The balance of payments as a whole

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A country incurs a "surplus" in its balance of payments if credit transactions exceed debit transactions or if it earns more abroad than it spends. On the other hand, a country incurs a "deficit" in its balance of payments if debit transactions are greater than credit transactions or if it spends more abroad than it earns.

Essentially, analysts focus on those transactions that occur because of self-interests. These so-called autonomous transactions include exports, imports, unilateral transfers, and investments. The arithmetic sum of these autonomous transactions, sometimes called "above-the-line items," represents the balance-of-payments surplus or deficit. A balance-of-payments surplus occurs when autonomous receipts exceed autonomous payments. By the same token, a balance-of-payments deficit takes place when autonomous payments exceed autonomous receipts. On the other hand, compensating transactions occur to account or compensate for differences between international payments and receipts. These compensating items, called "below-the-line items," are used to eliminate international disequilibrium.

Surpluses and deficits in the balance of payments are of considerable interest to banks, companies, portfolio managers, and governments. They are used to:

1 Predict pressures on foreign-exchange rates.

2 Anticipate government policy actions.

3 Assess a country's credit and political risks.

4 Evaluate a country's economic health.

The transactions of cases (a)—(e) in example 3.1 represent autonomous transactions. In case (a), the export of US machinery earns a foreign exchange of $30,000 and is thus a credit. Transactions of cases (b)—(e) cause the USA to expend a foreign exchange of $40,000 and are therefore debits. Consequently, the USA has an overall deficit of $10,000 in its balance of payments and must undertake $10,000 worth of compensating transactions to make up the difference. In this case, the compensating transactions of the USA involve sales of its gold, reductions in its balance of convertible foreign currencies, or increases in the balance of the US dollars held by other nations.

Now, for a moment, suppose that the USA has a surplus in its balance of payments rather than a deficit. To account for this surplus in the US balance of payments, US reserves, such as gold and convertible foreign currencies, would increase by $10,000, or the balance of the US dollars held by other nations would decrease by $10,000. These transactions, designed to account for the surplus in the balance of payments, are also called compensating transactions.

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