International trade is an economic condition that takes place when a country is importing and exporting merchandise and is measured from country to country not from business to business.
A deficit is a negative value of goods being imported and a plus the value of goods being exported. Both together provide the accounting method for net trade and it is given in the currency of the country in question. For instance, assume that the United States imports 100 billion US Dollars’ worth of goods, from China and exports 75 billion US Dollars to China. In this example, the trade deficit for the US would be 25 billion US Dollars.
Measuring a country's net trade is a difficult task, which involves measuring different flows of investment accounts. These accounts are the current account and the financial account, which are then totaled to help form the balance of payments figure. The current account is used as a measure of all transactions for import/export of goods and services, interest earned from foreign sources, and any money transfers between countries. The financial account is made up of the total changes in foreign and domestic equity. The net resulting from these are designated as the balance of payments.
The balance of payments (BOP) is the method countries use to monitor all international monetary transactions during specific periods of time. Usually, the BOP is calculated every quarter and every calendar year. It includes all trades conducted by both private and public sectors and is accounted for in the BOP to determine how much money is going in and out of a country. In general accounting terms it means that if a country receives money is counted as a credit. If instead a country pays or transfers money, to another country the transaction is counted as a debit. In theory adding credits (positives) and debits (negatives) should balance to zero. In essence the BOP can tell an observer whether a country has a deficit or a surplus and from which part of the economy the discrepancies are originating..
Balance of Payments Components
The BOP is divided into three main categories: the current account, the capital account, and the financial account. Moreover each division of accounts is further subdivided in different categories for different type of international monetary transaction.
Current Account
The current account is used to measure the inflow and outflow of goods and services into a country. Interest on capital and earnings on investments, from either public or private sources, are all put into the current account.
The current account comprises credits and debits on the trade of merchandise, which also includes raw materials and manufactured goods that are bought, sold or given away (possibly in the form of aid). Receipts arisen from services such as tourism, transportation, engineering, business service fees from consulting firms and royalties from patents and copyrights are all included in the current account.
When every item on the ledgers composed of goods and services is put together it results in a country's balance of trade (BOT). The BOT is typically the biggest bulk of a country's balance of payments as it makes up total imports and exports of all capital transactions in the country’s currency. Other income-generating assets such as dividends from stocks are also recorded in the current account. The last component is unilateral transfers. These transfers are credits that are mostly from worker's remittances, which can be salaries sent back to a home country from a worker abroad and foreign aid that is directly received by public or private institutions.
The Capital Account
The capital account is where all international capital transfers are recorded. This refers to the acquisition or disposal of non-financial assets such as waterfront land to build a port, mines etc., and other non-produced assets, which are needed for future production but which rights have not been yet exercised.
Capital account is broken down into monetary flows branching from debt forgiveness, the transfers of ownership on fixed assets such as oil rigs to extract oil, transfer of funds received for the sale or acquisition of fixed assets, gift and inheritance taxes, death levies and, finally, uninsured damage to fixed assets.
The Financial Account
In the financial account, international monetary flows related to investment in business, real estate, bonds and stocks and bank accounts are all documented. This includes government-owned assets such as foreign reserves, gold, special drawing rights (SDRs) from the International Monetary Fund (IMF), private assets held in foreign banks and direct foreign investment.
Balance of Accounts
We should note that, with fluctuating exchange rates, the change in the value of money can add to BOP discrepancies. When a deficit occurs in the current account, which is a balance of trade deficit, the difference can be covered or funded by the capital account. The balance of payments is divided into the current account, capital account, and financial account. Again, theoretically, the BOP should be zero.
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