Balance of Payments Forex

Given today's economic woes, developing an understanding of macroeconomics is critical for the savvy trader.  Balance of payments is one of the most important elements of understanding a nation's fiscal health and its ability to acquire capital.

What Balance of Payments Shows


The balance of payments data is very much like a cash flow statement for an individual company.  Unlike the balance of trade, the balance of payments reflects only how and by what degree capital is flowing in and out of a nation.

Balance of payments recording can be both positive and negative.  A country accruing wealth could have a negative balance of payments if it makes significant investments in a foreign country.  Likewise, a country in poor fiscal health could show a positive balance of payments if it imports significant amounts of foreign investment capital. 

It is important to remember that the balance of payments does not include the value of the assets, but instead the amount of currency trading hands in nominal terms.

When Balance of Payments Really Matters


A balance of payment crisis can occur when a nation is highly indebted and can neither pay for its imports or exports, nor can it borrow to pay off previous debts.  This phenomenon usually begins with an influx of foreign investment capital that creates an economic boom.  However, as the borrowed or invested capital runs thin, and with few dollars flowing in on the balance of trade, the creditors start to take profits, and the country is often left indebted, but with very little real income to cover its debts. 

Likewise, no creditors are willing to lend it more money to make good on immediate liabilities, since they are mostly interested (at this point) in recouping their original investment.

Balance of payment crises can happen virtually overnight.  The United States, which runs one of the largest current account deficits, but is still regarded as a highly stable nation, could fall into a crisis at any minute should its creditors, namely China and Japan, decide they are no longer interested in buying up more debt.  While these types of situations are extreme and happen most frequently in developing nations, they can and do happen in the developed world. 

To combat current account deficits, the affected country usually turn to inflation to solve their immediate worries.  The result is a precipitous decline in currency values and massive global sell off of the individual currency.  This happened most recently in the 1990s during the Asian currency crisis, where whole governments plunged into bankruptcy in a matter of weeks.
 
As a forex trader, it is paramount to understand the balance of payments, which belies the precarious situation each currency faces.
Tim Ord
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Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...

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