The Balance of Payments (BoP) is an account of all transactions between one country and all other countries--transactions that are measured in terms of receipts and payments. From the U.S. perspective, a receipt represents any dollars flowing into the country or any transaction that require the exchange of foreign currency into dollars. A payment represents dollars flowing out of the country or any transaction that requires the conversion of dollars into some other currency. The three main components of the Balance of Payments are:

1. The Current Account including Merchandise (Exports Imports), Investment income (rents, profits, interest)
2. The Capital Account measuring Foreign investment in the U.S. and U.S.investment abroad, and
3. The Balancing Account allowing for changes in official reserve assets (SDR's, Gold, other payments)

U.S. Exports are any goods or services produced in the U.S. and sold to other countries in the international market. U.S. Imports are goods or services produced by other countries and bought by individuals in the United States An increase in U.S. receipts (i.e., increased U.S. exports, investment income inflows, or more foreign investment in the U.S.) will lead to increased demand for dollars and an increased supply of foreign currency on foreign exchange markets (individuals and businesses are selling foreign currency and buying dollars). This increased demand will lead to a stronger dollar relative to other currencies. An increase in U.S. payments (i.e., U.S. imports, investment income outflows, or more U.S. investment abroad) will lead to an increase in the supply of dollars and thus a weaker dollar relative to foreign currencies.

The Balance of Payments (2010)

Currently, the U.S. maintains a deficit in merchandise trade -- the trade deficit and, in the absence of strong net investment income inflows, a current account deficit. These deficits are offset by the current account surpluses--the purchase of U.S. assets by foreign individuals and institutions such that net flow of receipts and payments is in balance (allowing for statistical discrepancy) without the need to any type of official transfers.

2.5.1 The (informal) History of the U.S. Balance of Payments

The history of the balance of payments in the U.S. can be divided up into five stages:

Stage I: The U.S. is a young debtor nation (1770-1870) -We have a current account deficit due to the need to import most goods and inability to produce many goods for export. -We have a capital account surplus due to a great deal of foreign investment in the U.S. in the areas of roads, farming, cattle ranches, railroads, and canals.

Stage II: The U.S. is a mature debtor nation (1870-1920) - There is still a current account deficit due to large investment income being paid back to foreign investors based on the investment of stage I. The merchandise account is in surplus -- exports > imports.

Stage III: The U.S. is a young creditor nation (1920-1945) --There is a huge surplus in the current account due to large volume of postwar (WWI) exports. -The capital account is now in deficit due to a great deal of U.S. investment in Europe for postwar reconstruction.

Stage IV: The U.S. is a mature creditor nation (1945-1980) --The current account has a merchandise deficit -- exports < imports but an investment income surplus with a slight net surplus overall. -The capital account is in deficit largely due to postwar (WW II) reconstruction in Europe and Japan.

Stage V: (1980-present) -There is a large (and growing) deficit in the merchandise accounts (The Trade Deficit) and a slight surplus in the investment income accounts. -There is a large surplus in the capital account partially to finance the above merchandise deficit (foreign individuals and banks lending money to individuals in the U.S.) Additionally, since the U.S. has had a low inflation rate since 1982 and consistent economic growth , the U.S. has been a good place to invest relative to the rest of the world. However the current inflow of capital investment could eventually lead to large investment income payments in the near future. The investment income surplus we now enjoy may soon be eroded thus worsening the current account deficit.