Most countries involved in global economy carefully keep a record of their financial activities. This record is called the Balance of International Payments. It is a double-entry accounting of the money value of all exchanges and transfers of goods, services, capital loans, and gold and international reserves between the individual residents, businesses, and government of one nation and rest of the world for a given time (usually one year). The exchanges and transfers also include the movement of interest and dividends, gifts, and short-term and long-term investment. All entries are either debits (payments) or credits (receipts), whether or not actual payment is made during the period in question; it is the claim for payment that counts. A debit for one nation automatically represents a credit for another; if an American family visits France and spends＄1 000 there, it creates a＄1 000 debit for the U. S. balance of payments and a＄1 000 credit for the French balance of payments.
A nation's balance of payments is divided into three accounts: current, capital and official reserve, an internationally accepted medium of exchange, formerly gold and today any banking obligation convertible into gold. The current account consists of commodity exports, re-exports, and imports (visible items of trade, or merchandise), and services such as tourism, banking, insurance, and transportation, profits earned abroad, and interest (invisible items of trade). It also includes unilateral transfers, that is, one-way transactions such as grants of foreign aid or individual gifts. The difference between the total export of goods and services and the total imports is called the balance on current account. The difference between total goods (merchandise only) imported and exported is the balance of trade.
The capital account consists of the inward and outward flow of investment capital. It usually is subdivided into long-term and short-term capital flows, based on when claims fall due (if in a year or more, long-term; otherwise, short-term). Short-term classifications include bank deposits, call loans, short-term government bonds, and currency holdings; long-term categories include bond issues sold abroad and direct investment in foreign plant and equipment.
In the double-entry system, payments must always balance over a given period, that is, debits must equal credits. If the combined capital and current accounts show a deficit (with more goods and services and/or capital investment coming into a nation than going out), the difference is made up by the third account, the reserve and gold account, which consists of compensatory gold and reserves movements. Thus, if a nation's debits exceed its credits, it must either export gold or spend of its foreign-currency reserves (usually U.S. dollars) to meet its obligations; if, on the other hand, it has a surplus (credits exceed debits), the statement is brought into balance by an inflow of gold and reserves. Since the creation of Special Drawing Rights (sometimes called "paper gold") on the International Monetary Fund, these have become an important means of offsetting a deficit.
International investment is an important financial activity. It refers to the creation of ownership by a private individual, business, institution, or government of assets—in the form of securities; titles to land, buildings, or equipment; bank deposits; etc. ---in a foreign country. In effect, such investment represents the export of money capital from one country to another, and in fact it is so, represented in that country's balance of payments. International investment may be undertaken either to obtain higher profits (through higher dividends or interest, greater political stability, lower taxes, or expected changes in the exchange rate) or for political, diplomatic, military, or long-term economic reasons. Investment purely for higher profits is usually private, that for political and other purposes is nearly always made by governments. Both private and government investment may consist of either portfolio investment-----that is, securities traded in the conventional securities market of the foreign country in question----or direct investment, that is, the purchase of a controlling interest in a foreign business or subsidiary, which usually involves managerial control over the business and generally also technological input.
Foreign investment holds both advantages and disadvantages for the investor country. If too much capital is invested abroad relative to trade surplus or loans that bring in money, a balance of payments deficit may result. On the other hand, foreign investment not only may lower the prices of imports, but the higher yield on capital invested abroad will eventually return to the domestic economy as dividends are remitted from abroad. Advantages and disadvantages exist for the foreign country as well. Foreign capital can be a good means of stimulating rapid growth, particularly in countries where savings are insufficient compared to potential investment opportunities (as in Australia). On the other hand, most people do not always welcome the idea that their destiny is controlled by foreign capitalists, even when they benefit economically. In addition, direct investment can lead to ruthless exploitation (as in the past in Africa and Latin America), as well as create economic and political rivalries among the in investors that sometimes erupt in warfare. Supporters of foreign investment for underdeveloped nations say that private investment does not have these pitfalls. Nevertheless, since World WarⅡmany individual underdeveloped nations have complained that foreign capital is akin to colonialism and imperialism, and some have responded by nationalizing some or all of the foreign enterprises within their borders.
In the United States an independent Federal agency, the Overseas Private Investment Corporation, was created in 1969 to encourage private American citizens to invest in some 90 underdeveloped nations. One of its functions is to insure investors against the risks of political expropriation and other losses by guaranteeing loans made to eligible private foreign enterprises. It also extends loans and loan guaranties to help finance their projects.
The most important organization that helps each country to handle with financial affairs is the International Monetary Fund (IMF). It is an institution affiliated with the United Nations and set up at the Bretton Woods Conference in 1944 to promote international monetary cooperation, facilitate the expanded and balanced growth of international trade, promote exchange stability, help establish a multilateral system of payments for current transactions among members, and make available to members the fund's resources. Thus the overall aim of the IMF is to minimize imbalances in the international balance of payments of any of its members and to tide them over temporary deficits. A member with a balance of payments deficit can borrow foreign currency from the IMF in exchange for its own currency; it must then repurchase that currency within three to five years with some acceptable currency, although in an emergency it may have up to eight years. In 1962 ten member countries and Switzerland signed a General Agreement to Borrow, making available an additional sum of＄6.2 billion in credit should it be required. Much like a commercial bank, the Fund, which is based in Washington, D. C. , does not make unrestricted loans to just anyone. Rather, its loan decisions are made after careful negotiations concerning changes in economic policy that must be followed by the would-be borrower. Critics point out that although these negotiations are supposed to be apolitical, they rarely are.
In 1969 the IMF established a kind of international paper money in the form of Special Drawing Rights (SDRs), providing for annual increases in international credit. In the next few years SDRs became an important medium of exchange in international trade. In 1974 the IMF decided to expand both its long-term and its short-term lending. The former, represented by an extended "fund facility", was designed particularly to aid underdeveloped nations. The latter, a so-called oil facility, was an attempt to tide over nations whose balance of payments had been thrown badly into deficit by the fourfold increase in Arab oil prices begun in 1973. At the same time the IMF decided to support a managed floating exchange rate. In 1976 it was agreed to set up a new gold trust fund to make more internationally usable money available to the poorer nations. In 1978 the IMF legalized floating exchange rates and planned steps to replace gold with the SDRs as the central international monetary reserve currency. By 1983 the resources of the IMF, which had＄21 billion in outstanding loans, were showing signs of strain, and it was agreed that the pool of currencies and SDRs contributed by richer members should be increased by about 50 per cent, and that the Group of Ten should put up more money as well. Some authorities felt the IMF itself should raise money by borrowing in international money markets, a method long used by its sister agency, the World Bank.
One of the most important international money markets is the Eurocurrency market, which governments, international organizations and companies can rely on to solve their financial problems Eurodollar is the key currency in the market. It is the U. S. dollar held outside the United States, usually as a deposit in a commercial bank. Funds from such deposits, which may be made either by U. S. residents to by nonresidents, are lent either to other banks or to corporate or government borrowers throughout the world. Eurodollars were first created after World WarⅡ, when the United States bought more goods and services with dollars than other nations bought from it with foreign currency, creating a substantial balance of payments deficit. Part of the deficit was made up by American sales of gold, but most of the surplus dollars simply remained in circulation in bank deposits owned by foreigners. These deposits, which until 1971 were freely convertible into gold (by foreign central banks), became foreign exchange reserves for the foreign country in which they were held; since they were convertible into gold they were treated as thought they were gold. Thus foreign banks could indirectly use Eurodollars as a basis for deposit expansion, and the Eurodollar became a substitute for increased gold production, permitting economic expansion. It remained in circulation only so long as European interest rates were somewhat higher than those in the United States; if the American rate was higher, the Eurodollar owner (usually a bank) would "repatriate" the Eurodollar by investing it in securities in America; and the Eurodollar would thus become an ordinary U. S. dollar.
However, European countries tended to keep their interest rates slightly higher in order to prevent excessive domestic inflation. Thus the Eurodollar benefited both lenders, who earned more interest on them, and borrowers, who could use them to circumvent American exchange controls and raise money overseas. Further, Eurodollar funds increased when American businesses bought European firms or set up branches and built new pants in Europe with U. S. dollars that remained in circulation abroad (as Eurodollars). Earnings from these properties enabled the American owner to pay off their loans and repatriate the dollars if they wished. In practice, however, they have continued to use them, along with even more Eurodollars, to acquire other European assets. Other key currencies are used in this way, but none has found so large a market as the Eurodollar. The center for Eurodollar transactions is London. By 1980 the Eurodollar market had grown so that it was the dominant channel for international movements of capital. For many central banks it became the major investment outlet for their reserves. It lent far more than the International Monetary Fund to support countries with balance of payments problems and was a major source of financial aid to less developed countries.
The Eurodollar borrowing rate is based on the London interbank offer rate (LIBOR), which measures the rate at which banks in the foreign market will lend dollars to one another. This interest rate is considered one of the most valid barometers of the international cost of money. Unlike other bank deposits, Eurodollar are not influenced by the monetary policy of the Federal Reserve (because they are out of the United States), or the Bank of England (because they are not a British currency), or any other central bank. For this reason, speculators began trading futures on Eurodollar time deposit rates, a financial future officially approved by the Commodity Futures Trading commission late in 1981. In this trading, no Eurodollar futures contracts actually change hands, just as New York banks operate in the London Eurodollar market without a single dollar bill actually moving between the two cities. Rather, when a contract expires, the exchange on which it is traded averages the interbank rates of the leading London banks on that day, and that is the final settlement price for the delivery.