When we buy something from another country, we use the currency of that country to make the transaction. We record international transactions in the balance of payments accounts.
A country's balance of payments accounts records its international trading, borrowing, and lending.
Balance-of-payments accounts are recorded using the regular bookkeeping method.
The main categories of the balance of payments are:
It records payments for imports of goods and services from abroad, receipts from exports of goods and services sold abroad, net interest paid abroad, and net transfers (such as foreign aid payments).
When combined, goods and services together make up a country's balance of trade (BOT). The BOT is typically the biggest bulk of a country's balance of payments as it makes up total imports and exports.
This is where is where all international capital transfers are recorded. It also includes net sales of non-produced, non-financial assets. Capital inflow transactions are recorded as credits and capital outflow transactions are recorded as debits.
This documents all international monetary flows related to investment in financial assets such as bonds and stocks. Also included are government-owned assets such as foreign reserves, gold, and special drawing rights (SDRs) held with the International Monetary Fund.
Analysts often lump financial account and capital account into one category named "capital account," which consists of portfolio investment flows (short-term) and foreign direct investment (long-term).
A U.S. citizen purchases a rug from India for $100. The U.S. debits its current account for $100. Now the Indian rug-maker has two options:
In each case the balance of payments will balance.
The balance of payments must balance, meaning the balances of these three components must sum to zero. A deficit in one area implies an offsetting surplus in other areas. A current-account deficit implies a capital-account surplus (and vice versa).
What do these balances mean in economic terms? A country that runs a current account deficit is spending more than it produces, making up the difference between how much a country saves and how much it invests. A rising current account deficit could imply rising investment or falling saving, or both.
Net exports are exports of goods and services, X, minus imports of goods and services, M. Net exports are determined by the government budget and by private saving and investment.