Question

Explain how each of the following transactions generates two entries-a credit and a debit-in the Japanese balance of payments accounts, and describe how each entry would be classified: a. A Japanese investor buys a share of a stock company in Thailand, paying by writing a check on an account with a Singapore bank. b. A Japanese investor buys a share of a Thai stock company, paying the seller with a check on a Japanese bank. c. The Malaysian government carries out an official foreign exchange intervention in which it uses Yen held in a Japanese bank to buy ringgit (Malaysian currency) from its citizens. d. A tourist from Kyoto buys a meal at an expensive restaurant in Bangkok, paying with a traveler's check. e. A saké brewery in Kobe contributes a case of saké bottles for a Paris winetasting event. f. A Japanese-owned factory in Germany uses local earnings to buy additional machinery.

Short answer

a. and b. - Debit: financial account outflow for stock purchase. Credit: financial account decrease in bank assets. c. - Debit: financial account decrease in foreign holdings of Yen. Credit: increase in foreign currency reserves. d. Debit: current account service outflow. Credit: financial account decrease in foreign assets. e. Debit: current account goods outflow. Credit: financial account other investment. f. No entry, as the transaction is internal to foreign subsidiaries.

Step-by-step solution

Japanese investor buys Thai stock with Singapore bank

When a Japanese investor purchases a share of a Thai company and pays with a check from a Singapore bank, there are two transactions in the balance of payments. The debit entry will record an increase in the Japanese investment abroad under the financial account as an outflow. The credit entry will reflect a decrease in Japanese banks' foreign assets, as the payment is made from a Singapore bank, also under the financial account.

Japanese investor buys Thai stock with Japanese bank

In this case, the debit entry will be the acquisition of the Thai stock, recorded under the financial account as an outflow of investment. The credit entry will be the reduction in domestic bank assets, as money flows out of a Japanese bank to Thailand, which is recorded under the financial account as well.

Malaysian government foreign exchange intervention with Yen

During the Malaysian government's foreign exchange intervention, the use of Yen will constitute a debit entry as it represents a decrease in foreign holdings of the Japanese currency and is reported under the Reserve Assets in the financial account. The credit entry happens as the Malaysian government increases its foreign currency reserves, which will be an inflow in the same Reserve Assets category.

Tourist from Kyoto buys a meal in Bangkok with traveler's check

The purchase of a meal by a tourist using a traveler's check results in a debit in the current account under travel services because it is spending on goods and services abroad. The credit entry reflects a decrease in Japan's foreign assets as the traveler's check is cashed in, which is recorded under the financial account.

Saké brewery contribution for a Paris winetasting event

A saké brewery’s donation of saké for a Paris event will appear as a debit under the current account since it is a gift of goods. Correspondingly, the credit entry will be under the financial account as other investment, assuming the product is a donation and does not involve financial claims.

Japanese-owned factory in Germany buys machinery with local earnings

When a Japanese-owned factory in Germany uses its earnings to purchase additional machinery, there is no direct transaction involving Japan's balance of payments, as both the earnings and expenditure occur outside of Japan. Therefore, it does not generate a debit or credit entry in Japan’s balance of payments.

Key concepts

Financial Account

Understanding the financial account in the balance of payments is crucial for grasping the broader picture of a country's financial interactions with the rest of the world.

The financial account tracks transactions that involve the transfer of ownership in foreign financial assets and liabilities. These include investments in foreign stocks, real estate, or bonds, and also changes in holdings of foreign currency. When a Japanese investor buys shares of a company abroad, like in the Thai stock market case using a Singapore bank, it's recorded in the financial account as a debit, indicating an outflow of capital.

Similarly, if the payment were made from a Japanese bank, this would still be considered an outflow and recorded as a debit in the financial account. The credit entry, in this particular context, occurs due to a decrease in Japanese bank assets or a decrease in Japan's reserve assets when used for foreign exchange interventions.

In summary, the financial account provides a clear image of a nation’s external wealth and debt status by tracking the movement of financial resources across borders.

Current Account

The current account is a primary component of the balance of payments and reflects a country's net income over a period of time. It includes the trade in goods and services, primary income (like dividends and interest from foreign investments), and secondary income (which involves transfers like remittances).

For instance, when a Japanese tourist pays for a meal in Bangkok with a traveler’s check, it records as a debit in the current account under travel services, signifying an outflow of funds for services. Meanwhile, the contribution of saké bottles to a Paris event would appear as a debit for goods, once again reflecting an outflow.

The current account is essential for determining a country's financial health as it indicates whether a country is a net lender or borrower in relation to the rest of the world.

Foreign Exchange Intervention

Understanding the Impact on Balance of Payments

Foreign exchange intervention is an act by a government or central bank to influence the value of its currency in the foreign exchange market. When the Malaysian government uses Yen to purchase its own currency, it's conducting such an intervention.

This action results in two entries in the financial account of Japan's balance of payments. The debit entry records the outflow due to a reduction in the foreign currency reserve, with Yen leaving the Japanese system. Concurrently, the credit side reflects the increase in foreign reserves for Malaysia, which is, in fact, an inflow from Japan's perspective.

Interventions can stabilize or devalue a country's currency value, thus affecting trade competitiveness, economic growth, and inflation rates.

International Investment Position

The international investment position (IIP) is a financial statement that provides a snapshot of a country's financial assets and liabilities at a particular point in time. It complements the balance of payments by offering a stock perspective, whereas the balance of payments provides the flow of funds.

The IIP includes the accumulation of all financial account transactions. For example, when Japanese investors acquire assets abroad, whether in physical form like a factory in Germany, or financial assets like stocks, these are reflected in the IIP. The factory example from the exercise doesn't affect Japan's balance of payments at the transaction time, but it does influence Japan's IIP by increasing its foreign assets.

Regular monitoring of the IIP is crucial, as it reveals a country's vulnerability or strength financially. A lot of external debt reflected in the IIP could signal potential economic instability, while a solid position could highlight economic robustness.