Balance of Payments

Nations trade with each other in (a) goods and services and (b) financial assets such as government bonds and shares, and real estate.

The current account of the balance of payments summarises the transactions in goods and services between nations. (Strictly it also includes net income from abroad and net current transfers.) A positive value implies that the value of the goods and services the country exports exceeds the value of the goods and services it imports. The capital account of the balance of payments deals with the other type of transactions – primarily in financial assets and real estate. Very broadly the capital account is the mirror of the current account: a current account deficit implies a capital account surplus. If for example country A is importing more than it exports to the rest of the world (RoW), its current account will be in deficit; but the RoW will have acquired more of A’s currency: A has in effect ‘exported’ one of its financial assets and its capital account will be in surplus. [Of course the RoW may not want to hold this currency for long and use it to buy A’s bonds, but then A has exported the bond.]

Most political and media comment focusses on the current account. The UK’s current account has been in deficit for most of the 60 years, which media commentators generally regard as a ‘bad thing.’ This isn’t necessarily correct. Whilst deficits can be a sign of an economy which has become uncompetitive or where aggregate spending is excessive and is consequently drawing in too many imports, they can also be a sign that the rest of the world has confidence in the economy and is buying the country’s financial assets and thereby driving up the value of the country’s currency and making its exports more expensive.