What Is Balance of Payments? Components and Deficit

3 Ways a Country Pays for Its Growth

Definition: The balance of payments is the record of all international financial transactions made by a country's residents. A country's balance of payments tells you whether it saves enough to pay for its imports. That reveals whether the country produces enough economic output to pay for its growth. The BOP is reported for a quarter or a year. 

A balance of payments deficit means the country imports more goods, services, and capital than it exports. It must borrow from other countries to pay for its imports. In the short-term, that fuels the country's economic growth. In the long-term, the country becomes a net consumer, not a producer, of the world's economic output. It may have to sell off its assets, such as natural resources and commodities, to pay for its consumption. 

A balance of payments surplus means the country exports more than it imports. Its government and residents are savers. They provide enough capital to pay for all domestic production. They might even lend outside the country. A surplus boosts economic growth in the short term. But in the long run, the country must encourage its residents to spend more and build a larger domestic market. That keeps it from being too dependent on export-driven growth. It will protect the country from exchange rate fluctuations. That also allow its companies to refine goods and services by using its own people as a huge test market. 

BOP Components

The balance of payments has three components. They are the current account, the financial account, and the capital account. The current account measures international trade and the net income on investments, as well as direct payments. The financial account describes the change in international ownership of assets. The capital account includes any financial transactions that don't affect economic output. Here are the balance of payments components and how they work together.

Current Account

Balance of Payments includes the current account
A current account includes the trade balance, income and payments. Photo: John Slater/Getty Images

The current account includes a country's trade balance. Also, it adds the effects of net income and direct payments. When the activities of a country's people provide enough income and savings to fund all their purchases, business activity, and government infrastructure spending, then the current account is in balance. More

Current Account: Deficit

If a country's residents would rather shop than save, it can cause a current account deficit. Photo: Chris Hondros / Getty Images

A current account deficit is when a country's residents spend more on imports than they save. In addition, the country's businesses are seen as a good investment to foreign lenders. It also helps if the lender country's businesses profit from exports. It's a win/win for both countries. However, if the current account deficit continues for a long time, it can be a drag on economic growth. Why? Because the foreign lenders may eventually wonder whether they will get an adequate return on their investment. If demand falls off, the value of the borrower country's currency can start to fall. This can lead to inflation as import prices rise. It can also lead to higher interest rates as the government must pay higher yields on its bonds. More

Current Account: U.S. Deficit

U.S. Current Account Deficit
Could foreigners ownership of U.S. assets become too big of a risk? (Photo: Don Kravitz / Getty Images).

The U.S. current account deficit reached its record of $803 billion in 2006. That created concern about the sustainability of such an imbalance. Even though the recession scaled it back, it appears it's on the rise again. The warnings made by the Congressional Budget Office, and the solutions it proposed, seem as relevant today as when they were made. The safety of investing the U.S. could once again become a concern to foreign investors. Americans have cut back on credit card spending, and the savings rate has inched up, but is it enough to fund domestic business growth? If not, it could lead to inflation and higher interest rates -- just when the U.S. economy appears to be leaving behind the worst recession since the Great Depression of 1929. More

Current Account: Trade Balance

businessmen-at-lunch.jpg
All countries would prefer a trade balance with each other. Photo: Thomas Barwick/Getty Images

The trade balance measures a country's imports and exports. This is the largest component of the current account, which is itself the largest component of the balance of payments. Most countries try to avoid a trade deficit, but it's actually the best thing for emerging market countries. More

Trade Balance: U.S. Imports and Exports

The United States should be the world's largest exporter, but it's not. Photo: Joern Pollex//Getty Images

The United States traded $5.02 trillion with foreign countries, consisting of $2.272 trillion in exports and $2.744 trillion in imports. It's the third largest exporter, but  imports more than any other country. With it's size and wealth, it should be exporting more. Find out why it isn't in U.S. Exports: Challenges and Opportunities

Why can't we make everything at home? Find out, in U.S. Imports. It imports more than half of its good from just five countries. Here's more in U.S. Imports by Year for Top 5 Countries More

Current Account: What's a Trade Deficit?

Trade Deficit
Trade deficits occur when a country's imports are greater than its exports. (Photo: Justin Sullivan / Getty Images).

A trade deficit results when a country's imports of goods and services is greater than its exports. Imports are any goods and services produced in a foreign country, even if produced overseas by a domestic company. Therefore, a trade deficit can occur even if all the imports are being sold by, and sending profit to, a domestic firm. With the rise of multinational corporations, and jobs outsourcing, trade deficits are on the rise. More

Current Account: U.S. Trade Deficit

U.S. Trade Deficit
Imported oil and automobiles are large components of the U.S. trade deficit. (Photo: David McNew / Getty Images).

A large part of the U.S. trade deficit is caused by America's reliance on foreign oil. When oil prices rise, so does the trade deficit. America also imports a lot of automobiles and consumer products. The U.S. exports a lot of the same things, but not enough to balance the deficit in goods.  More

Capital Account

Intellectual property rights are included in the capital account. (Photo: Koichi Kamoshida / Getty Images).

The capital account measures financial transactions that don't produce income or production. For example, it records international transfers of drilling rights, trademarks, and copyrights. Many capital account transactions happen infrequently, such as a cross-border insurance payment. The capital account is smaller than the other two components of the balance of payments. More

Financial Account

Financial Account
Stocks, bonds and CDs are some of the assets measured in the financial account. (Photo: Getty Images).

The financial account measures 1) changes in domestic ownership of foreign assets and 2) foreign ownership of domestic assets. If domestic ownership increases more than foreign ownership does, it creates a deficit in the financial account. This means the country is selling off its assets, like gold, commodities and corporate stocks, faster than it is acquiring foreign assets. More

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