New Paradigm in Economics Byrne and Derbin

Drilling down on the Trade Deficit and the BOPA

May 1, 2009

New Paradigm Associates

Don Byrne Ph.D.

Ed Derbin MA, MBA

http://byrned.faculty.udmercy.edu/

Drilling down on the Trade Deficit and the BOPA

In the first blog on the U.S. Trade Deficit, we examined that specific BOPA (Balance of Payments Accounts) deficit directly.  It was shown that neither a deficit nor a surplus in the Trade balance is all good or all bad.  There are both costs and benefits of each type of imbalance.  In this issue, we will examine related balances in the BOPA and the implications of each.

As indicated in the first issue pertaining to the U.S. Trade Deficit, there are a dozen or more balances in the BOPA.  It depends upon what factors are included or “above the line” as the expression goes and which factors are excluded or “below the line”.  The Trade Balance or technically, the Balance on Merchandise and Services Accounts includes only two of the five accounts in the BOPA.  By adding the Balance on Unilateral Transfers Account to the Trade Balance, the new combined balance is called the Current Account Balance.  It receives nearly as much notoriety as does the Trade balance.  Verbally, it is equal to the sum of the U.S. exports of merchandise and services and unilateral transfers (gifts by the rest of the World, both official or governmental and private remittances) to the U.S., less the sum of U.S. imports merchandise and services from the rest of the World and U.S. unilateral transfers (gifts by the U.S., both official or governmental and private remittances) to the rest of the world.

U.S. Department of Commerce

Bureau of Economic Analysis

U.S. International Transactions Accounts Data

http://www.bea.gov/international/bp_web/simple.cfm?anon=71&table_id=1&area_id=3

Of course we have such a balance with each nation such as China, and with groupings of nations such as the rest of the OECD members.  To maintain continuity with previous blogs on the Trade Deficit, we will focus on China and the rest of the World including China.

Once the first three accounts, Merchandise or Goods, Services, and Unilateral Transfers are aggregated into the Current Account Balance of the BOPA, what remains are the two Capital Accounts: long-term and short-term.  Since the inclusion of all five accounts must balance or equal zero arithmetically, the Current Account Balance must equal the combined Capital Account Balance, with an opposite sign.  This means that a -$500 billion deficit in the U.S. Current Account balance must be accompanied by a combined Capital Account surplus of +$500 billion during the same period of time.

When the U.S. experiences a combined Capital Account Surplus, it means that the Rest of the World is “lending” that amount on a net basis to the U.S.  Remember that “lending or borrowing” in this context include both debt and equity flows.  The U.S. has had such a Current Account Deficit with the rest of the world most of the time since the early 1980s and with mainland China for nearly the past 15 years.  The cause of this chronic position will be examined in the next issue of this blog.

There are other balances in the BOPA that are useful for certain purposes.  Over the years some balances become very popular and then seem to wane in importance. 

For economic growth purposes, the Basic Balance is often stressed.  This balance adds to the Current Account Balance, the Balance on Long-Term Capital Account, leaving out only short-term capital flows.  A deficit in a developing nation’s Basic Balance is considered much more serious than a similar deficit in that nation’s Current Account Balance.  It is similar to a household financing a home on a thirty year mortgage versus financing the same home on a 30-day note payable.

In the days of the IMF fixed exchange rate system which started shortly after WW II and collapsed in the early 1970s, the Official Settlements Balance was closely scrutinized.  It measured the degree to which nations intervened into foreign exchange markets to maintain the official pegged rate of their currency vis-à-vis the U.S. Dollar.  Experts were looking for chronic imbalances that might indicate an official devaluation or revaluation of the exchange rate in question. The Official Settlements Balance was the Basic Balance plus the private short-term capital flows, leaving “below the line” only official or governmental capital flows.

Speculation about exchange rate changes hounded the British Pound, the French Franc and other currencies considered weak and ripe for a change in the official pegged levels.  A measure of hot money flows moving due to speculation against a currency was the Net Liquidity Balance.  This balance added to the Basic Balance, the non-liquid short-term capital flows.  This left only the liquid short-term capital flows below the line.  These were the hot money flows not related to fundamental international trade and finance activities.

Other balances also gained import such as the balance that drew the line above factors that influenced the Monetary Base.  This was very important to Monetarists who became increasingly dominant in influencing monetary policy decisions in the last third of the 20^th Century but has fallen in popularity as the velocity of the monetary aggregates became increasingly unstable and difficult to reliably predict.

In the next issue, we will examine the causes of what has become a chronic Trade Deficit in the U.S. BOPA.

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