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April 20, 1984 Which Trade Balance? Humpty Dumpty: "When I usea word, it meansjust what I chooseit to mean, neithermorenor less."(LewisCarroll, Throughthe LookingGlass.) In February, newspapers across the nation reported that the U.s."trade" deficit for 1983 was $60.6 billion. A month later they reported a 1983 "trade" deficit of $40.8 billion. But the national income account data given in the recent Surveyof Current BusinessIists still another version of the "trade"deficit-$7.1 billion. Will the real trade deficit please stand up? Neither media inaccuracy nor government revisions can be blamed for these discrepancies. Rather, what is commonly referred to as "the trade balance" is actually measured and reported in several different ways. Anyone wanting to know this balanc:e has the following choices: the merchandise trade balance, itself measured in several ways; " G N P net exports", which gives the balance of trade in merchandise and services; or the current account balance. While these balances generally move closely together over time, their levels are typically very different. For example, it was the merchandise balance that.was $60.6 billion in deficit last year, whilethe current account and GN P net export deficits were $40.8 and $7.1 billion, respectively. For those who sti II wantto know whatthe deficit really was, this Letterprovides a short II gu ide to the perplexed", expl ai ni ng the various balances, their relation to one another, and their economic significance. The current account includes all transactions that are "current" in an accounting sense, that is, all payments and receipts for goods and services exchanged with . foreigners, as well as transfers. Excluded from the current account are u.S.purchases from or sales to foreigners of financial or real assets. These items, which represent u.S. entities' lending to or borrowing from foreigners, comprise the capital account of the U.S. balance of payments. If, in any year, total U.S. payments to foreigners on a current basis exceed our receipts from them (that is, we run a current account deficit), our country must borrow from abroad to make up the difference. Conversely, we must lend to foreigners any difference between our sales to them on a current basis and our payments. The current account surplus or deficit therefore also measuresthe tietamountthe U.s.as a whole is lending to or borrowing from abroad during a given year. Last year, we ran a current account deficit of $40.8 billion; this means that we borrowed a net amount of $40.8 billion from abroad. The current account itself, though, contains three distinct types of transactions: merchandisetrade,productiveservices provided by land, labor, and capital; and transfers,which include foreign aid and private remittances as well as payments to foreigners of interest on their holdings of u.s.government debt: These, in turn, are "arranged'! into the three basic balancesmerchandise trade, GN P net exports of goods and services, and, finally, the current account balance itself. Current account The most comprehensive summary of u.s. trade with the rest of the world is given by the current account balance. Indeed, the current account contains the other balances mentioned above and all the transactions in them. Merchandise trade balance The merchandise trade account contains all exports and imports of tangiblecommodities,e.g., agricultural products, industrial materials such as steel, consumer manufactures, and capital goods. Actual merchan- in this not reiled lhe view'> of the }·""'!tCC" "I i<eserve of San FeH''''",,,n or of lhe Hoard of Covernors of llw Feder,,1 Reserve System, However, the largest and most rapidly growi ng component of factor services represents payments for services provided by physical capital. These include recorded earnings from u.s. investments abroad as well as payments to foreigners on their investments in the U.s., except for the interest they earn on their holdings of U.S. goverrfment (federal, state and local) debt. Interest payments to foreigners on government debt are not included in these services (although they are included in the current account) because, according to U.S. national income accounting conventions, they represent a transfer rather than a payment for a current factor service. dise trade figures are reported several different ways depending on the extent to which various services involved in transporting them are included. Imports and exports on a "free-along-side" (f.a.s.) basis are valued as del ivered to their point of embarkation for or departure from the U.S. The f.a.s. figures are thus the purest measuresof the values of the commodities themselves. Other export/import figures refer to their value "free-on-board" (f.o.b.), that is, inclusive of loading and related costs. Still other figures include the "cost of insurance and freight" (cU.) in addition to the loading costs and the aCtual (La.s.) commodity value. Overall, the service balance typically records a large surplus, nearly $54 billion in 1983. This mainly reflects the fact that the U.S. earns considerably more on its investments abroad than it pays to foreigners on their investments here. Indeed, our reported investment receipts totaled $85 billio'llast year (nearly two-thirds of all service. exports), exceeding payments to foreigners on their investments in the U.S. by nearly $47 billion. The first merchandise trade balance figures' . reported each month by the Commerce Department, and the ones most frequently quoted in the media, are the "census" figures based on the export and import invoices recorded at various U.s. customs stations. These figures value imports at their point of entry into the U.s., that is, on a cLf. basis, while they value exports on an f.a.s. basis. (Commerce reports the balance on an f.a.s. basis for both exports and imports several days following the release of the census data.) The census balance thus includes the transport and other service costs of bringing imports to the U.S. but excludes the service costs involved in getting our exports abroad. Not surprisingly then, last year's census-based deficit of $69 bill ion was substantially larger than the f.a.s. merchandise deficit of $60.6 billion . . The sum of the (f.a.s.) merchandise trade and service balances yields what is known as "G N P net exports." This is the net export figure given in the U.S. national income statistics and it is one of the four major components of U.S. GNP. Transfers and the remainder The remainder of the current account consists of unilateral transfers such as private contributions, pension payments, official foreign aid, as well as interest payments to foreigners on their holdings of U.S. government debt. The U.S. always runs a large deficit overall in these items, amounting to nearly $33 billion in 1983, $18 billion of which represented U.S. government interest paid to foreigners. Services Services provided by factors of production -land, labor and capital-are the second . major category of transactions in the cu rrent account. Included in such "factor" services are personal travel and tourism, royalties and other fees from professional services, as well as all services associated with transporting and insuring U.s. merchandise trade. Meaning On this basis, last year's $41 billion current account deficit was the sum of our $61 2 Chart 2' The Balances Chart 1 Components of the Current Account: 1983 BIllions of Dolllll'$ I Bll1lons al Oollars} 30 20 Merchandise Trade -$60.6 10 Services o + $53.5 .10 -$7.1 Transfers - $33.6 Net Exports· ·20 GNP Net Exports ·30 Current AccDunt ) ·40 - $40.8 ·50 ·60 Minus sign means dllltcil Merchandise Trade· ·70 ..............-'-'-" 1970 1972 1974 .......-'- ...... .-... .......... 1976 °NallonallntomeAccounls(I,a.s.) billion merchandise trade deficit, the $54 billion surpluson factor services (together making up the $7 billion deficit on G N P net exports), and our $33 billion deficit in transfers and U.S. government interest payments to foreigners (Chart 1). 1978 1980 1982 basis difference between foreign purchases of' U.S. goods and services and U.S. purchases of foreign goods and services. As such, variations in G N P net exports have a direct and potentially substantial impact on the growth of our national output. As the foreign sector has grown in importance to the u. s . . economy over the last decade, forecasts of U.S. growth have become increasingly sensitive to assessmentsof G N P net exports. Our merchandise trade balance has been in deficit in all but two of the last fourteen years, while the current account and G N P net exports have more often been in surplus (Chart 2). This pattern is due to the large U.s. surplus in factor services-a surplus that has grown very quickly in recent years mainly because of the rapid increase in receipts from our investments abroad. The services surplus means that the u.s. can have a substantial trade deficit even in years when our total current international payments and receipts (the current account) are in balance. Interestingly, the situation is the opposite for several of our trading partners. Japan, for example, typically runs a substantial deficit in services. Its merchandise trade therefore may be in surplus, as is usually the case, even when its current account is in deficit. Finally, the current account's significance lies mainly in the factthat it measures the net flow of u.s. lending to or borrowing from abroad, and hence, the change over time in net U.S. indebtedness to foreigners. (The U.S. is still a net claimant on abroad, butthis cou Id change if our present deficits persist.) This flow, in turn, has potentially very important implications for financial cond itions in the U.s. and for the val ue of the dollar on the foreign exchanges. In particular, the nearly $41 billion in funds the U.S. "imported" from abroad last year helped to meet the credit needs of our private sector and the growing demand for credit by the federal government. Upward pressures on U.s. interest rates would probably have been greater had these foreign funds not been available. Although the merchandise trade balance gets the most media attention, the G N P net export and current account balances are more economically significant. In particular, GN P netexports provide the best summary measure of the foreign sector's impact on U.S. output and while the current account balance measures the impact ofthe foreign sector on u.s. financial markets, i nclud i ng the value of the dollar on the foreign exchange markets. Likewise, concern is growingthatthe U.S. is borrowing from abroad at an unsustainably high rate through the current account. This has led several observers to predict a sharp decline in the dollar on the foreign exchanges in 1 984 (to bring the current account to a more sustainable level). Thus, for financial markets these days, the "trade" balance to watch is mainly our current account. GN P net exports comprise one of the four major components of U.S. G N P (along with private consumption and investment, and government expenditures), measuring the CharlesPigott 3 SSV1::> u01 8uI4SPM.4Pln • u08aJO • ppPAaN • 04PPI IIPMPH • PIUJoJllPJ puozp V. P>jsPjV ell dI CG) 'l!I!!;) 'OJSPU!!J:I U!!S lSL 'ON IIW}!:!d CIIVd:!!)VISOd 's'n llVW SSVl:) IS}!I:I O:II}!OS:!}!d {\ B AN KI N G D ATA-TWE L F TH FEDERAL RESERVEDI STRI CT ( Dollar amounts in millions) Selected Assetsand Liabilities large Commercial Banks Loans, Leases and Investments 1 2 Loans and Leases1 6 Commercial and Industrial Real estate Loans to Individuals Leases U.s. Treasury and Agency Securities2 Other Securities 2 Total Deposits Demand Deposits Demand Deposits Adjusted 3 Other Transaction Balances4 Total Balances6 Money Market Deposit Accounts-Total Time Deposits in Amounts of $100,000 or more Other Liabilities for Borrowed MoneyS Two Week Averages of Daily Figures ReservePosition, All Reporting Banks Excess Reserves ( + )/Deficiency (- ) Borrowings Net free reserves (+ )/Net borrowed( -) 1 Amount Outstanding Change from 4/04/84 177,973 157,976 47,111 59,510 27,557 5,011 12,241 7,757 189,072 45,744 29,888 13,033 130,295 3/28/84 1,323 1,309 150 91 121 12 42 27 3,955 2,838 1,102 976 140 40,287 - 272 37,913 17,114 - Change from 12/28/83 Percent Dollar Annualized - - 1,948 2,621 1,148 611 906 52 266 406 1,925 3,493 1,443 258 1,310 - - 690 - 120 -1 ,521 - Period ended Period ended 3/26/84 3/1 2/84 188 44 144 189 49 139 252 5,893 4.1 6.2 9.2 3.8 12.6 3.8 7.8 18.4 3.7 26.3 17.1 7.5 3.7 6.4 - 2.4 - 95.1 Includes loss reserves, unearned income, excludes interbank loans 2 Excludes trading account securities 3 Excludes U.s. government and depository institution deposits and cash items ATS, N OW, Super N O W and savings accounts with telephone transfers S Includes borrowing via FRB, TI&L notes, Fed Funds, RPsand other sources 6 Includes items not shown separately 4 Editorial comments maybe addressedto the editor (GregoryTong)or to the author .... 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