A nation’s balance of payments

A balance of payments (BOP) is the all monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, and financial capital, as well as financial transfers. After calculation all of the entries in its balance of payments, a nation has either in its balance of payments, a nation has either a net inflow or a net outflow of money.

The nation’s reserves may be compared to an individual’s savings. For a nation, they are maintained in holdings of gold and official deposits in foreign currencies. A deficit in the balance of payments can be accommodated by drawings on (removing some of) the reserves, that is the previous savings. But if a nation’s balance of payments continues in deficit for some time, then the reserves will be insufficient to cover further withdrawals, and additional measures must be taken.

The most direct means of correcting a deficit in the balance of payments and having an immediate impact is by reducing imports. This can be accomplished by imposing tariffs (taxes), quotas (import restrictions), or both. If successful, the cost of imports rises in the local market, and the imported goods are comparatively more expensive to the consumer than locally made goods. When a quota is imposed, the quantity previously imported and paid for is reduced. In either case, the net effect is the reduction of the nation’s outflow of money. Other measures may limit invisible trade expenditures. For example, citizens may be prohibited from taking more than a specified amount of money with them when they travel abroad.

Capital for investments abroad can be restricted by requiring government approval for any new foreign investments. When the United States encountered serious balance of payments problems in the 1960s, the government restricted the loans that United States banks could extend abroad. This was a large item in its balance of payments because of the United States’ role in world finance. The government also restricted the amount that the United States’ corporations could invest overseas.

If these measures are insufficient, a country may devalue its currency. This immediately makes imports mor expensive and exports more competitive, since the importing country can now pay fo the first country’s imports with less of their currency than previously. In time, these advantages are eliminated. A nation must at all times combine devaluation with other effective measures to balance its economy, resulting in a reasonable level of employ meant and low rate of inflation.

Gold has been the traditional reserves. At one time, gold moved freely from country to country, but successive constraints have been imposed in the past years, Today, gold counts as only one form among many in the reserves of a country. A number of countries have an agreement with the Federal Reserve Bank of New York to hold their gold in safekeeping. This makes it possible for these countries to buy gold from one custodian vault to another at the Federal Reserve Bank of New York.

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