The current account

1. Prepared by Ming Chien Lo Econ 474/574: International Economics The current account

2. The current account records the following transactions between a country and the rest of the world • Merchandise trade balance • Service balance • Income balance (investment income and compensation to employees) • Unilateral transfers balance (government grants, pensions, aids, and private remittances) Prepared by Ming Chien Lo The current account The sum is the trade balance

3. Prepared by Ming Chien Lo The U.S. Current account (2008) Although there are other entries, the trade balance has a disproportionally large share of the current account. In 2008, the current account has a deficit of $706 billion, $696 out of this figure is due to the trade deficit.

4. The U.S. trade deficit has been getting a lot of attention. The U.S. capital and the financial accounts have not. • The capital and the financial accounts record both the private-sector and the official (central bank) transactions of assets. Prepared by Ming Chien Lo Capital and financial accounts

5. Examples of entries in the U.S. trade balance: Imports of French wine (debit) Exports of U.S. made apparels (credit) • What is often ignored in the media is the corresponding entry in the financial account. In a non-barter economy, trade of goods and services involves exchange of assets. Prepared by Ming Chien Lo Dual entries

6. The financial account is credited when foreigners choose to hold more U.S. assets, including physical assets. Thus, when a foreign company purchases a site for a factory, that is capital inflow. • Likewise, when a foreign firm or bank acquires more U.S. dollars, that is capital inflow too. • This is why the concept gives people a conflicting feelings: foreign direct investment (FDI) is usually viewed as a good thing, but foreigners earning more U.S. dollars through trade is not. But both are of the same nature: foreigners acquiring U.S. assets. Prepared by Ming Chien Lo The concept of net capital inflow

7. Credit the U.S. financial account whenever: Foreigners acquire more of U.S. assets Americans acquire less of foreign assets • Debit the U.S. financial account whenever: Foreigners acquire less of U.S. assets Americans acquire more of foreign assets Prepared by Ming Chien Lo Entries to the financial account

8. A U.S. wine importer have US$500,000. He pays a French winemakers in dollars and imports the wine. Debit U.S. current account (imports of wine) Credit U.S. financial account (French acquires U.S. dollars) Prepared by Ming Chien Lo Example #1

9. A U.S. wine importer have US$500,000. He exchanges for euros with a U.S. bank. He pays a French winemakers in euros and imports the wine. Debit U.S. current account (imports of wine) Credit U.S. financial account (Americans holds less euros) Note: the transaction between the U.S. importer and the U.S. bank has no impact on the account because these are transaction between Americans. Prepared by Ming Chien Lo Example #2

10. A U.S. wine importer have US$500,000. He exchanges for euros with an European bank. He pays a French winemakers in euros and imports the wine. (1st transaction): Credit U.S. financial account (Foreign bank acquires U.S. dollars) Debit U.S. financial account (American acquires euros) Note: overall, the two effects cancel out each other (2nd transaction): Debit U.S. current account (imports of wine) Credit U.S. financial account (Americans holds less euros) Prepared by Ming Chien Lo Example #3

11. The balance of payments is BOP = Current Account + Capital & Financial Account + Statistical Discrepancy = 0 (Statistical discrepancy is small in general.) Prepared by Ming Chien Lo The balance of payments

12. Current Account (negative $706 billion in 2008) + Capital & Financial Account + Statistical Discrepancy (assumed zero) = 0  Yes, we have a surplus in the capital and the financial account. Foreigners are acquiring more U.S. assets in relative terms. Prepared by Ming Chien Lo The meaning of the U.s. trade deficit

13. What do foreigners do with the U.S. money? --buy U.S. goods and services, which can reduce the U.S. trade deficits (do they?) --buy U.S. assets in the form of… --financial investment (stock, bond and other financial markets) --foreign direct investment (investing on the soil of the United States) Prepared by Ming Chien Lo Food for thought

14. Prepared by Ming Chien Lo Then, Japan U.S. exports to Japan minus U.S. imports from Japan in millions US$. Data from the Federal Reserve Bank of St. Louis.

15. Prepared by Ming Chien Lo Now, China U.S. exports to China minus U.S. imports from China in millions US$. Data from the Federal Reserve Bank of St. Louis.

16. U.S. automobile manufacturers could not compete with the Japanese more fuel-efficient cars in the 1970s (recall the oil crises.) • Chrysler received a U.S. government loan of 1.5 billion in 1980, that’s a “bailout”. • In order to avoid U.S. protectionist policies, the Japanese limited their exports of cars to 1.68 million. This is known as “voluntary” export restrictions. • President Reagan joined in, threatening a 100% tariff on imported Japanese cars. • Results: Japanese car manufacturers “jumped” over the potential tariff barriers and set up operations in the U.S. soil. Note though, they stayed away from Detroit where union power is strong. This action is known as tariff jumping foreign direct investment (FDI). Prepared by Ming Chien Lo Then, Japan

17. Tariff is a tax levied on a product when it crosses national borders. There are many types. Import tariff can be used as a protectionist instruments. It can be a source of income too. In 1900, tariff revenue shares 41% of the U.S. government receipts. In 2004, just 1%. • Import quota restrict the quantity of a product importers can bring into the country. Quotas on manufactured goods are banned by WTO. The U.S. still impose quotas on agricultural products. Quotas are less favorable because of the issues related to the distributions of quotas. Prepared by Ming Chien Lo A note on tariff and quotas

18. The U.S. Congress blocked the deal of China’s state-owned CNOOC purchase of U.S. Unocoal, an oil and gas company in 2005. • GM sold the Hummer brand to China’s Sichuan Tengzhong, a private company. Prepared by Ming Chien Lo Then Japan, now china