Alfonso Llanes, Master Degree in International Development
Not many subjects in economics have caused so much confusion and economic uncertainty in the past and present that a country might have a deficit in its balance of payments. This notion of fear is unjustified for two reasons: (1) there is never a deficit (2) if there was one it would not inevitably hurt anything
The payments and receipts of the residents of a country in their transactions with residents of other countries is the balance of payments. When all transactions are included, the accounting payments and receipts of each country must be equal. Any surplus or deficit simply leaves one country acquiring assets in the other. For instance, if Americans bought goods from Europe and have no other transactions with the EU, this trade bloc must end up holding dollars in the form of bank deposits in the United States or in some other U.S. investment. The payments Americans make to the EU merchandise is balanced by the payments Europeans make to U.S. individuals and institutions, including banks, for the acquisition of dollar nominated assets. In simpler terms the EU sold the United States merchandise and the United States sold the EU dollars or dollar-denominated assets such as treasury bills, real estate or other holdings.
Accounting wise, the totals of payments and receipts are equal, however, there will be inequalities in excesses of payments or receipts, known as deficits or surpluses in specific of transactions. There may be a deficit or surplus in any transaction such as: merchandise trade, services, foreign investment, unilateral transfers, foreign aid, private investment, the flow of gold and money between central banks and treasuries, or any other combination of these international transactions. When a statement is made that a country has a deficit or surplus in its “balance of payments” it must refer to some particular class of transaction.
In the past, many different definitions of the balance-of-payments deficit or surplus have been used and each definition has had different implications and purposes. Until the year 1973 attention was concentrated on a definition intended to measure a country’s ability to meet its obligation by exchange of its currency for other currencies or for gold at fixed exchange rates. Countries maintained a stock of official reserves, in the form of gold or foreign currencies that they could use to value their own currencies. A decline in this standard was considered a balance-of-payments deficit because it threatened the ability of the country to meet its obligations.
Beyond 1973, the balance-of-payments deficit or surplus refers to what is presently called the current account. This account contains trade in goods and services, investment income earned abroad, and unilateral transfers. It excludes the capital account in the acquisition or sale of securities or other property.
Because the current account and the capital account add up to the total account, which is necessarily balanced, a deficit in the current account is always accompanied by an equal surplus in the capital account, and vice versa. A deficit or surplus in the current account cannot be explained or evaluated without simultaneously explaining and evaluating an equal surplus or deficit in the capital account.
According to the American Enterprise Institute in Washington, D.C by the end of 2003, “Americans owned assets abroad valued at market prices of $7.86 trillion, while foreigners owned U.S. assets valued at market prices of $10.52 trillion. The net international investment position of the United States, therefore, was $2.66 trillion. This was only 8.5 percent of the U.S. capital stock.”
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