RECORD TRADE DEFICITS, PART DEUX

INTERNATIONAL BALANCE OF PAYMENT ACCOUNTING IN TROIS EASY LESSONS

In the last post we introduced Lemon County Lead Sleds, a custom “chopper” motorcycle shop. Please recall that they had fallen on lean times last year and had sales of 1 million and expenses of 1.2 million. So they had a .2 million-dollar loss. The last post discussed two common strategies for Lemon County to absorb the loss:

Dip into their retained earnings (savings) to pay their suppliers and cover the .2 million deficit; or
Borrow the money to cover the loss. We discussed two ways to borrow the money to cover the loss.
Go to the bank or other lender and borrow .2 million dollars to pay the supplier.
Take delivery of the suppliers’ material on credit and pay for the materials as an accounts receivable. In other words, Lemon County would make the supplier its “Lender”.

These are common strategies for companies to adjust their sales and purchase among themselves in their day-to-day relationships. From here, we will jump right on the Current Account.

CURRENT ACCOUNTS, CAPITAL ACCOUNTS AND A DEFINITION

First, the definition. Post 1 and Post 2 up to this point were included to lay the groundwork for trade deficit and balance of payment analysis. The example of Lemon County Lead Sleds was used to put out general concepts from the business world that serve as good analogies for the rest of Part Deux, and what looks like Part Trois. The Author doubts he can cram it all into this post. And he hopes there will not be a Part Quatre, as the Author cannot count any further in French.

International balance of payments is the record of international transactions in a defined period of time made in the form of double-entry accounting. Debits, credits, that stuff. And a lot of this is estimated, not finally and officially tracked.

Current Account. Most of what we read and hear about is the trade deficit or surplus. Did the US import more than it exported (the case since at least 1982), or did it export more than it imported? Trade deficit or surplus is “booked” in the Current Account. The Current Account is made up of three[i] categories:

1. Merchandise. Trains, planes, automobiles and gummi feet. The US consistently runs merchandise trade deficits while its key trading partners like Germany, Japan and China run merchandise trade surpluses in relation to the US.
2. Services. This includes things like accounting, engineering, consulting services, as well as tourist expenditures. The US has generally maintained trade service surpluses.
3. Factor income. This category includes things like dividend and interest received on foreign investments. And on the other side of the ledger, dividends and interest that the US must pay to foreign investments.

AN EXAMPLE

In a hypothetical “Year”, the Current Account of the US looked like this:


CREDIT/DEBIT
Imports. 200 billion dollars

1. Merchandise 100 billion dollars
2. Services 50 billion dollars
3. Factor income 50 billion dollars

B. Exports 175 billion dollars

1. Merchandise 50 billion dollars
2. Services 75 billion dollars
3. Factor Income 25 billion dollars

Current Account Surplus/Deficit: Imports 200 billion dollars
Exports 175 billion dollars

-25 billion dollars, or a 25 billion
dollar debit (deficit).

The US then had a 25 billion dollar deficit in its Current Account in this Year. This, on its face, looks bad. But remember that the US has run a Current Account deficit since at least 1982, has not gone “bankrupt”, and in fact has the highest “credit rating” in the world. So what is going on? That is where the Capital Account comes in.

POST TROIS

In the next post, we will discuss the Capital Account and how trade deficits may be “offset” by the financial strength of the US economy. And in later posts, we will take a look at how long the US can sustain huge trade deficits. And what investors will need to consider in an environment of huge trade deficits.

Bienvenue au désert du vrai!

[i] There is a fourth category called “Unilateral Transfers”. This category will not be included for sake of simplicity. It includes foreign aid, reparations, gifts and the like. It is a small category. American foreign aid is miniscule as a budgetary component, comprising less than ½ of one-percent of its federal budget.