A brief and clear explanation of the Balance of Payments accounts with links to comparative international data.

1. Neven Valev
www.TheGlobalEconomy.com

2. The Balance of Payments summarizes the
international transactions of a country.
These transactions can be broadly categorized into two
types – international trade and payments (current
account) and international investment (financial
account).

3. The Current Account includes:
Imports and exports of goods.
Imports and exports of services – financial, legal, medical,
travel, etc.
Income on financial assets. For example: if a U.S. mutual
fund invests in a Mexican company, the dividends from
that investment will be recorded in the current account.
Also, if the Chinese government buys U.S. government
bonds, then the interest on these bonds will be recorded in
the current account.
Transfers between countries. This includes, for example,
foreign aid, remittances, and international gifts.

4. The Financial Account includes:
Foreign direct investment: the purchase or creation of
facilities for the production of goods or services (e.g. a
Toyota plant in the U.S.).
Portfolio investment: the purchases of equity (less
than 10% of the value of a firm) and bonds.
Other financial transactions such as cross-border bank
deposits.

5. Deficit and surplus
The current account could be in surplus if, for example,
exports are greater than imports. It could be in deficit if
imports are greater than exports or if, say, the domestic
country makes large transfer payments to foreign
countries.
The financial account is in surplus if the foreign
investment into the country is greater than the country's
investment in other countries. In contrast, the financial
account is in deficit if domestic citizens invest more
internationally than the amount foreigners invest in the
local economy.

6. The current accounts of the U.S. and China

7. Bookkeeping rules
A simple rule of thumb is that transactions that require the sale
of the local currency for a foreign currency enter with a minus
sign.
For example, if a U.S. family goes on a holiday to Mexico, they
have to sell dollars and buy peso to make payments in Mexico.
This transaction will go with a minus sign in the U.S. Balance of
Payments (more specifically in the current account) and with a
plus sign in the Mexican Balance of Payments.
The reverse is true for transactions that require the purchase of
the domestic currency: these are recorded with a plus sign. For
example, a German company that wants to import machinery
from the U.S. has to buy dollars to make the payment. That will
be recorded with a plus sign in the U.S. Balance of Payments and
with a minus sign in the German Balance of Payments.

8. Double entry for transactions
Each international transaction creates two entries in
the balance of payments with the same absolute
magnitude and an opposing sign.
For example, a Japanese consumer buys an American
car for $10,000. This is recorded as + $10,000 in the U.S.
Current Account. To purchase the car, the Japanese
consumer buys $10,000 from, say, Citibank.
Now Citibank has $10,000 worth of yen. It uses the yen
to buy Japanese government bonds. That purchase
enters with a (-) sign in the U.S. Financial Account.

9. Always in balance
So, we have two transactions of equal absolute magnitude
but with opposite signs. Since this is true for each
international transaction, when we add up all the “+”
entries and all the “-“ entries, we’ll arrive at the same
absolute number. Therefore,
Balance of Payments = Current account balance + Financial
account balance = 0
In other words, while the current account and the financial
account can be in surplus or deficit, the overall Balance of
Payments is always in “balance.”

10. More information
Current account balances by country
Foreign direct investment by country
Compare countries over time

11. www.TheGlobalEconomy.com
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