Essay on Finance: Pricing and Exchange Rates

The Balance of Payment measures all the economic transactions involving the movement of goods, services and capital between the residents of a country and those of the rest of the world over a specified period, usually quarterly and annually. It is one of the accounting measures used to monitor the inflow and outflow of capital into and out of a country. Usually, the BOP should be zero if all the transactions are included, as cited by TOLAR. Any inequality leads to a state of either deficit or surplus. A deficit implies that a country is importing more than its exporting, while a surplus means that the countrys exports are more than its imports.

As an accounting measure, Balance of Payment can be useful in driving the economy of a nation. A deficit BOP fuels the economy of a country in the short term as it relies on borrowings from other nations to pay for its imports. However, if the situation persists and the economy does not grow fast enough to enable savings, the country becomes a net consumer instead of a producer of the worlds economic output and is forced to sell its estates to settle its debts in the long run. A surplus means that residents are savers and the economy provides enough to finance its local production. The country can become an international lender to the countries purchasing its products. This boosts the economy in the long run as the residents can invest more on the domestic market, enlarging them. It also allows production of goods and services by its people increasing their financial security. Building larger local market shields the country from the constant fluctuations of exchange rates, as it does not depend on exports to drive its growth, (Xingyun, 2015).

The balance of payments comprises of three components namely current, financial and capital accounts. The current account contains investment income earned through international trade; trade in goods and services and unilateral transfers. When a countrys economy can provide enough funds to finance its purchases and government investments, then the current account of such a state is in the balance. A deficit in the current account is likely to cause higher price levels, higher interest rates, lower import barriers and higher exchange rates. A deficit in current stock is in itself not an indication of a bad economy. It is simply a result of certain conditions in the country such as low productivity, inadequate saving or high inflation levels. If for instance, the United States has a deficit on its current account; it means that the country is importing capital which is not a bad economic condition. Current account and capital account add up to the total account. This implies that a deficit in the former is always accompanied by a surplus in the latter, and vice versa.

Capital accounts measures transactions that do not directly affect production, income or savings of a country. These deals include international transfers of ownership of copyrights, trademarks or drilling rights. These transactions do not generate revenue in the short run but may do so in the long term. When they eventually generate earnings, they are classified under the financial account. If they lead to the production of goods and services, they are categorized under current account. In the United States, these operations are measured by the Bureau of Economic Analysis. However, they do not appear in the bureaus regular reports because the operations are irregular and large. In comparison with the other two components of balance of payment, the capital account is smaller.

Financial account measures how international ownership of assets increases and decreases. These assets include securities such as stocks and bonds, commodities such as hard currency or gold and direct investments. They can be owned by individuals, companies, governments or its central bank. The financial account is divided into two components. The first one is domestic ownership of foreign assets. The increase in this sub-account leads to an addition in the financial account. Ownership in this sub-account could be private, (individuals or companies), government or central bank reserves. Assets owned includes money deposits in foreign banks, investments made directly in foreign countries, securities of foreign-owned companies, loans given to foreigners, or commodities held in foreign countries, such as gold. The second component of the financial account is foreign ownership of domestic assets. An increase in ownership of a countrys assets by foreigners increases financial account deficit. The assets owned are similar to those mentioned under the domestic ownership of foreign assets, with the difference being that they belong to foreigners. Ownership of these properties can either be private or official, which means ownership by foreign governments or foreign central banks. The financial account can be of importance in the growth of an economy if a balance is established between domestic ownership of foreign goods and foreign ownership of local goods.

In the United States, current account deficit has been fluctuating over the years, (Obstfeld and Rogoff, 2007). Over the past three decades, the deficit has realized an increase in the US economy leading to increased borrowings from other countries. One cause of this rise is increased integration of international financial markets, causing the value of foreign assets and liabilities to rise, (Xingyun, 2015). For instance, the value of assets held by U.S investors in foreign countries moved from 32% of GDP in 1982 to 106% in 2006. During the same period, the value of U.S liabilities to foreign investors rose from 22% to 123% of GDP, which was equivalent to $803 billion. Current statistics show that current account deficit stood at $469 billion in 2016 and was considered the largest in the world. The factors that have caused the recession of the years are increased consumer debt, the budget deficit and debt of U.S Federal, and increased savings in Japan and China. These factors pose a threat to the U.S economy if not addressed. However, the U.S economy is a major determinant of global prosperity. As such, lenders would ensure that the economy stays afloat. Despite concerns by some experts on the fate of the rising deficit, the situation is making other investments more attractive. Regarding balance of payments, increasing deficit in traded goods has opened up investments in Latin America and South East Asian countries. China has been pressured to raise its currency to create a competitive ground for the U.S. The situation has also created transparency in the global stock markets. The U.S Federal government had the lowest drop in rates in its central banks as compared to the other countries. All these factors are positive developments resulting from the current deficit in traded goods.

In conclusion, the balance of payment is an important measure of a countrys economy. The current account is the major contributor in determining the economic stability, in comparison with capital and financial accounts. A country should aim at achieving current account surplus and minimizing deficit in the long run.

References

Gruber, J. W., & Kamin, S. B. (2007). Explaining the global pattern of current account imbalances. Journal of international money and Finance, 26(4), 500-522.

Reinhart, C. M., & Rogoff, K. S. (2008). Is the 2007 US sub-prime financial crisis so different? An international historical comparison (No. w13761). National Bureau of Economic Research.Obstfeld, M., & Rogoff, K. (2007). The unsustainable US current account position revisited. In G7 current account imbalances: Sustainability and adjustment (pp. 339-376). University of Chicago Press.

TOLAR, P. Balance of payments.

Xingyun, P. E. N. G. (2015). Balance of Payments. World Scientific Book Chapters, 453-477.