The balance of payments accounts capture two sides of an equation: the current account and the capital account. The current account side of the ledger covers the flow of goods, services, investment income, and uncompensated transfers such as foreign aid and remittances across borders by private citizens. Within the current account, the trade balance includes goods and services only, and the merchandise trade balance reflects goods only. On the other side, the capital account includes the buying and selling of investment assets such as real estate, stocks, bonds, and government securities.
If a country runs a capital account surplus of $100 billion, it will run a current account deficit of $100 billion to balance its payments. If a country is buying more goods and services from the rest of the world than it is selling, the country must also be selling more assets to the rest of the world than it is buying.
The necessary balance between the current account and the capital account implies a direct connection between the trade balance on the one hand and the savings and investment balance on the other. That relationship is captured in the simple formula:
Savings - Investment = Exports - Imports
Thus, a nation that saves more than it invests, such as Japan, will export its excess savings in the form of net foreign investment. In other words, it must run a capital account deficit. The money sent abroad as investment will return to the country to purchase exports in excess of what the country imports, creating a corresponding trade surplus. A nation that invests more than it saves--the United States, for example--must import capital from abroad. In other words, it must run a capital account surplus. The imported capital allows the nation's citizens to consume more goods and services than they produce, importing the difference through a trade deficit.
Now, foreigners can use dollars to purchase U.S. assets: stocks, bonds, bank deposits, government debt, real estate, businesses. When Toyota buys land and equipment for a factory in the United States, when a British investment fund buys stock in a U.S. corporation, when a German bank purchases U.S. Treasury bonds, then the United States is said to be "financing" its current account deficit by selling assets. In 2002, foreigners acquired $612 billion in U.S. assets.
The United States has run persistent and increasing current account deficits since the 1980s, and foreigners have used the dollars to stake significant claims on U.S. assets. At the end of 2007, the value of U.S. assets owned by foreigners exceeded the value of foreign assets owned by U.S. residents by around $3 trillion. This is the reason the United States is often said to be a debtor nation, with a net debt to the rest of the world of. This "debt" is denominated in their own currency. For that reason, dollar is weakening.
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2 comments:
You are right in saying that current account transactions are offset by an equal and opposite capital account transaction. But sometimes countries like China run both Current as well as Capital account surpluses. I guess thats when we get the third aspect in the equation - Forex reserve.
But a country like US does not maintain a forex reserve. So I think it just prints to balance....
Even for US to print to balance is a problem as it will have to control inflation. As US relies heavily on import and more the dollar floating in the market inflation in dollar terms will grow reducing dollar value. So they dont literally print dollars. They sell Bonds and other assets to economies like european ones who buy them. Thus having euro and other currencies to fund their deficits. Till now all the other big economies didnt have anyother place to invest other than US. But now with BRIC coming up strong as investment opportunities, US is losing its stand as an investment hub and finding it difficult to fund its deficit and has to now rely more on printing to balance as you correctly stated thus weakening their dollar.
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