Kenneth R. Szulczyk
more goods and services than it exports, causing an outflow of U.S. dollars into the foreign
exchange markets. International investors obtain U.S. dollars and use it to buy assets in the
United States, creating a financial account surplus. Foreigners invest in government securities,
stocks, bonds, and real estate in the United States. Balance-of-payments equation shows this
relationship in Equation 1, which is the current account plus the financial account should equal
zero.
Balance of Payments (BOP) = current account + financial account = 0 ( 1 )We use Equation 1 as an equilibrium equation to predict changes in a country’s exchange
rate. If a country’s balance of payments equals zero, then that country’s exchange rate may not
change. For example, the United States has a current account deficit, causing U.S. dollars to
flow into the foreign-exchange markets. Foreign countries collect these U.S. dollars and invest
them in the United States. What happens if the foreign investors do not want to invest in the
United States? Consequently, balance of payments becomes negative, causing the U.S. dollar to
weaken or to depreciate because the international markets have a surplus of U.S. dollars.
Subsequently, a weaker U.S. dollar causes the current account to shrink over time as imports fall
while exports rise until restoring equilibrium.
If the Federal Reserve does not want the dollar to weaken, then it can buy these U.S. dollars
by using official reserve assets. The Federal Reserve can finance a balance-of-payment deficit or
reduce U.S. dollars on the international market by doing one or more of the following:
The Fed could sell gold to buy U.S. dollars. The Fed could sell foreign currencies and buy U.S. dollars. The Fed could borrow from foreign central banks. The Fed could use its reserves at the International Monetary Fund or ask the International
Monetary Fund for a loan. The Fed could use Special Drawing Rights (SDRs). We discuss them further under the
Exchange Rate Regimes.Economists record official reserve assets under the Financial Account as the U.S. Official
Reserve Assets. In 2011, the official settlements balance was a minus $15.9 billion, and we
already included this balance in the financial account in Table 1. The Federal Reserve paid
$15.9 billion by selling assets to foreign countries, which we itemized in Table 2.
Economists add a non-zero amount called statistical discrepancy to force the current
account plus financial account to equal zero. Discrepancy arises from measurement errors, and
some people and businesses do not report revenue from illegal businesses, evade taxes, or hide
their money from their government in another country. People hiding money is a form of capital