Assignment 1

Components of Balance of Payment

The balance of payments (BOP) is a comprehensive record detailing all economic

transactions occurring between a country and the rest of the world during a specified
period, typically annually or quarterly. It comprises three primary components:

1. Current Account: This segment encompasses the balance of trade (the variance between
exports and imports of goods), services (such as tourism, financial, and professional
services), income (including wages, interest, and dividends), and current transfers (like
foreign aid and remittances). A surplus in the current account indicates that a country
exports more goods and services than it imports, while a deficit suggests the opposite.

2. Capital Account: This category logs the transfer of capital between nations, covering
investments in fixed assets (e.g., factories, real estate) and financial investments (such as
stocks and bonds). It also includes debt forgiveness and the transfer of ownership rights. For
many countries, especially those with developed financial markets, the capital account is less
prominent.

3. Financial Account: This segment tracks changes in the ownership of foreign assets and
domestic assets held by foreigners. It encompasses foreign direct investment (FDI), portfolio
investment (such as purchases of stocks and bonds), other investments (like loans and
currency reserves), and alterations in reserve assets maintained by the central bank. A
surplus in the financial account implies that more capital is flowing into the country than
out, whereas a deficit suggests the reverse.

These three accounts must offset each other, accounting for statistical discrepancies. Any
transaction impacting one account will invariably affect another. For instance, if a country
experiences a current account deficit, it must be balanced by a surplus in either the capital
or financial account.

Balance of Trade vs Balance of Payment

Certainly! Here's the distinction:

1. Balance of Trade (BOT):

- The balance of trade focuses specifically on the difference between the value of a
country's exports and imports of goods over a certain period, typically annually or monthly.
- It only considers the trade in tangible goods, such as manufactured products, raw
materials, and agricultural goods.
- A surplus in the balance of trade occurs when a country exports more goods than it
imports, leading to a trade surplus. Conversely, a deficit arises when imports exceed exports,
resulting in a trade deficit.
- The balance of trade is a subset of the broader balance of payments.
2. Balance of Payments (BOP):
- The balance of payments encompasses a comprehensive record of all economic
transactions between a country and the rest of the world over a specific period, usually
annually or quarterly.
- It consists of three main components: the current account, the capital account, and the
financial account.
- In addition to the balance of trade, the balance of payments includes trade in services,
income from investments, unilateral transfers, financial flows, and capital movements.
- While the balance of trade focuses solely on goods, the balance of payments provides a
more holistic view by incorporating all financial transactions, both tangible and intangible,
between residents of a country and the rest of the world.
- The balance of payments must always sum to zero when taking into account statistical
discrepancies, as every transaction that affects one account necessarily affects another.

Evolution of Gold Standard System including reasons for its failure

The Gold Standard system underwent a series of transformations throughout history and
encountered various challenges before its eventual downfall. Here's a rundown of its
evolution and the factors contributing to its failure:

1. Origins: The Gold Standard emerged in the 17th century as a mechanism to facilitate
global trade and stabilize currencies. It tied the value of a nation's currency directly to a
specific quantity of gold, ensuring a fixed exchange rate.

2. Classical Gold Standard (19th Century): The classical gold standard reached its zenith
during the 19th century, promoting stable exchange rates and facilitating international
commerce. Countries adhering to this system maintained a fixed price for gold and allowed
unrestricted convertibility of their currencies into gold.

3. Interwar Period and Gold Exchange Standard: The Gold Standard faced significant
challenges during the interwar period due to World War I and the Great Depression. Many
nations temporarily abandoned it to finance wartime expenditures and stimulate economic
recovery. Post-World War II, the Bretton Woods Agreement introduced a modified version
known as the Gold Exchange Standard, where the U.S. dollar was pegged to gold, indirectly
linking other currencies to gold through the dollar.

4. Collapse of Bretton Woods (1971): The Bretton Woods system collapsed in 1971 when the
United States, under pressure from Vietnam War spending and domestic programs,
terminated the direct convertibility of the dollar into gold. This decision, termed the Nixon
Shock, effectively ended the Gold Exchange Standard and ushered in the era of fiat
currencies.

Reasons contributing to the demise of the Gold Standard include:

1. Rigidity: The Gold Standard constrained countries' ability to implement autonomous
monetary policies to address domestic economic conditions, limiting flexibility during
economic downturns or periods of inflation.

2. Speculative Attacks: Nations adhering to the Gold Standard were vulnerable to speculative
attacks on their gold reserves, which could destabilize their currencies.

3. Gold Supply Constraints: The finite nature of gold reserves did not align with the needs of
modern economies for flexible money supply expansion to support economic growth.

4. Global Economic Turmoil: Events such as wars, economic crises, and fluctuations in gold
production could disrupt the functioning of the Gold Standard, eroding confidence in the
system.

In summary, while the Gold Standard fostered stability in international trade and finance
during its prime, its inherent limitations and susceptibility to external shocks eventually led
to its downfall.