The chapter under discussion deals with such economic phenomenon as the balance of payments. The elements and subaccounts of the balance of payments are studied, described and analyzed. Attention is also paid to the difference between goods trade and services trade. Differences between government policies of different countries are also singled out.
To begin with, every country during the course of a year carries out some international economic transactions. The term “balance of payments (BOP)” is used to identify the accounting record of all international economic transactions between one country and the rest of the world. These transactions may be of different forms, and some of them may be very difficult to identify.
It is also stated that the most important fact connected with the BOP is that it should always be balanced. The imbalanced BOP occurs only in cases when something has not been counted. To count all the transactions properly, one should keep in mind three important elements of the process of accounting international economic activity. Those three elements are: 1) proper identifying of what belongs to international economic transactions; 2) understanding that the BOP is the cash flow statement rather than a balance sheet; 3) understanding the procedure of double-entry bookkeeping.
In the chapter, there are also identified two major types of business transactions, that are real assets (when some goods and services are exchanged for other goods and services) and financial assets (the value is derived from financial claims, e.g. exchanges of deposits, bonds and stocks).
The method of double-entry bookkeeping is based on the fact that every transaction includes a debit and a credit that are of the same amount. In other words, any financial transaction should have equal and opposite effects in two different accounts. Ideally, the result of transactions should be a perfect balance, but, in fact, it is very rarely so.
The two major subaccounts of the balance of payments are also identified: the Current Account and the Financial/Capital Account. The Current Account is the sum of all international economic transactions that bring income within the current period (a year). It consists of four elements: goods trade, services trade, income and current transfers. The attention is paid to the goods trade and services trade in the U. S. within recent years. Major gains and losses of goods and services trade are singled out. Although a decline is observed in some traditional manufacturing industries, the amount of export grows in recent years. In addition, services trade in the U. S. has achieved a surplus in income.
The chapter proceeds with dealing with the Capital and Financial Account of the BOP, which are used to identify all international economic transactions of financial assets. Two major components are singled out: the Capital Account (change in ownership of non produced and nonfinancial assets); the Financial Account (involves financial assets). The classification of the Financial Account is presented on the basis of the degree of control over the assets. Therefore, direct investment, portfolio investment and other investment assets/liabilities are singled out. It is stated that direct investment may have positive, as well as negative, influence on the economy of the country. The negative impact is connected with the facts of controlling and receiving the profits by a foreign country. Hence, restrictions for direct investment should be applied.
On the other hand, portfolio investment is much more welcomed, as its main objective is to be profit-motivated, rather than controlling. The forces that motivate portfolio investment flows are return and risk.
It was also observed that relationship between the Current and Financial Accounts is always inverse; it is due to methodology of double-entry bookkeeping. Additionally, there is nothing shocking in the fact that there may appear net errors and omissions: they are checked and counted in the net errors and omissions account.
What is more, the phenomenon of the official reserves account is presented and analyzed. It is stated that the vehicle that identifies the significance of official reserves is the exchange rate system of the country that may be fixed or floating.
It is obvious that by controlling the balance of payments the economic conditions of a certain country and its economic crisis can be predicted. In the chapter, it is stated that the mechanism of economic crisis is always the same. Firstly, there is a rapid change in the relationship between the current and financial account. When the current account of the country experiences deficits, the financial account builds surpluses. The second step is when the capital that is invested by foreigners “finances” merchandise and services deficits. Then the government states the fact of economic instability and it leads to the “capital flight”, when foreign investors withdraw their capital.
Using the example of the Asian Crisis, the author of the chapter tries to show how all that mechanism works. Firstly, the economic crisis in Thailand in 1996-1997 is described. The currency collapse in the country that was caused partly by government and central bank interventions gave a push to economic crisis inside the country. It also led to similar currency collapses in the neighboring countries. Apart from currency collapse, the causes of the Asian Crises were corporate socialism, corporate governance and banking liquidity, and management. The negative impact of the economic crisis in East Asia was enormous: the countries suffered from social disruption and total unemployment.
All in all, the main task of the economic system of every country is to monitor subaccounts of the balance of payments in order to foresee the results of the international economic activity of the country.