Like any business, a country has to keep track of its inflow and outflow of goods, services, and payments. At the end of any given period, every country has to look at its own “bottom line” and add up all international trade and investments.
The narrowest measure of a country’s trade, the merchandise trade balance only counts “visible” goods such cars, food, and computers. This measure is often referred to in the press as the “trade balance” even though it actually includes only tangible goods – those that can be loaded on a ship, on an airplane, on a mule, or any other means of transport that moves goods from one country to another.
Due to today’s awesome technology and globalization, it’s much more important to look at total trade – including services, such as tourism and movies. When services are added into the picture, a country’s trade balance is called a current account.
It may not be obvious, but many countries’ exports and imports of services make up a big part of their foreign trade. For example, Hollywood movies earn more money abroad than they do in the United States excluding J. Lo movies. Tourism, for many countries, such as Italy or Jamaica, also provides huge earnings. A tourist’s purchase of hotel and restaurant services abroad counts just as much as a consumer at home buying an imported car.
The current account shows us which countries have been profitable traders – running a trade surplus, with money in the bank at the end of the year (like Canada and China) – and which countries have been spending willy nilly (United States) – spending more abroad than they have earned.
Countries with a current account surplus often use their extra money to invest abroad (China buying US stocks) – or simply put the money in their national “piggy bank” of foreign currency reserves, which are usually held at the central bank.
In theory, no country can run a current account deficit indefinitely. Before long, a country running a consistent trade deficit will see its currency value depreciate as it buys more and more foreign money to pay for imports.
Countries running a current account deficit usually look abroad for financing, either in the form of loans or investments abroad. Since most countries hate to see their assets being bought up by foreigners, they try to run trade surpluses or dip into their foreign exchange reserves to pay for the difference. All these payments in and out constitute the country’s capital account.
The widest measure of a country’s trade is called the balance of payments. It includes not only goods and services, but also all the payments from the country’s capital account. It is called a “balance” because, in theory, all the payments in and out add up at the end of the year.
Every orange, every car, every investment –basically every payment that crosses a country’s borders – is included in this final tally of international trade and investment.