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International Trade

Capital and Current Accounts

Capital and current accounts are the two components used when calculating a nation's balance of payments.

An account of all exchanges of goods and services, including payments and receipts, from one country to all other countries with which it is involved with trade is known as a nation's balance of payments. The balance of payments has two components: the current account and the capital account. The current account is the net value of exports and imports in a given country. The capital account (also known as the financial account) is the net value of a country's purchases of foreign financial and capital assets and foreign purchases of that country's financial and capital assets. The capital account is not included in the calculation of GDP, while the current account (imports and exports) is included.

The balance of payments is calculated by adding the country's capital account and current account together. In principle, it is calculated by subtracting the change in domestic ownership of foreign assets in a financial account from the change in foreign ownership of domestic assets. In practice, this means adding foreign direct investment to portfolio investment, other investment, and the country's reserve account. Foreign direct investment (FDI) is investment from one country in long-term projects in other countries. Foreign investment adds to a surplus on the capital account, while investment in foreign countries increases the deficit of the receiving country. For example, if the United States invests in Volvo, a company based in Sweden, the United States' capital account increases because of its investment, while Sweden's capital account decreases because it accepts an investment from a foreign nation in exchange for some ownership of Volvo's output. Portfolio investment consists of spending on shares and other investments. Other investment consists of loans issued by banks, while the reserve account is the reserve held by a nation's central bank for the purchase of foreign currency.

The current account is a country's trade balance (exports minus imports) plus net income and direct payments. It assesses the value of the goods and services produced or acquired by a country. A current account surplus arises when the value of net exports of a country is positive; a deficit arises when the value is negative. The current account can be calculated by adding together the values of exports minus imports and current transfers of money from one nation to another. A current transfer is a transfer of wealth from one nation to another, usually in the form of aid. Goods and services add to the current account when they are sold in a foreign market (exports), while goods are subtracted from the calculation when they are bought from a foreign market (imports).

The sum of the current account and the capital account equals zero. The flow of money received from exports (selling goods) is then used to buy foreign assets, and vice versa. The transfer of money between current accounts and capital accounts is cyclical and should leave a nation with no surplus or deficit in its balance of payments.

A surplus in the capital account may not be a positive factor for a country's overall economic health, however, as it indicates the sale or ownership of assets by foreign entities. Conversely, a surplus in the current account is generally viewed as a positive, as it shows an increase in the goods and services sold by a country.