APMacro: Balance of Payments

Balance of Payments Econ Cartoon     International trade refers to the sales of goods and services to other countries. International asset transactions refer to exchanges of financial assets between countries, such as sales of stock and real estate. In order for a buyer in one country to make a purchase from another country, he must first buy the currency of that country in a foreign exchange market. The exchange rate, the value of one currency in terms of another currency, is determined by supply and demand.

The balance of payments is the sum of all of the financial transactions between two countries. The balance of payments includes two primary categories: the current account and the capital/financial account. The current account includes the trade of goods and services with other countries. Funds flowing in from the sale of exports and investment income count as a credit (+), while funds flowing out from the purchase of imports and transfers of funds to foreigners count as a debit (-). A trade deficit occurs when a nation imports more than it exports. The capital/financial account primarily compares the foreign purchases of domestic assets (+) with our purchase of foreign assets (-), though a small amount of the total recognizes debt forgiveness between the countries. What is important to note is that no matter how large or small the size of the accounts, the current account and the capital/financial account must balance over time. While a short-run balance of payments surplus or deficit may develop, assets will eventually be transferred to balance the payments.

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