deficit blamed on mismanagement by politicians. Clearly the Balance of payment is very important to the citizens of the country. But is having a budget deficit really that bad?

This essay will begin by firstly explaining the composite construct of the Australian Balance OF Payments (BOP). Secondly we will compare and contrasts the United States (US) system of accounts with the Australian BOP. Thirdly, we will use the recent 10 year BOP data to compare the performance, direction and implications for these countries. It will be shown that by just quoting a budget deficit, it is not enough to see the overall picture of where the economy is heading. It is not in the scope of this essay to prove existing economic theory on the BOP, as this is not an economic paper.

Cumby and Levich (14, p. 11) describes the balance of payments (BOP) as "the name given to the record of transactions between the residents of one country and the rest of the world over a period of time."

In Australia the BOP is made up of two general main categories the current account and the capital and financial account.

Help with essay on Balance of paymentsThe current account records all international goods and services. The Australian BOP current account consists of sub-accounts states McLennan (18, p. 5). The first is goods and services, second is income and the third account current transfers. With in each one they are further sub-categorized in to smaller accounts. It is usually a one year timeframe that all short term transactions are recorded in the current account.

Figure 1 shows the current account with the board categories.

According to McLennan (18, p. 5) the goods account comprise most movable goods that change ownership between an Australian resident and a non-resident. This account is further broken down into, general merchandise, goods for processing, repairs on goods, goods procured in ports by carriers, and non-monetary gold for a more in-depth analyses.

Services account is where services are provided or received between an Australian resident and non-residents. It is also broken down into smaller more informative sub-accounts providing specific information on our major service sectors.

In the income account is where all transactions of income are kept. These include everything from dividend payments received by a resident from a non-resident foreign company to an Australian receiving an income form a foreign based firm. Again the accounts are also further divided into its relevant sub-accounts.

The last account in the current account is the current transfer account. Transfers are considered to be the provision of resources to a non-resident country with no expectations of an economic return. These include foreign food aid other donations supplied to non-residents. McLennan (18, p. 7) stressed that current transfers needs to be distinguished form capital transfer which is located in the capital account. The distinction is that if the aid is consumed within 1 months of being received then it is considered a current transfer, while if it is longer than 1 months it will be classified as a capital transfer and will be located in the capital account. This distinction is in line of the view that all short term transaction will take place within 1 months and are recorded in the current account.

The capital account and financial account are the second category of accounts used in the BOP. The capital account comprises of both capital transfers as distinguished with the current transfers. The "acquisition and disposal of non-produced, non financial assets" (McLennan, 18, p. 8) such as copyrights are also included. Figure gives an in-depth look at the capital and financial accounts.

The financial comprises of long term financial transactions between an Australian and a non-resident which will lead to a change of ownership in Australian's foreign assets or liabilities. This account is closely related with Australia's international investment positions.

Together the capital account and the financial account represents Australia's financial long term foreign investment position.

Figure shows the Capital and the Financial account

The BOP uses a double entry accounting system to replicate the financial position of a country as if it is treated as a business entity. A debit entry on the BOP is any transaction that gives rise to an outflow of foreign currency or a negative sign, while a credit on BOP is a transaction which will cause an inflow of foreign currency shown with a positive sign. As in accounting for a firm, all transactions have a credit entry and also a corresponding debit entry to produce a net balance of zero.

However in reality this is never the case and there is a special account on the BOP called Net Errors and Omissions which exists for completion of the accounting style. It is located on the last line of the capital and financial account. It exists so that discrepancies between credit and debits entries can be balanced off.

Discrepancies in amounts arise because of the complexities of recording an entire nation's transactions in the international arena for a particular period of time. For every given period there are a large number of transactions taking place. Because there are no single source of getting the transactions, each and every transactions needs to be individually recorded in order to produce the BOP data. The sources of data are form very diverse areas, from a bank trading in financial derivatives to a university selling education overseas.

Timing is also another factor which further makes it hard to get accrete numbers. Firstly there are lags in time between payments of goods and the when the goods actually arrive.

Secondly because the exchange rate is always fluctuating, converting local currency into us dollars at different exchange rates will lead to inconsistencies. The Australia Bureau of Statistics (ABS) is the organization responsible for compiling the BOP figures and the figures are revised each quarter.

Before we can start to compare the Australian BOP with the American BOP we will firstly need to make sure they are comparable in structure and classification. The latest edition of the Balance Of Payments Manual 5th edition (BPM5) published by the International Monterey Fund (IMF) in 16 is the standard which the Australian BOP is compiled in accordance with. According to the Bureau of Economic Analysis (BEA) (10, p) the US BOP complies with the standards of the Balance Of Payments Manual 4th edition (BPM4) with a few slight exceptions. However because BEA (10) seems rather dated, it is very possible that by now the US BOP will have been written in accordance with the latest BPM5 which is the international standard.

The major difference between the Australian BOP and the US BOP in the naming and the additions of specific accounts in the BOP and also the currency the data are reported in. According to the BEA most of the accounts have the same basic meaning as with the Australian BOP.

As with the Australian BOP, the US BOP is also conceptually also split into board accounts. The accounts are the current, capital and the financial account. Differences arise because each country is different in the products they produce and trade. The BOP is a summary of their trading position in comparison with other countries, each country will alter the structure of their BOP to better present the structure of their economy. This is much like a company adjusting their financial records to better reflect the specific type of business they are in. One good example is, the US have a large proportion of their budget spending in the US Military so it is only natural they will have a specific account for that. While Australia is a great exporter of minerals, so under the goods account there is a specific account just for that. But however the over all meaning behind the current, capital and financial account remains the same.

The second difference is that the US BOP is in US dollars while the Australian equivalent is compiled with Australian dollars. Before attempting the compare the performance of the two countries one must make sure the data are comparable.

Initially, the overall look of the two BOP looked different, however it is just the way in which they are set out. The IMF does not have a preferred way in which the accounts are placed. There are many different ways you could represent these figures to best suit your needs.

These initial differences can be clearly seen in figure .

What are the implications of the BOP?

As we can see in the figure 4 and 5, both Australia and the US has been running a deficit. These figures are still in their raw form. That is the US bop is still in US dollars while the Australian BOP is in Australian Dollars (AUD). However it can be clearly seen that both countries have a deficit in trade and a surplus in-flow of foreign funded investments.

Over the page are the 10 year BOP data for both Australia and US.

A structural evaluation approach can be used to determine which state of development the countries are in. Both have a deficit on trade (current account) and a long tern capital inflow (surplus in the capital and financial account). According to the characteristics devised by Maximo, Francis and Laurence (18, p.5), both Australia and the US are considered to be an immature debtor. Net foreign investment income is close to zero.

From 186 to 00, Australian has always had a current account deficit, and a capital account surplus. In the periods between 1 to 00, the US too seems to have the characteristics of an immature debtor. Nadler (001, p.4) says, there seems to be a trend continuing as current accounts deficits get increasing larger and the capital account surplus get bigger.

This suggest a slow down in the domestic industries of both countries. As imports over take exports, it is a sign that their exports are un-competitive in the international markets compared with countries like China. Also with "deflation and recession in Japan and Europe" (Waggoner and Shell, 00, p1), demand for US and Australian made products continues to fall.

Unless the currency depreciates prices for exports are still seen as too expensive. Being an immature debtor, the implications for both countries are that their currency not depreciate, but will remain relatively stable.

Although, both countries are running trade deficits, their currency is unlikely to devalue unless there is a drop in foreign funded domestic investments.

There is a sell correcting mechanism where there are free floating exchange rates. It is always thought that when a country run a continual current account deficit (that is they import more than they export), then they will need to sell their own domestic currency to purchase foreign currency in order to repay foreigners. This disposal of domestic funds would devalue the domestic currency.

A devaluation of the currency will then make the domestic products more competitive overseas. As more exports occur, imports will become more expensive and hence domestic consumption of imports will decrease, resulting to a balance of trade.

However there is no evidence of this happening. What is happening is that the currency is being recycled back into the US and Australia by the continual investment in to these countries. This is shown by the surplus in the capital and financial accounts of both countries.

Because US and Australia (as compared to Japan) are seen as a stable economy, investments are coming in which offsets the current account deficit. This is why the dollar is still in demand and would not fall in the foreseeable future unless there is government intervention to lower interest rates or other change monetary and fiscal policy. Or there are signs of depression in either country.

Recently there are some signs that the US might be heading into recession. "Depression is an economic slowdown accompanied by falling prices. Its hallmarks rising inventories, falling demand, rising unemployment and lower wages." (Waggoner and Shell, 00, p1). This scare resulted in a falling USD.

The fall in USD will mean that for the next period, US products are more completive. This will reduce their trade deficit. By now having more exports and hopefully the domestic consumers will avoid more expensive imports.

A further drop in the US dollar is also expected in the coming year because of the elections. "It is a normal attitude of foreign fund managers to take to the side lines and adopt a wait and see approach during election year" says Aquino (00, p11). This will further see a decree in investment into the US.

Warburton (00, p8) argues that the saving rate of a country is important. He says that if a country does no have enough domestic funds to draw upon i.e. to borrow. Then the country will need to borrow form aboard. This will lead to an increase capital account surplus, or a current account deficit. Another way to make the capital account go in deficit is to make domestic residence save more. Increasing the interest rate and decreasing inflation will encourage residence to save more and spend less. With low inflation, real return will be high. Low interest rates will stimulate imports because residence sees less incentive to save, while higher interest rate encourages more domestic savings. With a pool of domestic funds, there will be less need to borrow over seas.

At this point in time there is no evidence which suggest that having a deficit is an undesirable situation. In both Australia and the US, the BOP deficit has no direct negative implications to the economy.

In conclusion it can be seen that by just judging on the bias of one figure which is the current account balance; weather it be a deficit or a surplus. It is impossible to say if this is good of bad for the economy. It can be seen with the Japanese example that by having a surplus does not automatically make an economy boom. There are so many other factors to consider.

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