Question

1. Explain how each of the following transactions generates a credit and a debit in the American balance of payments accounts and described (BRIEFLY) how each entry would be classified:
   1. An American buys a share of German stock, paying by writing a check on an account with a Swiss bank.
   2. The Korean government carries out an official foreign exchange intervention in which it uses dollars held in an American bank to buy Korean currency from its citizens
   3. A tourist from Detroit buys a meal at a restaurant in Lyons, France, paying with a traveler’s check
   4. A California winemaker contributes a case of cabernet sauvignon for a London based win tasting.
   5. A US owned factory in Britain uses local earnings to buy additional machinery
2. Why might a government be concerned about a large current account deficit? Why should policy makers not be concerned about a large current account deficit (name at least two reasons)? Why might a government be concerned about a net positive or negative balance of payments?

b

Answer 1

a	The debit side would be to the US Financial account. The corresponding credit is to the US financial account when American pays with his balance in Swiss account because after this transaction his claim on Switzerland would fall by this amount. One foreign asset is being traded for another
b	This transaction involves sale of US asset and would thus be debited to the US Financial account. Since the citizens would have dollars, they can use them to acquire American assets and create a credit in US Financial account
c	When the payment is made, it is a debit to US Current account. There would be a reduction in the French assets, this would be a credit in the US account
d	There is no market transaction in this case. It won't be recorded.
e	This is entirely offshore. Not to be recorded in US Balance of Payments

A huge current account surplus or a deficit is a temporary situation. It is not sustainable in the long run. There are instances in which a deficit may be necessary and there are situations where a surplus would be warranted. But if there is a deficit now, there must be a surplus later in order to pay off the foreigners so that the Balance of Payment is balanced.

In the absence of unusual investment opportunities, the best path for an economy may be one in which consumption, relative to income, is smoothed out over time. The reserves of foreign currency held by a country’s central bank change with nonzero values of its official settlements balance. Central banks use their foreign currency reserves to influence exchange rates. A depletion of foreign reserves may limit the central bank’s ability to influence or peg the exchange rate. For some countries, central-bank reserves may be important as a way of allowing the economy to maintain consumption or investment when foreign borrowing is difficult. A high level of reserves may also perform a signaling role by convincing potential foreign lenders that the country is credit-worthy.