Question

Indicate whether each of the following items represents a debit or a credit on the U.S. balance-of-payments: a. A U.S. importer purchases a shipload of French wine. b. A Japanese automobile firm builds an assembly plant in Kentucky. c. A British manufacturer exports machinery to Taiwan on a U.S. vessel. d. A U.S. college student spends a year studying in Switzerland. e. American charities donate food to people in drought-plagued Africa. f. Japanese investors collect interest income on their holdings of U.S. government securities. g. A German resident sends money to her relatives in the United States. h. Lloyds of London sells an insurance policy to a U.S. business firm. i. A Swiss resident receives dividends on her IBM stock.

Short answer

a. Debit, b. Credit, c. Credit, d. Debit, e. Debit, f. Debit, g. Credit, h. Debit, i. Debit

Step-by-step solution

Analyze transaction a.

A U.S. importer purchases a shipload of French wine. This transaction increases the liabilities of the US, because it involves an outflow of capital from the U.S. to France. This is a Debit.

Analyze transaction b.

A Japanese automobile firm builds an assembly plant in Kentucky. This involves an inflow of foreign capital into the U.S, hence it is considered a Credit.

Analyze transaction c.

A British manufacturer exports machinery to Taiwan on a U.S. vessel. Here, although the country exporting is Britain, the transaction is made using a U.S. vessel, meaning the U.S. is earning in the transaction. Therefore, it is a Credit.

Analyze transaction d.

A U.S. college student spends a year studying in Switzerland. This means the capital is flowing from the U.S. to Switzerland for the student's expenses. Thus, it is a Debit.

Analyze transaction e.

American charities donating food to people in drought-plagued Africa causes a decrease in U.S. assets. Thus, it is a Debit.

Analyze transaction f.

Japanese investors collecting interest income on their holdings of U.S. government securities. Since this deal increases the liabilities for the U.S (paying interest), it is a Debit.

Analyze transaction g.

A German resident sends money to her relatives in the United States. This is an inflow of capital to the U.S, hence it is a Credit.

Analyze transaction h.

Lloyds of London sells an insurance policy to a U.S. business firm. As this transaction involves an outflow of capital from the U.S., it is a Debit.

Analyze transaction i.

A Swiss resident receives dividends on her IBM stock. It involves an outflow of funds from the U.S (payment of dividends), it is a Debit.

Key concepts

Debit and Credit in International Economics

In the context of international economics, 'debits' and 'credits' reflect financial transactions between countries. These terms are quite similar to debits and credits in business accounting, but in the international arena, they are applied to a country's economic transactions with the rest of the world.

When a country imports goods, services, or capital, it is recorded as a debit because it's an outflow of resources. Conversely, exports, income from foreign investments, or incoming transfers are credits because they represent an inflow of resources. For instance, when a U.S. importer purchases wines from France, the transaction is a debit for the U.S. and a credit for France.

Understanding these transactions is crucial as they help in tracking the economic activities of a country and provide valuable information on its financial health and international economic relationships.

U.S. Balance-of-Payments Analysis

The U.S. balance-of-payments is a comprehensive record of all economic transactions between residents of the U.S. and residents of other countries over a specific time period. It includes not just trade in goods and services, but also capital flows, such as investments and financial transfers.

The balance-of-payments is divided into two main accounts: the current account and the capital account. When a Japanese automobile firm constructs a plant in the U.S., it's a credit in the capital account, showing foreign investment in the country. Meanwhile, money spent abroad by a U.S. student is a debit in the current account. By analyzing these transactions, economists can understand the economic transactions of a country and how they affect the overall economy. The balance-of-payments data can indicate whether a country is living beyond its means, fostering excessive foreign investment, or facing potential exchange rate instability.

Capital Flows

Capital flows refer to the movement of money for the purpose of investment, trade, or business production. It includes the net flow of investments from one country to another and can be both incoming (inflows) and outgoing (outflows).

In the U.S. balance-of-payments, when foreign investors collect interest on U.S. securities, it's considered a debit because it's an outflow of money from the country. Similarly, dividends paid to foreign investors also signify a financial outflow. Conversely, when German residents send money to their U.S. relatives, it's an inflow of capital and thus, logged as a credit. Capital flows are significant as they impact exchange rates, foreign exchange reserves, and the overall financial stability of a country.

Components of Capital Flows

Capital flows include Foreign Direct Investment (FDI), portfolio investment, and other investment such as loans and banking flows. The nature and impact of these flows can vary, with FDI often being longer term and potentially contributing to growth, while portfolio investments may quickly enter or leave a country, sometimes leading to economic volatility.