hi everyone everyone's favorite topic the balance of payments remember what the balance of payments is it's just a big account a big spreadsheet that measures the inflows and outflows of money into and out to a country we're measuring International transactions with the balance of payments here I'm not going to focus on the current account because I've already done a video on that if you're not sure of the current account of the balance of payments then watch my video on it to understand it now remember it consists of the trading Goods trading Serv Services uh sections which together constitute the trade balance it also looks at two uh income Parts as well the primary income balance which is known as investment income and the transfers balance known as secondary income together that gives us our total income balance so that's all just recap of the current account you should be aware of all of that what I'm going to focus on in this video are other parts of the balance of payments two other accounts and something known as a balancing tool or the balancing item of the balance of payments right um um the capital account is another part of the balance of payments but a very very small part of it if you actually look at the balance of payments records for countries you'll see that there is the current account which is a big big big the most substantial part of the balance of payments the financial account which is a very big part as well and the capital account which a much much smaller part and it accounts for international transactions that are very minor in nature and uh I'm not going to spend much time going through them you'll never be asking the exam to explain the capital account what's actually recorded in it it's not important so what is actually measured well debt forgiveness there's a lot of talk about that in the news at the moment so if a countries owed lots of debt and they decide to cancel that debt out for that would be recorded as a negative okay so debt forgiveness uh is accounted for in the capital account so by forgiving debt that is a debit essentially you're not getting money that you should be being owed um so that'll be recorded there any inheritance taxes that need to be paid internationally will be recorded here any International death duties uh any transfer of financial assets by migrants coming into or leaving the country um will be recorded in the capital account also sales of tangible assets so if a company is selling uh a factory or selling a skyscrape or selling office space abroad that will be recorded in the financial account in the capital account and any sales of intangible assets or non-produced assets like um land for example uh will be recorded so any buying and selling of land internationally we record in the in the capital account any buying and selling of nonfinancial assets like copyrights like patents will be recorded in the capital account of the balance of payment so you don't really need to know much about that just know that it exists what I'm going to focus very much on the financial account which is the next biggest part of the balance of payments beyond the current account very very important for lots of countries this is substantial very significant uh some examples only make you learn two accounts of the balance of payment they say the current account obviously but also they call it just generally the capital account and that's confusing because the way some exam boards talk about the capital account being important actually what they mean is the financial account so what I'm doing here is the official balance of payment structure uh that all countries really adopt and if you look at the documents you will see these different accounts of the balance of payment so when I talk about the financial account this is what the IMF agree is the financial account and what the IMF agree uh what the capital account is based on what I've written down here don't get confused okay if your examp board says you just need to learn two then they mean that the financial account what I'm going through here is the second account you need to learn so what else is uh is measured in the balance of payments what else is recorded in terms of international transactions well the financial account looks at portfolio investment transactions okay so portfolio investment transaction and this is just the buying and selling of financial assets what kind of financial assets well that could be bonds corporate bonds or government bonds it could be the buying and selling of shares and it could be the buying and selling of derivatives Financial Market derivatives like options and swaps um financial instruments that can be bought and sold by investment bankers and investors so very simply let's so we're looking at the UK balance of payments if uh lots of us firms decide to buy UK government bonds well that would be an inflow into the UK that would be money entering the UK in order to buy our government bonds U that would be recorded as a credit uh for the UK and recorded in the financial account on the balance of payments in the portfolio investment part of the account let's say uh lots of UK individuals decide to buy us company shares well that's money leaving the UK okay that would be a debit in the uh Financial account of the UK balance of payments measured in the portfolio investment part of the financial account um so any movement of money in and out of a country in terms of the buying and selling of financial assets will be recorded in the portfolio investment part of the financial account what about uh another part of the financial account well foreign direct investment flows are also measured in the financial account so let's say a German firm decides to set up shop and open up a Factory open up shops in the UK without money entering the UK that will be a credit for the UK measured in the foreign direct investment part of the financial account similarly if lots of UK firms decide to shut down in the UK and move elsewhere move to other countries well that would be a debit for the UK that would be an outflow of money uh measured in the foreign direct investment part of the financial account and the third thing that's measured in the financial account reserves okay reserves held either in currency or held in Gold so any changes in our reserves positive or negative will be recorded in the financial account of the balance of payments right in terms of theory knowing now what different transactions are recorded in different parts of the balance of payments in different accounts the key thing is to realize how a current account deficit or Surplus can actually be maintained in the long run because think about what a current account deficit means if a country has a current account deficit it means it's buying more from the rest of the world than it's actually selling to the rest of the world more money is leaving the country through International transactions than it's entering the country and that's not sustainable that means as an economy uh let's say the UK who has got a large current account deficit that means that we are owing the rest of the world that can't be sustained in the long run right that money's got to come from somewhere we can't buy more from the rest of the world forever that money's got to come from somewhere and that money tends to come from surpluses in the financial account and all the capital account the whole financial kind of uh spreadsheet here needs to balance it's not called the balance of payments for nothing the whole record has to balance you can't owe the rest of the world more than uh than what you're actually selling them okay you need to actually balance the account so what what what often happens here is if a country is experiencing a large current account deficit then they will often record a financial account Surplus which balances the entire account let's take two countries let's take the USA and let's take China now we know that that the USA have got a large current account deficit whereas China have got a large current account Surplus now we know that a current account deficit can't be sustained in the long run the Financial account here the financial spreadsheet the balance of payments has got to balance and at the moment it's not balanced there's a large current account deficit so therefore what needs to happen the USA needs to have a financial account Surplus and that's exactly what is happening at the moment in the USA remember what I said about the capital account how minor it is that doesn't really feature very much so we look at the financial account to balance the overall uh balance of payments here how can the USA actually gain a financial account Surplus well simply countries that are running a current account Surplus are sitting on lots and lots of excess cash for countries like China they're selling more to the rest of the world than they're actually buying from the rest of the world which means they have massive reserves of cash that they can be that can be used to invest and where are they going to invest it they're going to invest it in countries where um they have a current account deficit like the USA they're going to invest in countries where Investments are say safe and secure and give a good rate of return so that might mean buying US government bonds which will mean that the US get a credit in the financial account a positive money inflow into the financial account it might be buying lots of us company shares it might be buying lots of US Financial Market derivatives in which case uh that props up the financial account for the USA and it leads to a surface in the financial account whereas for China That's Money Le leaving China right to buy US government bonds so that will mean a financial account deficit for China both ways the US balance of payments will be balanced and the China balance of payments will be balanced as well where current account surfaces will turn uh will be uh overridden by Financial account deficits and current account deficits will be overturned and overridden by Financial account surpluses that's what needs to happen for this whole account to balance maybe it's not the port investment part of the financial account that balances the the overall spreadsheet here maybe it's inflows of foreign direct investment so the USA for example is deemed a very good country to invest to uh set up factories to set up production so lots of countries like China lots of Chinese firms lots of other countries their firms will come and set up in the USA and provide an inflow of money into the USA leading to potentially a financial account Surplus so countries that are deemed a very good place to invest in terms of foreign direct investment like the USA and the UK okay can see inflows in that way leading to a financial account Surplus maybe balancing out a current account deficit in that sense and just in case uh the financial account and the capital account together cannot balance out the current account deficit we have also net errors and Emissions part of the account where funky accountants get together and they fiddle the numbers to make sure that the overall account does balance that the overall spreadsheet here sums to zero it needs to be balanced we can't owe money to the rest of the world that money's got to come from somewhere and if the two accounts here financial and capital account together don't come to a surface that balances out a current account deficit then the balancing tool will actually make sure that the account sums to zero all right so that's the balance of payments in detail looking all all the different sections of the balance of payments I hopefully now you understand that a current account deficit can't be sustained in the long run a financial account Surplus must be being achieved for the whole uh structure for the whole balance of payments to some to zero and if it doesn't you have the net errors and Emissions tool but even for countries that have a current account Surplus um they would want to invest a lot of that money they don't just want to sit on the cash and often they'll run a financial account deficit to ensure that the um balance of payment sums to zero the issue with this though I'm going to make another video on this is that countries that run a current account deficit will often Finance it by borrowing money by issuing bonds by issuing shares which require interest pay P back on there and that is borrowing money and that again you can argue is not sustainable in the long term what really needs to be taken care of is the current account deficit not just maintaining or increasing it through issuing more debt but actually finding a way to reduce the current account deficit we look at the consequences of that in my next video thanks for watching guys see you next time