LOS 14.h: Describe the balance of payments accounts including their components. When a country’s firms and individuals pay for their purchases of foreign goods, services, and financial assets, they must buy the currencies of the foreign countries in order to accomplish those transactions. Similarly, payment for sales of goods, services, and financial assets to foreigners requires them to purchase the currency of the domestic country. With adjustment for changes in foreign debt to the domestic country and domestic debt to foreign countries, these amounts must balance each other. According to the US. Federal Reserve, “The BOP [balance of payments] includes the current account, which mainly measures the flows of goods and services; the capital account, which consists of capital transfers and the acquisition and disposal of non-produced, non-financial assets; and the financial account, which records investment flows.’L Drawing on the NY. Fed's explanation, the items recorded in each account are as follows. Current Account The current account comprises three sub-accounts: = Merchandise and services. Merchandise consists of all raw materials and manufactured goods bought, sold, or given away. Services include tourism, transportation, and business and engineering services, as well as fees from patents and copyrights on new technology, software, books, and movies. = Income receipts include foreign income from dividends on stock holdings and interest on debt securities. = Unilateral transfers are one-way transfers of assets, such as money received from those working abroad and direct foreign aid. In the case of foreign aid and gifts, the capital account of the donor nation is debited. Capital Account The capital account comprises two sub-accounts: = Capital transfers include debt forgiveness and goods and financial assets that migrants bring when they come to a country or take with them when they leave. Capital transfers also include the transfer of title to fixed assets and of funds linked to the purchase or sale of fixed assets, gift and inheritance taxes, death duties, and uninsured damage to fixed assets. = Sales and purchases of non-financial assets that are not produced assets include rights to natural resources and intangible assets, such as patents, copyrights, trademarks, franchises, and leases.Financial Account The financial account comprises two sub-accounts: = Government-owned assets abroad include gold, foreign currencies, foreign securities, reserve position in the International Monetary Fund, credits and other long-term assets, direct foreign investment, and claims against foreign banks. = Foreign-owned assets in the country are divided into foreign official assets and other foreign assets in the domestic country. These assets include domestic government and corporate securities, direct investment in the domestic country, domestic country currency, and domestic liabilities to foreigners reported by domestic banks. A country that has imports valued more than its exports is said to have a current account (trade) deficit, while countries with more exports than imports are said to have a current account surplus. For a country with a trade deficit, it must be balanced by a net surplus in the capital and financial accounts. As a result, investment analysts often think of all financing flows as a single capital account that combines items in the capital and financial accounts. Thinking in this way, any deficit in the current account must be made up by a surplus in the combined capital account. That is, the excess of imports over exports must be offset by sales of assets and debt incurred to foreign entities. A current account surplus is similarly offset by purchases of foreign physical or financial assets. LOS 14.i: Explain how decisions by consumers, firms, and governments affect the balance of payments. ‘The primary influences referred to here are on the current account deficit or surplus. If a country’s net savings (both government savings and private savings) are less than the amount of investment in domestic capital, this investment must be financed by foreign borrowing. Foreign borrowing results in a capital account surplus, which means there is a trade deficit. We can write the relation between the trade deficit, saving, and domestic investment as: X - M = private savings + government savings - investment Lower levels of private saving, larger government deficits, and high rates of domestic investment all tend to result in or increase a current account deficit. The intuition here is that low private or government savings in relation to private investment in domestic capital requires foreign investment in domestic capital.We can make a distinction, however, between a trade deficit resulting from high government or private consumption and one resulting from high private investment in capital. In the first case, borrowing from foreign countries to finance high consumption (low savings) increases the domestic country's liabilities without any increase to its future productive power: In the second case, borrowing from foreign countries to finance a high level of private investment in domestic capital, the added liability is accompanied by an increase in future productive power because of the investment in capital. LOS 14,j: Describe functions and objectives of the international organizations that facilitate trade, including the World Bank, the International Monetary Fund, and the World Trade Organization. Perhaps the best way to understand the roles of the organizations designed to facilitate trade is to examine their own statements. According to the International Monetary Fund (IMF; more available at www.IMF.org): Article I of the Articles of Agreement sets out the IMF's main goals: = promoting international monetary cooperation; = facilitating the expansion and balanced growth of international trade; = promoting exchange stability: = assisting in the establishment of a multilateral system of payments; and = making resources available (with adequate safeguards) to members experiencing balance of payments difficulties. According to the World Bank (more available at www.WorldBankorg): The World Bank Is a vital source of financial and technical assistance to developing countries around the world. Our mission is to fight poverty with passion and professionalism for lasting results and to help people help themselves and their environment by providing resources, sharing knowledge, building capacity and forging partnerships in the public and private sectors. ‘We are not a bank in the common sense; we are made up of two unique development institutions owned by 187 member countries: the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA). Each institution plays a different but collaborative role in advancing the vision of inclusive and sustainable globalization. The IBRD aims to reduce poverty in middle-income and creditworthy poorer countries, while IDA focuses on the world's poorest countries. Together, we provide low-interest loans, interest-free credits and grants to developing countries for a wide array of purposes that include investments in education, health, public administration, infrastructure, financial and private sector development, agriculture and environmental and natural resource management.According to the World Trade Organization (W10; more available at www.WT0.0rg): ‘The World Trade Organization (WTO) is the only international organization dealing with the global rules of trade between nations. Its main function Is to ensure that trade flows as smoothly, predictably and freely as possible Trade friction is channeled into the WTO's dispute settlement process where the focus is on interpreting agreements and commitments, and how to ensure that countries’ trade policies conform with them. That ‘way, the risk of disputes spilling over into political or military conflict is reduced. «At the heart of the system—known as the multilateral trading system—are the WTO's agreements, negotiated and signed by a large majority of the world’s trading nations, and ratified in their parliaments. ‘These agreements are the legal ground-rules for international commerce. Essentially, they are contracts, guaranteeing member countries important trade rights. They also bind governments to keep their trade _Policies within agreed limits to everybody's benefit. 6. Which of the following is /east 'kely a component of the current account? A Unilateral transfers. B. Payments for fixed assets, C. Payments for goods and services. 7. Acurrent account deficit is mast Jikely to decrease as a result of an increase in: A domestic savings. B. private investment. C. the fiscal budget deficit. 8, Which international organization is primarily concerned with providing economic assistance to developing countries? A World Bank. B. World Trade Organization. C. International Monetary Fund.