Current Account - Explained
What is a Current Account?
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What is a Current Account?
Current account refers to the summary of all transactions (including imports and exports) involving goods and services which are related to income generation.
The balance of trade or the current account balance which includes other international flows of income and foreign aid. The four components of the current account balance include:
- Income Receipts and Payments
- Unilateral Transfers
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How is the Current Account Used?
A current account balance refers to an accounting document which forms part of the payment balance structure. It is generally seen as an economic indicator of how a country economically associates with other countries or regions. Unlike the balance of capital and financial balances that outline financial assets and investment accounts, current account balance breaks down the purchase and sales that a country makes on goods and services with other countries. In other words, the current account balance provides a summary of all imports and exports of goods and services that a country makes, thus, relating to national income generation.
Balance of Accounts International Trading
Current account balance refers to the country's balance of trade and reflects the level of imports and exports of goods and services of a nation and whether there is an equilibrium between the two. A current account is also concerned with measuring the movement of money in the international arena.
The current account is termed to be well balanced if those living in the country have enough money to engage in buying activities in the country. By those, we mean all businesses, government, and the people. The source of such capital consists of all the savings and income. Purchases entail all that is spent by final consumers, government expenditure on infrastructure and for the growth of businessesOne major objective of most countries is to engage in more exports that they import so that they can accumulate a lot of money. This is commonly referred to as surplus in trading to mean the country will earn more money. In some cases, governments, individuals and businesses may experience trade deficit when they import more products as opposed to those that they export.
The implication of this is that they receive less money from these foreign trade partners and give them more money.The current account forms part and parcel of the nation's balance of payments. The other two components are the financial accounts and capital accounts.
The Four Current Account Components
The Bureau of Economic Analysis classifies the current account into four parts namely net income, asset income, trade and direct transfers of capital.
Trade: Trading in various products and commodities are the major aspects of the current account. As a result, the trade deficit has the capacity to result in a current account deficit. This is true due to the fact that a deficit in products and services has the capacity to offset surplus in direct transfers, asset income and net income.
Net Income: This is the money received by those residing in a country less the money paid to foreigners. This money is mostly gotten from two origins. The first income emanates from foreign assets belonging to the businesses and the residents in a country. These entail dividends and interests earned from foreign investments. The second origin is from citizens working abroadMoney paid to foreigners is usually the same as the first level of payment being dividends and interests earned by foreign internationals who have assets in the nation. Another category is the wages earned by foreigners who are employees in that nation.The net income is said to be positive if the money earned by the country's businesses, government and individuals from foreign entities exceeds the amount of money paid to them. On the other hand, a deficit is brought about if the sum received is less than the amount paid out.
Direct Transfers: This is composed of all the contributions from foreign workers to their home nation, for instance, Mexico earns up to the tune 25 billion dollars from overseas. As far as there are no specific figures, there is a possibility that most of the amount comes from immigrants staying in the United States of America. The current head of state Mr. Donald Trump during his campaigns had alleged that he was going to cancel those payments in case Mexico did not remit the money for the construction of the border wall that he had proposed. He was going to achieve this by the use of the Patriot Act to do away with the payments in the Western Union. This was going to decline Mexicos economic output by 1% and double its current account deficit of 29$ billion.Direct Transfers entails foreign direct investments too. An example is the 22 billion dollars that the United States channels towards annual foreign aid. This in result increases America's current account deficit from the present $502 billion which is the largest globally.The third avenue of direct transfer is foreign direct investments. This occurs when businesses of a country of or residents open investment in other countries. For it to qualify as a Foreign Direct Investment, it must contain at least 10 percent of the foreign firms capital.The fourth means of direct transfer are loans given to foreigners by banks.
Asset Income: This consists of growth or decline in bank deposits, government and central bank reserves, real estate and securities. For instance, if the assets of a nation perform well, the earnings from the assets will be more. Normally, the assets belonging to the United States foreigners get deducted from the asset earning. They entail the following:
- A nations obligation to foreigners like deposits belonging to overseas residents at the banks in the country.
- Loans given to local banks by overseas banks.
- Overseas private buying of a nations government bonds, like the U.S. Treasury securities.
- Disposing of such securities like bonds and stocks through selling to foreigners by the country.
- A foreign direct investment like equities, debt and reinvested earnings.
- Debts belonging to foreigners.
- Assets retained by governments abroad.
- Net shipments of the country's currency to foreign governments
Sub-balances of the current account
According to the VI Manual of the Balance of Payments and the International Investment Position of the IMF, current account balance constitutes four sub-scales: Commercial balance: This balance includes both imports and exports of merchandise. If exports exceed imports, a country is considered to be in a surplus situation. On the other hand, if imports exceed exports, then the country is considered to have a trade deficit. Services balance: This includes operations that are conducted using intangible products such as services offered to other companies, travel services, transport services, and insurance services. Income balance: This balance includes all operations that relate to work remuneration. For instance, wages for work done for a foreign company. Additionally, the income from foreign investment is included including loan interests and dividends. Current transfers balance: This balance entails current transactions which do not need counterparts. The balance includes personal foreign remittances for individuals who have their residence in another country, donations, and aids from the public or private sector.
- Trade Balance: Surplus and Deficit
- J Curve
- National Trade Data Bank
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- Is it better to have a trade surplus or a trade deficit?
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