Balance of Payments Term Paper

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Balance of Payments

Explain briefly what a country's balance of payments is and the main elements of the balance of payments

One of Shakespeare's not so foolish fools once said that all pleasure must be paid. Analysts such as Matthew Wolf of the Financial Times have added that the imbalance of trade between the United States and the other nations it is currently trading with may be a pleasure the U.S. economy will soon pay for in strength, jobs, and financial confidence, as its balance of payments increasingly turns into an imbalance of payments. (Why the U.S. current account deficit is a cause for concern, 25 August 2004)

Thus, one could add to Shakespeare's quotation, that in the modern economy of international trade, the current balance of payments of U.S. national's economy must be paid or at least reckoned with, as the pleasures of free and fair trade are not to be enjoyed, gratis by participant nations, when imports of foreign goods radically outbalance exports to foreign nations, and the currency of a nation grows weaker and weaker. or, to use an equally memorable turn of phrase of Wolf's, America is now on the comfortable path to ruin," as it luxuriates in cheap goods. Americans purchase foreign goods at discount prices at Wal-Mart and spend themselves out of jobs, and their children out of jobs, in the future, as more and more jobs are outsourced to foreign nations and fewer foreign nations are willing to engage in long-term investment in the United States. (18 August 2004)

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When one asks why the balance of payments of the United States is so out of sync with its power and apparent influence in the world, and how a yawning U.S. deficit fuels fears for the global economy, (C Swann, Financial Times, 13 May 2004), one must first define what a balance of payments in terms of trade is, from an economist's perspective. A national balance of trade is the account of all transactions between one country and all other countries. These are transactions that are measured in terms of receipts and payments. (Ruby, 1999)

Term Paper on Balance of Payments Assignment

From the U.S. perspective, a receipt of the balance of payments represents any dollars flowing into the United States as country or any transaction that requires the exchange of foreign currency into its U.S. dollars. A payment representing dollars flowing out of the country or any transaction that requires the conversion of dollars into some other currency is called a payment to that nation, or the translation of dollars into that nation's foreign currency. (Ruby, 1999)

The three main "account" components of the balance of payments are the current account, including merchandise of exports and imports (usually understood in terms of the balance of trade in the popular investment and financial media), investment income such as rents, profits, interest, the capital account, including the measuring of foreign investment in the U.S. And U.S. investment abroad, and the balancing account, which includes the allowance for changes in official reserve assets such as SDR's, gold, and other payments. (Ruby, 1999)

Currently, the U.S. In 2004 maintains a deficit in merchandise trade and the absence of strong net investment income inflows, a current account deficit. This has occurred for some time, but before these deficits were of not much concern, as they were theoretically and comfortably offset by the current account surpluses, such as the purchase of U.S. assets by foreign individuals and institutions. The result was such that net flow of receipts and payments was in balance, allowing for statistical discrepancy, without the need to any type of official transfers. (Ruby, 1999) but concern in light of the continuation of this state of affairs, combined with a weakened U.S. dollar has grown and the widening deficit reveals U.S. continued and more sustained reliance on foreign cash than previously thought. (J Hughes, Financial Times, 15 September 2004) Moreover, a weakening U.S. dollar has thus far failed to narrow the trade gap. (Falling dollar fails to narrow U.S. trade gap, C Swann, Financial Times, 11 March 2004)

In fact, for the first time, European tourists are flocking to America to take advantage of cheaper U.S. prices for goods on Euro-tourist shopping expeditions. In contrast, American tourists are in a state of collective dismay as their dollars are worth less and less of other currency units abroad. Indeed, while the U.S. Department of Commerce said the trade shortfall with China swelled to a record $16.78 billion while the deficit with Japan contracted, down to $5.86 billion, the trade gap with the Euro area increased to a staggering an unprecedented $7.08 billion. Even the United States deficit with Canada expanded to $5.63 billion, while, to the United States' South, the shortfall with Mexico widened to $4.41 billion.

Section II

Discuss the links between a country's balance of payments and its rate of economic growth

Developing nations have the advantage of cheaper labor. Thus, they usually export labor in return for investment dollars to fuel growth. If a nation's monetary unit of currency becomes too expensive, however, its goods may become too costly for the international market to support. If the nation's currency is too weak, it becomes difficult for the nation to recoup upon its investment in exported goods, unless mass-produced at great scale, hence the association of the phrase, 'made in China' with inexpensive products in this developing nation with a relatively inexpensive currency. But Asia's game with America is a long way from ending writes the erstwhile Matthew Wolf in the Financial Times, on 11 August of this year 2004. China's trade deficit with the U.S. shows that its cheap goods strategy is working well -- while it continues to invest in the education of its labor force. In all of Asia, outsourcing of jobs has brought dollars to Asia, combined with technical know-how that can now be deployed by Asian companies.

Discuss the links between a country's balance of payments and the exchange rate of its currency

An increase in U.S. receipts, that is increased U.S. exports, means investment income inflows, or more foreign investment in the U.S. will lead to increased demand for dollars and an increased supply of foreign currency on foreign exchange markets as individuals and businesses are selling foreign currency and buying dollars. This increased demand will lead to a stronger dollar relative to other currencies, as was evident in the past history of trade for the United States, in relation to most nations that traded with the United States or competed with it for world market share. (Ruby, 1999)

For instance, after World War II, when the U.S. first became the major mature creditor nation in the world, a historical period that lasted roughly from 1945-1980, the United States' current account had only a slight merchandise deficit, although exports were less than imports, the dollar remained incredibly strong in relation to other currencies. Thus, it was extremely attractive for Americans to travel abroad. This also meant the United States had an investment income surplus with a slight net surplus overall. (Ruby, 1999)

The capital account status of the United States at the time in a state of deficit was largely due to postwar (WWII) reconstruction in Europe and Japan, and the varied economic and political weaknesses of those nations, and their indebted status to the United States. (Ruby, 1999) but in recent years, since 1980, the United States has seen an increase in U.S. payments, in the form of U.S. imports, investment income outflows, and more U.S. investment abroad. This has lead to an increase in the supply of dollars and thus a weaker dollar relative to foreign currencies. At present there is a large and growing deficit in the merchandise accounts of the United States trade deficit and a slight surplus in the investment income accounts. There is a large surplus in the capital account partially to finance the above merchandise deficit in the form of foreign individuals and banks lending money to individuals in the U.S. (Ruby, 1999)

Of course, since the U.S. has had a relatively low inflation rate compared to other industrialized nations since 1982 and consistent economic growth, the U.S. has remained a relatively good place to invest relative to the rest of the world, despite an expensive labor force. However the current inflow of capital investment could eventually lead to large investment income payments in the near future. The investment income surplus the United States now enjoys may soon be eroded thus worsening the current account deficit. (Ruby, 1999)

Section III

Analyze the main reasons for the U.S.A.'s balance of payments deficit over the past five years and the effects of these deficits upon the economy

Relative is not good enough, however, for the United States -- the United States wishes to remain economically on top of the world in decades to come, as a place to invest as well as a leading investor around the world. Recently, the Bush administration released a statement to the press, that the United States'… [END OF PREVIEW] . . . READ MORE

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