Running head: BALANCE OF PAYMENTS

Balance of Payments An Assignment Submitted by Name of Student Name of Establishment Class XXXX, Section XXXX, Fall 2011

BALANCE OF PAYMENTS Balance of Payments The world economic is highly interdependent. Each country conducts a large number

of trade and financial transactions with other countries. These transactions are recorded in the balance of payments accounts. The balance of payments consists of two subaccounts: current account consisting largely of the trade balance, which records imports and exports of goods and services; and the capital and financial account, which records U.S. net sales or purchases of assets with other countries. This paper is aimed at comparing different items of the balance payments of the US and the UK over the last decade. Based on the analysis, some recommendations will be done to address some deficiencies in the balance of payments of these countries. 1. Major trading partners When it comes to international trade, the United States is the largest and the United Kingdom is the worlds fifth-largest trading nation. Curiously enough, one can hardly find the country which does not import some goods or services from the US; however, it is also the US that remains one of the largest importers of the world. The US exports machinery and equipment, industrial supplies, non-auto consumer goods, motor vehicles and parts, aircraft and parts, food, feed and beverages. Main imports are non-auto consumer goods, fuels, production machinery and equipment, non-fuel industrial supplies, motor vehicles and parts, food, feed and beverages. Canada, European Union, Mexico, China and Japan are the main trading partners. The UK imports almost all its copper, ferrous metals, lead, zinc, rubber, and raw cotton and about one-third of its food. The major export items are telecommunications equipment, automobiles, automatic data processing equipment, medicinal and pharmaceutical products and aircraft. It deals mostly with European Union countries, The United States, China and Japan.

BALANCE OF PAYMENTS 2. Analysis of the Balance of Payments of the US and UK

The global financial crisis caused trade deficit of the UK and the US to decrease from August 2008 through May 2009 (U.S. Census Bureau, 2010). Imports dropped faster than exports. However, since then it has begun to increase again as recovery has slowly progressed, and the pace of the widening UK trade deficit was twice as much as the US ones. By the end of 2010, the UK trade deficit has fallen even deeper than its peak in the middle of 2008, $4 billion (Bank of England, 2010). Broadly speaking, trade deficit is underpinned by excess spending in the domestic economy and an overreliance on capital imports to finance the shortage of savings. Trade deficit causes a great concern for Congress as well because it may impose an additional pressure for the government to take actions to protect national manufacturers from overseas competitors. A widening trade deficit, not matched by capital inflows, leads to the shortage of dollars used to pay for imports. Therefore, it puts downward pressure on the value of the dollar, which, in turn, makes the deficit shrink by making US exports cheaper and imports more expensive. The balance on current accounts

BALANCE OF PAYMENTS The balance on current account includes merchandise trade plus trade in services and unilateral transfers. In 2011, the deficit on current account in the US remained almost the same, $473.4 billion being $470.9 billion (The World Bank, 2012). The situation has

worsened since 2009, when the deficit on current account grew to $376.6 billion, after a sharp decline from 2002 with the bottom at $800.6 in 2006 (The World Bank, 2012). In the UK, the trend of the current account balance has the similar pattern but not with such a sharp fluctuations. Thus, the UK deficit on current account decreased from $75.2 in 2010 to $46.4 in 2011 (The World Bank, 2012). During the last decade the highest level of the deficit on current account $82.0 was registered also in 2006 (The World Bank, 2012).

The capital account balance

In the UK, during the last decade the deficit on current account has been offset by the capital account surplus. This surplus meant that foreign investors purchased more UK assets than UK investors purchased in foreign assets, investing more in the United Kingdom than the United Kingdom invested abroad. Thus, over the last decade the surplus of the UK capital account has been gradually increasing from $1.224 billion in 2002 to $6.186 billion in 2011

BALANCE OF PAYMENTS with a slight decline in 2005 and 2006 and subsequent sharp growth in 2007 from $1.819 billion to $5.159 billion (The World Bank, 2012). When it comes to the US, its deficit of current account in 2003 and 2006 was not matched by the surplus of the capital account, when they equaled $1.820 billion and $1.788 billion respectively (The World Bank, 2012). The financial account balance The financial account is the current account minus capital account. Thus, in 2011 the deficit of the US financial account equaled $474.6 billion after a gradual increase since 2006 when it reached its lowest level of $802.4 billion. In the UK, it amounted $40.2 billion in 2011 with the bottom of $80.2 billion in 2006 (The World Bank, 2012). The official reserves accounts

In 2011, the deficit of the official reserve accounts increased from $16.0 billion in 2010 to $1.8 billion in 2011 after a sharper increase to $52.2 billion in 2009 that was due to an allocation of special drawing rights to the United States by the International Monetary Fund (The World Bank, 2012). Over the last decade, the US has faced an official reserves surplus only during a period from 2003 to 2006 with the peak in 2005 equaling $14.1 billion (The World Bank, 2012). In the UK, the official reserves accounts were maintained at the

BALANCE OF PAYMENTS comparatively stable level over the last decade but three last years, when they has been declining and finally equaling to $10.9 billion in 2011 (The World Bank, 2012).

2. The relationship between the balance of payment and the countrys exchange rate With consideration to the fact that the dollar is used as an international reserve currency, the United States can run trade deficits without the same downward pressure on the value of the dollar as other nations. Because the United States, as well as the United Kingdom, has a floating exchange rate, changes in its official reserve assets were small. 4. Recommendations It is important to place a great deal of emphasize that the global financial system is interdependent, thus, no single country can reduce its external imbalance through policy action on its own. However, as an FDI experts I would recommend some actions to be taken by the US and UK in particular. Our financial analysis revealed that both UK and US are countries that are net capital importers, since they run capital account surpluses and current account deficits. For capital importers, it is essential to increase domestic investment rate that will hae an impact on countrys capital and current accounts balances. For example, an incline in domestic investment relative to saving will, all else equal, result in the capital account surplus increase and the current account balance decrease. In this case, net capital inflows will increase. Conversely, an increase in domestic saving relative to investment will cause the capital account balance to decrease and the current account balance to increase. In that case, net foreign capital outflows will increase. Particularly, the higher US saving is, the less US demand for other countries savings are. In order to increase saving, the US should reduce its fiscal deficit and raise its personal saving rate. Reforms in health care, social security, and other entitlement programs are essential, given their impact on future public spending.

BALANCE OF PAYMENTS References Bank of England. (Feb., 2010) Inflation Report. Retrieved September 28, 2012 from http://www.bankofengland.co.uk/publications/inflationreport/ir09feb.pdf Bureau of Economic Analysis (April 2011) U.S. International Transactions. Retrieved September 28, 2012 from https://www.bea.gov/scb/pdf/2011/04%20April/0411_itaqtext.pdf Nanto, D.K. and Donnelly, J.M. (September 6, 2011) U.S. International Trade: Trends and Forecasts. Congressional Research Service. Retrieved September 28, 2012 from http://www.fas.org/sgp/crs/misc/RL33577.pdf The World Bank. Changes in net reserves. Retrieved September 28, 2012 from http://data.worldbank.org/indicator/BN.RES.INCL.CD/countries/GBUS?display=graph The World Bank. Current account balance. Retrieved September 28, 2012 from http://data.worldbank.org/indicator/BN.CAB.XOKA.CD/countries/GBUS?display=graph The World Bank. Net capital account balance. Retrieved September 28, 2012 from http://data.worldbank.org/indicator/BN.TRF.KOGT.CD/countries/GBUS?display=graph U.S. Census Bureau, 2010. Economic Indicators. Retrieved September 28, 2012 from http://www.census.gov/cgi-bin/briefroom/BriefRm