All Things Held Equal: Cross-Sectional View of BoP
In academia and economic analysis the BoP is often used to illustrate the interconnectivity of global economies.
The BoP roughly looks like:
Current Account = Capital Account + Financial Account
The Current Account is a measure of net Production (goods/service) flow, Capital Account the net flow of non-financial Assets and the Financial Account the net flow of well Financial Assets. Simply put, on the left side, a country is buying or selling something and on the right side is getting paid or paying.
At a quick and general level the US has run a Current Account deficit in recent years (the argument can be made that it has to in a post Bretton Woods system as the US Dollar as the de facto medium of payment also becomes the central source of liquidity and thus to grow the global economy the aggregate supply of dollars must increase as well, although we can see the trouble in this scenario in creating global overheating without an effective mechanism to slow down or sterilize the supply). This Current Account Deficit has been offset though buy the reflow through the Capital and Financial accounts of dollars back into the US. This general relationship has been described as the US being financed by the rest of the world.
Now if the Current Account is balanced by the Capital Account and Financial Account, the aggregate supply of dollars remains level and the value of the dollar is maintained. If however the payees and/or creditors start investing the dollars they received for Goods/Services not into the US but elsewhere, then the supply of dollars increases and the value of the dollar would subsequently fall.
This BoP relationship is quite interesting as we look to the current US crisis. The Current Account is in deficit, but instead of rising values of Financial and Capital assets, we see core US Capital Assets (ie. houses, land) and Financial Assets (stocks) losing value.
How foreign payees/creditors react will offer great insight into the robustness and nature of the global economy.
In nearly any country but the US, this situation would drive foreign creditors/payees to pull their Capital/Financial assets as we’ve seen in the recent non-US financial crises.
Where will they invest however? This is one of the central concepts behind ‘decoupling’.
This is only a basic cross-sectional view of the complexity of global markets. Forex, liquidity, depth of market, commodity prices, asset substitution, and innumerable factors all play into the eventual market dynamics.
At a slightly higher level of complexity but also abstractness the BoP can also be viewed as a primary tenet of the impossible triangle, whereby it’s contended that a country can only maintain control over 2 out of 3 of the following: Open Capital Account (BoP), Monetary Policy Control, Exchange Rate Control.
The BoP roughly looks like:
Current Account = Capital Account + Financial Account
The Current Account is a measure of net Production (goods/service) flow, Capital Account the net flow of non-financial Assets and the Financial Account the net flow of well Financial Assets. Simply put, on the left side, a country is buying or selling something and on the right side is getting paid or paying.
At a quick and general level the US has run a Current Account deficit in recent years (the argument can be made that it has to in a post Bretton Woods system as the US Dollar as the de facto medium of payment also becomes the central source of liquidity and thus to grow the global economy the aggregate supply of dollars must increase as well, although we can see the trouble in this scenario in creating global overheating without an effective mechanism to slow down or sterilize the supply). This Current Account Deficit has been offset though buy the reflow through the Capital and Financial accounts of dollars back into the US. This general relationship has been described as the US being financed by the rest of the world.
Now if the Current Account is balanced by the Capital Account and Financial Account, the aggregate supply of dollars remains level and the value of the dollar is maintained. If however the payees and/or creditors start investing the dollars they received for Goods/Services not into the US but elsewhere, then the supply of dollars increases and the value of the dollar would subsequently fall.
This BoP relationship is quite interesting as we look to the current US crisis. The Current Account is in deficit, but instead of rising values of Financial and Capital assets, we see core US Capital Assets (ie. houses, land) and Financial Assets (stocks) losing value.
How foreign payees/creditors react will offer great insight into the robustness and nature of the global economy.
In nearly any country but the US, this situation would drive foreign creditors/payees to pull their Capital/Financial assets as we’ve seen in the recent non-US financial crises.
Where will they invest however? This is one of the central concepts behind ‘decoupling’.
This is only a basic cross-sectional view of the complexity of global markets. Forex, liquidity, depth of market, commodity prices, asset substitution, and innumerable factors all play into the eventual market dynamics.
At a slightly higher level of complexity but also abstractness the BoP can also be viewed as a primary tenet of the impossible triangle, whereby it’s contended that a country can only maintain control over 2 out of 3 of the following: Open Capital Account (BoP), Monetary Policy Control, Exchange Rate Control.
posted by howa at
1/11/2009
