Follow-up activitiesUsing the key-words from the article prove that contrary to conventional wisdom, the rise in the price of oil could yet give the world economy a nasty shock. UNIT TWO BALANCE OF PAYMENTS Special Terms Pre-text assignment Special Terms A. Match these terms with their definitions Trade balance, capital account, liquidity basis, deficit, devaluation, debtor nation, balance of payment, country risk, basic balance, surplus, capital account, official reserve transaction basis, invisible transactions, creditor nation a) a detailed record of all financial and economic transactions between the b) the loss of foreign exchange reserves that occurs when residents of a country c) the gain in foreign exchange reserves that occurs when nonresidents spend d) the net balance between a country's exports and imports. e) a country with an overall deficit balance of payments. f) country with an overall balance-of-payments surplus. g) transactions which pertain to services rather than goods. Examples are ship h) the inherent risk in doing business with a country. When risk in a certain country decreases, trade with that country will increase. i) an increase in the value of gold, making a country's currency based on its gold reserves worth less in relation to the currencies of other countries. j) the total of the trade balance and invisible transactions. k) the total of long-term and short-term loans received from and extended to foreign countries. I) the total of current and capital accounts. m) an accounting procedure whereby only a change in official reserves (gold, foreign exchange, etc.) is considered to settle the balance remaining after current account long-term and short-term capital movements have been accounted for. n) an accounting procedure whereby a change in short-term private loans and borrowings, in addition to official reserves, settles the balance remaining after long-term movements and the current account have been accounted for. B. Vocabulary Practice 1. Define balance of payments. 2. How does a deficit on the balance of payments arise? 3. How does a surplus arise? 4. What is a trade balance? 5. Countries are either debtor or creditor nations. Define both. 6. Why are certain transactions called invisible? Give some examples. 7. What is the significance of country risk? 8. What part of the balance of payments is made up by the current account? 9. What is the accounting procedure called liquidity basis? Balance of Payments Trading nations have developed an accounting concept called balance of payments, which records a country's trade and capital flow in relation to other countries. All financial and economic transactions between a country's residents and the rest of the world are measured in money terms. A French father, sending money to his son in New York for educational purposes, will have an effect on the French, as well as on the United States balance of payments. The Brazilian importer who buys Italian shoes also affects the Brazilian as well as the Italian balance of payments. If residents of one countiy spend more abroad than nonresidents spend in that country, it is said to have a deficit on its balance of payments. When a country's exports exceed its imports, that part of the balance of payments will show a surplus. Even if there is a surplus, a substantial outflow of capital could swing the balance into a deficit. One should note thai one country's deficit is another country's surplus. Japan traditionally has a big surplus on its import-export balance with the United States. The United States therefore, has a deficit on its trade with Japan. The part of the balance of payments which records imports and exports is called the trade balance, Japan's trade balance is said to be favorable, as it shows a surplus. A surplus of exports over imports will naturally boost employment. Deficits, which are said to be unfavorable, have to be financed. Large deficits can have a disturbing effect on a country's national economy, and governments usually strive to avoid them. Deficits are financed by borrowing from international organizations or by shipping gold or foreign money to the surplus country abroad. Once the deficit has been financed and the surplus lent, the balance of payments is said to be in balance. Keep in mind that the total balance of payments consists of trade and capital (money) flow. Countries with a deficit after all these transactions have been recorded are called debtor nations. Countries with a surplus are called creditor nations. Any country will go through these stages at various times in its history. Today the developing countries are, on the whole, debtor nations. Initially their trade balance will show deficits, although these are mitigated if the country possesses mineral reserves. However, the country will need long-term capital to industrialize or simply finance its own development. An inflow of capital is a surplus, but it will eventually have to be repaid, causing a deficit on the capital account. The idea is that once the country has achieved a measure of development, it will be able to repay long-term loans by exporting the products it will produce. The country could eventually become a creditor nation, lending its surplus funds to a debtor nation. Not all transactions on a balance of payments are visible. Invisible items are tourist expenditures abroad, gifts sent to relatives abroad, shipping insurance, and banking services provided for foreigners abroad. How does any government keep track of all its citizens' transactions? International trade is conducted on the basis of documents, such as invoices, bills oflading, and other records. Further, international capital transactions are carried out through banking systems, which keep records of international money movements. The system, of course, is not watertight, so the balance of payments carries an item called errors and omissions This takes into account statistical errors. Some transactions, such as deposits in Swiss banks, are never recorded. Since we know that there was an outflow of capital but do not know where it went, we have no choice but to record it in errors and omissions. The condition of a country's balance of payments influences the value of its money (currency) in relation to currencies of other countries. A country with consistent deficits will see its currency weaken. That is, its value will decrease in terms of other currencies. This is so because the deficit country will have to finance the deficit with foreign currency, which will now be higher priced. The value of the foreign currency will increase as demand for it increases. The value of the home currency, thus, will decrease in relation to the foreign currency. A country with consistent deficits and dwindling gold and foreign exchange reserves constitutes a greater risk than a country with consistent surpluses. A nation with a high country risk may find it difficult to get its deficits financed. A government can take various steps to attempt to achieve a balance or a surplus on the balance of payments. It can take stringent austerity measures, such as raising taxes, to limit people's ability to spend money on goods and services. This may lead to a decrease in imports. It could lower wages so that goods could be sold more cheaply abroad, thereby boosting exports. It could set up a system of import quotas for certain goods, meaning that only a limited quantity of specified products can be imported during a period of time. Tariffs, which are taxes on imports, can also be established to discourage prospective importers. A government can even prevent its citizens from spending too much abroad. If a government prefers not to limit foreign trade through such protective steps, as a last resort, a country may choose to devalue its currency in order to achieve a balance. A devaluation causes the price of one currency to drop in relation to other currencies. The result is that foreign currency can purchase more in the devaluing country since it costs less to acquire the devalued currency. From the point of view of the country that devalued, however, there is an advantage. Its exports will increase as they cost less in world markets, and thus a balance-of-payments deficit can be wiped out. International agreements stipulate that a country planning to devalue or revalue its currency should consult the International Monetary Fund (IMF), if such adjustment in value is more than 10 per cent. Although there are variations in each country's accounting records, they are all relatively similar. How does one know whether an entry should be a debit or a credit? Very simply, the way in which the foreign exchange position is affected determines whether a particular transaction is a credit or a debit. In cases where foreign currency is earned, the item is registered as a credit; where currency has to be paid out abroad, it is registered as a debit. When goods are exported, foreign exchange is earned and a credit is registered; when goods are imported, foreign exchange is lost and a debit is registered. If a country receives dividends or interest on loans from abroad, foreign exchange is earned and therefore a credit entry is represented. On the other hand, if a country extends a loan to another country, there is an outflow of funds and thus a debit item is registered on the balance of payments. The next items are the invisible transactions. Invisible means that there are no documents (as there are with imports and exports) which are evidence of trade transactions. Investment income, an invisible transaction, covers dividends and interest on loans. The United States, a major investor as well as a major lender overseas, can expect investment income to remain an important item. Other invisible items are transportation, travel, and military expenditures. An American soldier buying a beer in West Germany obviously has an effect on the balance of payments, but this occurs in an invisible way. The trade balance and the invisible transactions together make up the current account.
The next category shows capital accounts. This includes long-term and short-term loans received from and extended to foreign countries. It also comprises the private sector. United States industry, making direct investments abroad, such as setting up factories. Capital accounts also registers foreign direct investment and portfolio investment at home. Portfolio investment takes place when a United States corporation or private citizen buys shares or obligations from a foreign company. How should the United States register an investment made by the Sony Corporation of Japan in California? It obviously should be registered аь a credit because foreign currency has entered the United States. But when the Sony Corporation borrows locally in the United States market to set up an investment, the balance of payments is no longer affected. Sony has then become a United States company, a resident. As we have seen, the balance of payments only registers transactions between residents and nonresidents. Therefore, capital transactions between Sony in Japan and Sony in the United States will continue to have an effect on the balance of payments. Government loans and borrowings are also included in capita! accounts. Government military aid appears in the current account. But it is, so to speak, a self-canceling item; a gift of equipment from the United States to a foreign army could be counted as an export of military goods (a credit), but military aid to allies (a debit) would wipe out this credit. The current and capital accounts together are the basic balance. The IMF reports balance of payments on an official reserve transaction basis. This means that only a change in official reserves can settle the balance remaining after current account and long-term and short-term capital movements have been accounted for. This is the system that has just been discussed above. The United States government, along with many other nations, reports on a liquidity basis. In this system the balance is settled not only by a change in reserves but also by a change in private short-term loans and borrowings. C. Expanding vocabulary A. Say it in English Країни, що торгують, розробили концепцію; інша частина світу; коли експорт країни перевищує імпорт; уряд прагне уникнути: уряд може простежити за угодами громадян; вартість валюти відносно валюти іншої країни; вартість валюти зростає, оскільки збільшується попит на неї; уряд робить різні кроки, намагаючись досягти; уряд може знизити зарплату, щоб дешевше продати товар за кордоном, стимулюючи в такий спосіб експорт; повернути кредит; уряд докладає зусиль, щоб уникнути; пам'ятайте, що; уряд може встановити систему квот; перевага експорту над імпортом; відтік капіталу; помилки і недогляд; у грошовому вираженні; військова допомога. B. Find in the text and give the translation Financial transactions are measured; it could swing the balance into deficit; the favorable balance; a disturbing effect on a country's national economy; the inflow of capital: the system is not watertight; a country with consistent deficits; countries with dwindling gold; stringent austerity measures; to raise taxes, to limit people's ability to spend money on goods; to discourage prospective importers; protective steps: and thus a balance-of-payment can be wiped out; devalue and revalue the currency; international agreements stipulate; to earn foreign currency; a credit entry is represented; invisible transactions; to extend the loan; a self-canceling item; to settle the balance.
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