Thursday, December 15, 2011

In the balance of payments, why does a Current Account Deficit imply a Surplus in the Capital and Finance Accs?

Quote


"Because the balance of payments always balances, a CAD necessarily implies a surplus on the capital and financial account. Therefore, a CAD paradoxically is a vote of confidence by offshore investors in local investment opportunities"





I don't understand why a CAD (Current Account Deficit) has to imply (by definition) a surplus in the Capital account, why does the money HAVE to come back in equally?





Can someone explain this please, thanks|||It is simply a way that words are used and their defined meaning. It's analagous to saying that if you as a person spend $100 and your income is $65 then you have a debt of $35. By definition your "debt" is equal to your spending minus your income. The balance of payments is just book-keeping of this kind for a country.





The second sentence is not necessarily true. Sometimes, sure, a country is attractive for real and/or financial investment, therefore foreign money comes in, therefore the exchange rate goes up, therefore the current account goes into deficit.





But in other situations a country through incompetence or greed gets a current account deficit, borrows the money to bridge the gap (possibly at high interest rates if banks, wisely, don't trust it to repay on time) and eventually its ability to borrow dries up. Then it has to go to an intergovernmental source of loans for a bailout and to take austerity measures to persuade even them to lend to it. This was the problem Greece ran into recently.

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