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Why current and capital accounts net out

Intuition behind why the current account and capital account should balance. Created by Sal Khan.

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  • blobby green style avatar for user raghav.kheria
    I still don't understand why Current account and Capital account MUST net out? Lets assume there are no capital account transactions. US citizens don't buy any assets abroad and foreign citizens don't buy assets in the US. However trade continues in a normal way (current account). What happens then?
    (26 votes)
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    • piceratops sapling style avatar for user Alfie C.
      You have to consider that, if there is a net amount of money going out of the US, some foreigner will be holding to that money. Sal forgets to mention that, if the foreigner decides to hold on to the USD without using them to purchase anything, he will still have acquired one of our assets: our currency. That way the capital account will increase to cancel out the decrease in the current account.
      (31 votes)
  • leaf green style avatar for user pierrejan95
    The US should balance its current income and are there ways to solve the Current Account balance?
    (6 votes)
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  • blobby green style avatar for user aswinhanagal
    Is an overall BoP surplus always a positive thing for an economy
    (3 votes)
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    • blobby green style avatar for user samburton1
      No, a BoP deficit could and often is a good thing, as long as it is not huge and continued in the long run. For example if a country was doing really well and growing at a high rate causing the citizens incomes to go up, but the countries in the rest of the worlds economies were stagnating. The country doing well would be able to import more than it would be exporting, as the stagnating countries citizens could not afford to import more.
      (4 votes)
  • mr pants teal style avatar for user rhmtsang
    What about purchases made by tourists to the US? How is it categorized? Export?
    (5 votes)
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  • leaf orange style avatar for user Madeline
    From , if this is the US Balance of Payments, why is the 'Change in official reserves' a negative? Wouldn't it add to America's official reserves? He says it will deplete the reserves of other countries, but aren't the other figures on the Capital Account America's money?
    (5 votes)
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  • male robot hal style avatar for user Enn
    If the current account and capital account always balance, how can there be a balance of payment surplus or deficit when it consist of just them ?
    (3 votes)
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    • blobby green style avatar for user 6266901
      As stated in the previous video, sometimes there are discrepancies because some numbers go unrecorded. For instance, say that someone had an aunt in Germany who was in need of money and so that person sent several thousand dollars overseas to that aunt. This would technically be included in the net transfers of the current account; however, it is quite possible that this transaction could go unnoticed by the government, and therefore not be included in the account numbers.
      If this situation (where American families send money to their relatives abroad and the transactions go unnoticed) happened quite frequently, then that could amount to several billion dollars going uncounted. The value of net transfers would actually be lower (because of all the money sent to foreign countries), yet it would be calculated in the current accounts as a value higher than what it actually is, most likely resulting in a balance of accounts surplus.
      (3 votes)
  • male robot johnny style avatar for user llhpetit987
    What are assets?
    (3 votes)
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  • male robot hal style avatar for user Enn
    Why is a Current Account Deficit much more common than a Capital Account Deficit ?
    Like in the example Sal uses in this video also shows a Current Account Deficit.
    (2 votes)
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    • blobby green style avatar for user Olaide Yinka Kehinde
      First, All this us under balance of payments and you have the Current account deficit means that the current account has more money and/or value of products imported than exported. The you have the Capital & Financial accounts is the account which holds portfolio investment and FDI (Foreign Direct Investment) purchased or sold by foreigners or domestic respectively. Current account mostly reflects trade in goods and services so most developed countries tend to buy goods and sometimes services from developing nations because of their lower labour and unit cost which makes good cheaper compared to buying them domestically and depending on which country it is, the accounts will be in a surplus or deficit. This is mostly within regions of Billions of dollars but the Capital accounts are within the region of millions of dollars so Current Accounts have a bigger affect on Balance of payments which are why they are mentioned more than the other
      (3 votes)
  • male robot hal style avatar for user Enn
    If a deficit in the Current Account will always be balanced by a surplus in the Capital Account why is a current account deficit a matter of concern ?
    (1 vote)
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    • blobby green style avatar for user Olaide Yinka Kehinde
      First, A capital account never really amounts to the same value as the current account, so they never balance each other, however, the most common balancing of accounts are the Trade in goods being in a deficit while trade in services being in a surplus. Why a CAD (current account deficit) matters is that it is a component of Aggregate demand (C+I+G+(X-M)) which reflects GDP growth. A deficit in Current accounts which out weighs the capital account shows of as a Balance of Payments Deficit which is M>X (iMports > eXports) meaning a decrease in GDP
      (3 votes)
  • male robot hal style avatar for user Harry
    Why do the foreigners buy American assets instead of just holding on to their money or trading it on the currency markets?
    (1 vote)
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    • ohnoes default style avatar for user Tejas
      American assets are considered to be extremely safe assets. This is true for a variety of reasons. One reason is that the dollar is incredibly stable. Another reason is that the United States has a very strong rule of law, and strong property rights, which may seem appealing to some foreigners from unstable countries. Additionally, the United States Constitution does not allow it to default on its public debt, which undoubtedly adds another level of confidence.
      (3 votes)

Video transcript

- [Tutor] Let's see if we can give ourselves an intuitive understanding of why the current account balance and the capital account balance nets out and over here I have simplified versions of the current account and the capital account for the US in 2007. We'll just go line by line and think about what this is saying and also think about the big picture in terms of the actual transfer of US dollars. So first right over here on the current account, we see that we have a balnce of trade or we have a trade deficit right over here, the US is importing much more than it is exporting and so for net basis, you're importing a bunch of stuff, you have to pay the foreigners for the stuff you imported and so you have an outflow of funds and this dominates the current account right here, it's the great majority of the current account balance. This right over here, this 95.7 billion, this tells us that in that year, in 2007, Americans got 95.7 billion more in income from assets that they owned abroad than foreigners got in income that they had from US assets, so this was an inflow of funds, a net inflow from that income, but then the US gave away more than that to the rest of the world, now this could be foreign aid from the US government or it could just be American citizens sending payments to their family members in other parts of the country or also doing some type of a donation for some type of aid program or whatever else, but we see that the balance of trade is really what's dominating. So if you really were to look at the current account in very rough terms, especially if you were to focus on the balance of trade, we see what's happening is, what's coming to the US and so let me write over here, this is the US and right over here let me write, rest of world. So the US for the most part, the story that this is telling us is that the US is getting a bunch of stuff and then it's paying for that stuff and then also giving away a little bit more than that and so what the rest of the world is getting, the rest of the world is getting is net 710.8 billion in US currency, so 710.8 billion times so in US currency. But we know that that's not the entire picture, we also have the change in ownership of assets and so what I'm gonna do is I'm just gonna focus on the top two lines of the capital account right over here, which focuses on change, foreign purchases of US assets and US purchases of foreign assets and oftentimes when people talk about the capital account, they're really just talking about these two lines, although technically the capital account is all three of these lines and the way some people differentiate it, this is kind of the narrow definition of the capital account and then the broader definition of the capital account would be all three of these lines. But let's just focus on these two lines right over here, the foreign purchases of US assets and the US purchases of foreign assets. So we see that foreigners are buying many more US assets, than Americans are buying abroad, but we could actually net it out and let's get our calculator to do it. So if we net it out, so foreigners are buying two trillion worth of US assets, so that's an inflow, they have to pay us dollars to buy our real estate and our stocks and whatever else, but then Americans are going out there and they're using those dollars and they're converting it to foreign currency and they're buying other foreigners' assets as well to the tune of about 1.3 trillion, so that's an outflow, so let's subtract that out, 1289.5, so if we just net out these first two lines, we have 768.2 billion, so one way you could view this, if you were to net this out, on a net basis foreigners are buying 768.2 billion of US assets, so let me write it this way. So foreigners are getting US assets, US assets, and in exchange Americans, Americans are getting, what was that, 768.2 billion of currency, now this is an interesting thing, Americans are shipping this currency abroad to buy mainly stuff, some of it's a kind of giveaway, but mainly to buy stuff, 710.8 billion, but more than that is coming back for foreigners buying US assets and so it leads to an interesting question, how is this possible? How is more coming in than going out? And the only way that this is possible, that foreigners are able to ship more dollars to us, than we're shipping to the rest of the world is if the foreigners had a pile of currency to begin with. So if they had a pile of currency to begin with, so let's say that they had this in their central bank, so they have a pile of US dollar reserves, well, maybe we'll have time to go into the details, but you can imagine there's a pile of dollar currency in the rest of the world and the only way that they're going to be able to ship us some more dollars than we've shipped to them is if they dig into their reserves of US currency and how much are they going to have to dig into the reserves? Well, it's just going to be the difference between these two, let's see how much they have to dig into it. So we are sending, this is how much they're shipping to us, we're shipping back to them mainly because of the balance of trade, but in general because of the current account deficit, 710.8 billion and so that leaves, there's 57.4 billion that's not accounted for by what we're shipping to them, so essentially they're going to have to dig into their reserves by 57.4 billion to make up the difference and that's what we have right over here, the foreigner's reserves are going to have to go down by 57.4 billion, so let me write this, this is net, let me make it clear, we could do this as our net change, net change in official, and I'll write it here, foreign, foreign, foreign reserves and in general we view this as the central banks of other governments, they had some piles of dollars around and for whatever reason, they decided to use some of those dollars in foreign exchange markets mainly probably so their own people could go out and buy US assets or to buy US things or transfer money in some way to the US and also we'll go into more detail, so it doesn't affect the exchange rates too much. But this is essentially why these two things add up, any amount that these two things don't add up, any amount by which the current account balance and the narrow definition of the capital account balance do not add up, then that's going to have to be a change in reserves, there's going to have to be in this case more net, more money US dollars are being sent to the US, so someone's pile of US dollars some place in the rest of the world had to be depleted to the effect of $57.4 billion. In future videos we'll talk a lot more about central banks' reserves of dollars and even interesting things about how George Soros made a lot of money by kind of gaming that and all the rest.