Learn the toughest concepts covered in your Macroeconomics class with step-by-step video tutorials and practice problems.

Balance of Payments

Balance of Payments: Financial Account and Capital Account


Balance of Payments: Financial Account and Capital Account

Play a video:
Was this helpful?
Alright, so now let's go more into the balance of payments regarding the financial account. And we'll also discuss the capital account. So we're really gonna focus on the financial account here. Remember the capital account is kind of beyond the scope of this course, and it's kind of really small when when it comes to when it comes to the big picture here. So the balance of payments, remember, we're focused on the country's transactions with other countries. This is where we're trading with other countries and where we're buying foreign assets, foreigners are buying us assets, these types of things. Right? So these financial account transactions, they're focused more on long term transactions. Okay, we're thinking of long term flows of funds uh compared to when we were talking about the current account and it was short term things where we dealt with those net exports and things like that. So, the financial account, we've got another snippet here from our our balance of payments. And we're going to focus here on the financial account and then we'll discuss the capital account just a little bit and then we'll close up our discussion on on the balance of payments here. So let's think about the financial account. What is included? What are these, these items that go into the financial account? So it's long term investments and financial assets. So when we talk about financial assets being stocks and bonds. So the long term investments, maybe building a factory or buying equipment. It also includes buying house when you buy a house in in another country, uh It is included here as well. Financial assets include the purchase of stocks and bonds. Okay so stocks and bonds. When you buy say a bond in in a european company, they're selling bonds. Well you're making a transaction that falls into the financial account. Okay so we we break it up into two things and they're basically the opposite of each other. First we have the change in foreign holdings of U. S. Assets. So foreign holdings of U. S. Assets. That's foreigners holding us assets right? Say a a japanese citizen buying a U. S. Treasury bond, right? That's what we have here. A foreigner spends money to buy us assets and that's the ones we defined up here. So let's say um that BMW comes and builds a factory in the United States to make cars here in the United States to make it cheaper to to to sell them here in the U. S. Well that would be a foreign holdings of U. S. Assets, right? They're building something here in the U. S. Well they're there, they're buying us land, they're building a factory here in the U. S. But a foreigner owns it. Right? So buying us assets. So an example would be a european citizen buying shares of Microsoft, right? That's another example there Microsoft. Being a U. S. Corporation. And a european citizen a foreigner buying stock in that company. Toyota builds a manufacturing plant in the United States. That's similar to the example I just said and then we have the opposite, this is US holdings of foreign assets. So now this is a U. S. Citizen owning something overseas, right? Us citizens spending money to buy foreign assets same as above what we defined above the stocks and bonds, factories buying a house. Right? So use us citizen buys a vacation home in Barcelona. Well there you go. That that is a U. S. Citizen spending their money to buy something overseas. Right? And that's like I said buying a house right? Buying a house also fits into this category. It's not just those uh firm investments like factories and things like that. How about a T. And T. Building a customer service center in India. So this is the same idea right? A. T. And T. Being a U. S. Company, they go to India and they now own this service center in India. So it's it's us owned in a foreign country, right? So that's the main thing with the financial account. You can see that it's these longer term things like it's not just selling, you know um just some goods to another country, right? We're not just importing uh toys that that we buy from china. No this is a longer term investment, like a stock, a bond house factory, things like that. That's what goes in the financial account, the capital account. Remember I said it's not as big of a deal here. We're not gonna focus on this as much and it's trivial items that are beyond the scope of this class. We talk about migrant transfers when someone moves to another country and they take their stuff with them intangible assets, debt forgiveness. Don't worry too much about the capital account. You can even notice that up here, It rounds down to zero right there. It's just a few million dollars. It doesn't reach even $1 billion dollars there. Okay? Um And so one last thing about the balance of payments, remember that since the capital account is essentially zero, right? Since it's essentially zero, everything that happens in the current account must balance out with the financial account. So basically the current account is the opposite of the financial account. Okay. The balance of payments must always equal zero. This is one of the biggest takeaways of the balance of payments. Is that it must always equal zero. Okay. Especially in this class where we don't go into too much detail about the balance of payments. This is like one of the big things to remember is that it always equal zero. Because any inflow in the current account must be matched by an equal outflow in the financial account. Okay so an example of that is let's think of that car sale. Okay so let's say BMW sells car two U. S. citizen, right? And they pay four Let's say 20. I don't know how much a BMW cost let's say $30,000 right? $30,000 for this. BMW. Well now what happens The US citizen has, there's been this import, right? There's an import which is in the current account. But now what's happened is that BMW owns us assets, right? They own the U. S. Asset which in this case is the $30,000. The $30,000 itself is a U. S. Asset. They own dollars. Right? These dollars are U. S. Assets. And now um BMW has imported a car to the US so let's say this German company imports this car to the US but now this German company owns us assets. So these $30,000 are in the financial account right? As a foreign holding of U. S. Assets, right? A foreign, the german company now owns US assets dollars right? By selling this car in the US. Okay, so that's basically how this works. And then being You can exchange those $30,000. But it's always going to have this balance right where this current account is going to be balanced with this financial account. And that's the main takeaway here is that they're always going to equal zero. The balance of payments always equal zero. Okay, so that's about it. When it comes to the financial account, this balance of payments, let's go ahead and move on to the next video