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CAPITAL FLOWS

The movement of Money for the purpose of investment, trade or business


production. Capital flows occur within corporations in the form of investment capital
and capital spending on operations and research and development. On a larger
scale, governments direct capital flows from tax receipts into programs and
operations, and through trade with other nations and currencies. Individual
investors direct savings and investment capital into securities like stocks, bonds
and mutual funds.
International capital flows are the financial side of international trade. When
someone imports a good or service, the buyer (the importer) gives the seller (the
exporter) a monetary payment, just as in domestic transactions. If total exports
were equal to total imports, these monetary transactions would balance at net zero:
people in the country would receive as much in financial flows as they paid out in
financial flows. But generally the trade balance is not zero. The most general
description of a countrys balance of trade, covering its trade in goods and
services, income receipts, and transfers, is called its current account balance. If the
country has a surplus or deficit on its current account, there is an offsetting net
financial flow consisting of currency, securities, or other real property ownership
claims. This net financial flow is called its capital account balance.
Capital flows are aggregated by the U.S. government and other organizations for
the purpose of analysis, regulation and legislative efforts. Different sets of capital
flows that are often studied include the following:
Asset-class movements measured as capital flows between cash, stocks,
bonds, etc.
Venture capital investments in startups businesses.
Mutual fund flows net cash additions or withdrawls from broad classes of
fund.
Capital-spending budgets examined at corporations as a sign of growth
plans.
Federal budget government spending plans.

Capital flows can help to show the relative strength or weakness of capital markets,
especially in contained environments like the stock market or the federal budget.
Investors also look at the growth rate of certain capital flows, like venture capital
and capital spending, to find any trends that might indicate future investment
opportunities or risks.
When a countrys imports exceed its exports, it has a current account deficit. Its
foreign trading partners who hold net monetary claims can continue to hold their
claims as monetary deposits or currency, or they can use the money to buy other
financial assets, real property, or equities (stocks) in the trade-deficit country. Net
capital flows comprise the sum of these monetary, financial, real property, and
equity claims. Capital flows move in the opposite direction to the goods and
services trade claims that give rise to them. Thus, a country with a current account
deficit necessarily has a capital account surplus. In balance-of-payments
accounting terms, the current-account balance, which is the total balance of
internationally traded goods and services, is just offset by the capital-account
balance, which is the total balance of claims that domestic investors and foreign
investors have acquired in newly invested financial, real property, and equity
assets in each others countries. While all the above statements are true by
definition of the accounting terms, the data on international trade and financial
flows are generally riddled with errors, generally because of undercounting.
Therefore, the international capital and trade data contain a balancing error term
called net errors and omissions.

Because the capital account is the mirror image of the current account, one might
expect total recorded world tradeexports plus imports summed over all
countriesto equal financial flowspayments plus receipts. But in fact, during
19962001, the former was $17.3 trillion, more than three times the latter, at $5.0
trillion. There are three explanations for this. First, many financial transactions
between international financial institutions are cleared by netting daily offsetting
transactions. For example, if on a particular day, U.S. banks have claims on

French banks for $10 million and French banks have claims on U.S. banks for $12
million, the transactions will be cleared through their central banks with a recorded
net flow of only $2 million from the United States to France even though $22 million
of exports was financed. Second, since the 1970s, there have been sustained and
unexplained balance-of-payments discrepancies in both trade and financial flows;
part of these balance-of-payments anomalies is almost certainly due to unrecorded
capital flows. Third, a huge share of export and import trade is intrafirm
transactions; that is, flows of goods, material, or semifinished parts (especially
automobiles and other nonelectronic machinery) between parent companies and
their subsidiaries. Compensation for such trade is accomplished with accounting
debits and credits within the firms books and does not require actual financial
flows. Although data on such intrafirm transactions are not generally available for
all industrial countries, intrafirm trade for the United States in recent years
accounts for 3040 percent of exports and 3545 percent of imports.
Over the past two hundred years, the worlds dominant international investors have
been the Western European nations. Capital was invested in their own and other
European colonies and in developing nations. During the nineteenth century, the
British financed the transcontinental railroads in the United States and Canada and
built vast agricultural plantations in Africa and Asia. Today, Great Britain and the
Netherlands remain, as they have from colonial times, among the largest direct
investors in the United States: Britain is largest, followed by Japan, Germany, the
Netherlands, and France. After World War I, the United States emerged as the
worlds predominant direct investor and, in gross terms, remains so. As of 2003,
U.S. foreign direct assets were more than twice those of the United Kingdom, the
next largest asset holder at $2.7 trillion, while U.S. foreign direct investment
liabilities were $2.4 trillion, implying a net FDI position of $300 billion. During the
past two decades, the United Kingdom again became the worlds largest net
foreign direct investor, with about $600 billion in net holdings at exchange rates
prevailing in 2003. Following the United Kingdom in order are the United States,
Japan, Switzerland, and the Netherlands.