can someone explain to me why the balance of payments balances? im really confused lol. if we import more than export- how does that mean we have to borrow?!!? i understand that when we borrow it comes in as a credit (+) in the capital account but why does the economy need to do that when it doesn't need to?
are you sure it does balance? isn't the demand for goods in each country the determining factor of value of the currency. along with the quantity of the currency setting the supply. the more demand the higher the price and this affects exports and imports. the converse is also true. if the account balanced all currencies would be valued the same (the number of imports would equal the number of exports). the more exports or imports shows the demand or lack of it and is shown in the price of the currency. i think you are getting two things confused. the accounting term 'balancing' associated with double entry book keeping, essentially what comes in goes out and there is a balance on one side and the other (not necessarily equal but reflects operations), and the general term of balancing one side must equal another. you might have more imports than exports, that is not equal. but if you have more imports than exports you would have to borrow to get them. the current account of balance of payments reflects that in accounting terms and shows how the borrowing operation enabled the country to import more.
so the credits ,eg dividends etc are the money that flows in...and if the money that flows out is more than what flows in there's a deficit; but since we spent more than what came in it must be accounted for, the income from the credits is what is spent on imports? so if the import spending is more than the credits then there has been too much money spent;therefore that excess was borrowed or whatnot-that comes in as an equal and opposite credit to the debit ?
your getting there. i think the element you are missing is the borrowing is not like you borrowing or the government borrowing. the situation is like borrowing from a central or reserve bank that has the money or currency you require. just because you buy more in does not mean that the government or people are borrowing more they could be using cash or other money not credit. the borrowing is required as a short term thing. http://en.wikipedia.org/wiki/Balance_of_payments the above link explains. it confuses me though. it says that the current account of balance of payments should equal 0. but then states is does not always equal 0 and that countries have either surpluses or deficits. i think this is mainly the case, what country does not have debt. i think the link is misleading. i put it here to explain reasons for disparity. the main thing you have to take into consideration is it represents the buying and selling of the currency to buy and sell goods of that country. therefore there will naturally be a greater desire to hold some countries currency and buy their goods depending on what they produce and the opposite for other countries that do not produce as desirable goods. this will impact on the currencies value and the surplus or deficit. this suggests the attempt to get the balance to 0 is an attempt at currency stabilisation, which is not the reality in the real world. if you have a 0 alteration in the demand for currency you have a static position in currency relationships with the rest of the world assuming they also have a 0 alteration in demand. this means you have currency stability, which is not always what governments want. sometimes governments want a deficit or surplus because it increases or decreases the demand for goods and services in the country. i think the explanation in the link is one school of thought and does not explain it properly. try to think of it in another way. the money supply in your country relates to what you can buy, namely the output, goods and services. that means the ratio of money to output is the determinant of price. if there is more money to goods the price rises and if there is less money to goods the price falls. sometimes governments want prices to rise or fall to increase or decrease economic factors the money supply is the demand and output is the supply. this happens through mechanisms like the interest rate, fiscal policy etc. now consider the currency in your country as the ability to purchase goods in your country, it then becomes your international supply. the desire of other countries to hold your currency is the demand. so depending on the supply (your domestic demand) of money and the desire to hold it (the demand from other countries) it can increase or decrease the current account of balance of payments. by altering the money supply some countries can entice investment or the purchasing of their goods, increasing output and employment. therefore it questions whether a 0 alteration in the current account of balance of payments is always desirable as it can be a tools to encourage investment. has that helped? do you have an assignment on this?
here we go. this link backs up what i said. http://www.investopedia.com/articles/03/061803.asp quote "What Does It Tell Us? Theoretically, the balance should be zero, but in the real world this is improbable, so if the current account has a deficit or a surplus, this tells us something about the state of the economy in question, both on its own and in comparison to other world markets." this is what i said above. also you have to take into consideration the balance of payments is different to the current account of balance of payments. the current account of balance of payments is one aspect of the balance of payments there is also the capital account and the financial account. is this helpful. i need feedback to see if you understand. or if i have failed to explain it properly.
The main problem i have is understanding why we need to 'borrow' to finance spending; i don't get that; imagine im a made up economy; if i have 100000 in money and spend 500000 on imports, but we export nothing; there is a deficit; so why do we need to 'borrow' whenever we have enough money anyway. in the long run though we'll need to borrow but why in the short term? i don't really understand what you were saying about borrowing not being as in loans but as in borrowing from a central bank thanks btw edit: i have exams coming up;they focus more on current account deficits and FE rates;i understand but ut's just these little niggles i have trouble with
basically what i've been taught is that a surplus in the current account will be equaled by a deficit on the capital and financial accounts and vice versa. and that a deficit is financed by: selling currency reserves, selling gold,borrowing from abroad
i think you need to consider the way banks operate and the limitations of liquidity. the money you can get your hands on easily. this is whole point of central banks. when you go to a bank they will lend your money out. they have to hold some money to give to people that want money back too. this is the reserve. depending on the reserve amount it may not be sufficient to give people the money they want, depending on the demand of withdrawl and the reserve amount. if this is the case the bank has to get the money so it borrows it from another bank. sometimes it cannot get the money from other banks so it goes to the central or reserve bank to fund its short term borrowing. the bank then pays the money back at a later date. but the borrowed money has to be accounted for with the agreement to pay the money back at a late date using the future reserves. this is the equivalent to the capital or financial account. the point of the above is to explain to you that although there is the money it is the ease at which that money is withdrawn and the limitations of that which needs borrowing. the bank has the money in assets but it is tied up with its borrowers. so it has to borrow from another bank to get the cash required. the situation with the current account of balance of payments is similar. it relates the ability to get the currency that buys or sells the foreign goods. if the country or banks do not have enough liquid cash or cash assets it has to borrow to do what it wants. this is then offset by the capital or financial accounts reflecting the assets which are used to enable the lending of the cash assets. like a security but a bit different. the capital or financial accounts reflect the future repayment of that borrowing of cash assets and the agreement of the bank loan. is that clearer now. i don't know if i have explained it properly. basically accounting is used to show what is happening in an organisation and the operations it has. the balance of payments is a like a a double entry book sheet for a country. if you were to expend a dollar you would have to show the asset purchased with that dollar. the dollar did not stop existing it turned into the asset you purchased. the situation with debt is the same. you borrow currency so you have to reflect who that borrowing is a future liability in your capital assets or financial assets. does that make sense now.