In the section on Japan we're going to be talking about something called the balance of payments. So, I thought it would be worthwhile to make a parenthesis here as we review theory and to talk to you about what the balance of payments is. Now, the balance of payments has a record of all of a country's transactions with the rest of the world. So on one side, we're going to put something that we call the current account, and on the other side we're going to put something called the financial account. The current account records sales income from different sources, so it's the biggest part of it is trade which is exports minus imports and this is all kinds of exports, all kinds of imports, goods and services, visibles and invisibles. Usually, the major part of the account. Then we have something called primary income. Here the idea is that a country is constantly investing in the rest of the world, and the rest of the world is constantly investing in them, and each one of them builds a stock in the other, right? At the end of any given year or during any given year, they may bring home some of their earnings on that stock. So, those earnings will net each other out and we'll have primary income which is the difference between what I earn on my investments abroad and what foreigners earn on their investments in my economy. Then we have something that's called secondary income. Now, this is made up of items that we actually call transfers in economics. A transfer is a payment that runs in only one direction. So, when I as a country give aid to another country, that's a transfer payment and it appears here on the secondary income account. If I have a family member that goes and lives in another country, and they send home some of their earnings to help me live, that also goes into secondary income. So, those are the three parts of the current account. It could be positive, it could be negative, it could be balanced. On this side we have capital flows. Without going into too much detail, we have long term capital flows that we call direct investment, we have short term capital flows that we call portfolio investment, and then we have loans, and other liabilities, loans from banks and non-bank institutions, and we also put overhear something called errors and omissions. If the two sides don't match, we add some item here to make them balance. This again could be positive, negative, or zero. There's also a small item here, sometimes it's big change in reserve assets, but we're not going to discuss that much just so that you have it here. Now, let's imagine that I'm a country that imports more than I export, and all of the other items, adding them up, bring me to a negative here. That means that what I'm really doing is I'm spending more than I am earning from the rest of the world, so I'm actually buying from them more than they buy from me, net of all these flows. There's a negative there. Now, how can I do that? How can I have a negative over here? How can I buy from the rest of the world more than they buy from me? Well, only by borrowing from them. So, this side of the balance of payments in that case would have to be positive because they would be allowing money to flow into my country to finance the difference between this side, to finance the negative on this side with a plus on this side. Imagine that I am, or we looked at the United States and have a deficit here. Then the United States needs the rest of the world to pour capital into it's economy every year, to pour in more than it sends out so that there's extra money to be able to pay for that deficit. We're going to be looking at Japan today and we'll find that Japan's the opposite. Japan is a country with a current account surplus. Since the two sides have to match, Japan will have a negative over here which means that what Japan is doing is it is buying from the rest of the world less than the rest of the world buys from it. It exports more than it imports, it sells to the rest of the world more than it buys from the rest of world giving it a plus. What does it do then with the extra money it earns? Well, it has to lend it to those countries that have a current account deficit. It has to lend them that money so they buy their extra things. So, the countries that have a current account surplus are lenders to the rest of the world. They lend capital to the rest of the world. The countries that have a current account deficit are borrowers from the rest of the world. What we're also going to see is that a country that sells to the rest of the world more than it buys from them depends on others for their growth, so they need foreign demand to grow. And this is typical of the current account surplus countries. The current account deficit countries have no problem, they have plenty of demand, they spend more than they earn anyway. So, they don't depend on anyone for growth, but they do depend on others to lend them the money so that they can spend more than they earn. So, this is one concept I want you to hang onto, and we're going to be developing it with all the rest of the countries in this course. Just one other thing I want to mention here is a few points about currencies, because we're going to be referring to these as well. What we find is that currencies go up and down, sometimes because countries move them and sometimes just because markets move them. What happens if there is a decrease in the value of a currency? Well, usually what happens is we have one good result and two bad results. When the currency goes down in value, what happens is that I as a country, I'm able to export more because my goods look a lot cheaper outside the country. So, that's the good news. The bad news is that I will have a tendency to have more inflation because I'm importing goods from abroad and now their price is higher since my currency is weak. If I'm a country that has debt in other currencies my debt is going to go up if it's foreign. Foreign just means it's denominated in another currency. So, you can see that if my currency value goes down, I get one good thing happening, I get two bad things. Now, what if the value of my currency goes up? Well, it's exactly the opposite, but here I get two good things and one bad thing. So, the bad news is that the amount that I can export goes down because now they look more expensive to foreigners due to my strong currency, so that's negative. But on the positive side, since things are coming in now at a cheaper price because my currency is stronger, inflation is going to go down. At the same time, if I have foreign debt, my total debt is going to go down because my foreign debt is denominated in another currency but now mine is stronger, so I have to use fewer units of my currency to buy that foreign currency and my debt actually goes down. So, we have good news and bad news when currencies move, and this is the impact that they have on an economy. Now, one other thing that we find is that in general, a current account surplus country will tend to have all other things remaining equal, a currency that likes to rise over time. And a current account deficit country, all other things equal, will tend to have a currency that falls over time. So, these are the notions you need to have in order to understand our discussion in this section and later sections about the current account and about the value of currencies.
