There is no question the composition of a country's balance of payments is more important than its balance of trade. This does not make the balance of trade unsubstantial; after all, it comprises a large part of the balance of payments. But the balance of trade is only one side of the ledger, and it ignores much of what is really going on in an economy. Think of it like accounting; looking at the net balance of trade is like looking at debits but ignoring credits.

Understanding the Difference Between the Balance of Payments and Balance of Trade

It is unfortunate that the balance of trade, which is commonly known as the trade deficit or trade surplus, receives far more attention from the financial media and press than the balance of payments.

The balance of payments is divided into three parts: the current account, the capital account and the financial account. The current account includes trade-in merchandise and services between domestic and foreign producers and consumers, income receipts and unilateral transfers. The current account is roughly equal to the balance of trade.

Trade deficits and trade surpluses ignore the capital and financial accounts, though. These accounts include foreign ownership of domestic assets, domestic ownership of foreign assets, capital transfers, and the sales and purchases of intangible assets.

Problems With the Balance of Trade

Suppose the U.S. runs a balance of trade deficit with Japan. This means that, for any one period of time, consumers in the U.S. purchase more Japanese goods and services than the Japanese buy from Americans. This sounds like Japan is "winning" at international trade, but this is a silly notion; international trade always benefits both parties.

The Japanese are receiving an excess of U.S. dollars from American consumers and have to do something with those dollars. If they are not buying American products, those dollars have to come back home in the form of investments and assets or else stay with Japanese accounts and indirectly increase the value of American currency. This is the other side of the balance of payments.

  1. Is a deficit in the balance of payments a bad thing?

    Discover how it might be possible to run a balance of payments deficit, what that means in terms of international trade and ... Read Answer >>
  2. What transactions are included in a country's balance of payments?

    Learn about the many types of transactions that are recorded in a country's balance of payments, including the current, capital ... Read Answer >>
  3. What's the difference between the current account and the capital account?

    The current account considers goods and services currently being produced. The capital account is concerned with payments ... Read Answer >>
  4. Does the balance sheet always balance?

    Yes, a balance sheet should always balance. The name "balance sheet" is based on the fact that assets will equal liabilities ... Read Answer >>
  5. How does the balance of trade impact a nation's capital accounts balance?

    Find out how a country's capital account is related to the current account, the financial account, and the overall balance ... Read Answer >>
Related Articles
  1. Investing

    What's the Balance of Trade?

    The balance of trade is the difference between the value of all the goods and services a country exports and the goods and services it imports.
  2. Insights

    What Is The Balance Of Payments?

    The balance of payments helps countries to track how much money is coming in and how much money is going out.
  3. Investing

    What's a Trial Balance?

    A trial balance is a worksheet listing the debit or credit balances of all the ledger accounts for an entity. Under accounting theory, the total of all the debits must equal the total of all ...
  4. Insights

    Exploring the Current Account in the Balance of Payments

    Learn how a country's current account balance reflects the country's economic health.
  5. Investing

    Reading the Balance Sheet

    Learn about the components of the statement of financial position and how they relate to each other.
  6. Personal Finance

    How Credit Card Balance Transfers Work

    The pros and cons of credit card balance transfers.
  7. Insights

    The Balance Of Trade

    The balance of trade is the difference between a country’s imports and exports. A trade deficit occurs when a country buys or imports more goods from other countries than it sells or exports. ...
  8. Personal Finance

    0% Balance Transfers: Can You Beat the Odds?

    Before you accept that 0% balance transfer offer, understand why you got it and who will probably profit most. Only accept if you can beat the odds.
  1. Current Account

    The current account records a nation's transactions with the ...
  2. Account Balance

    1. The amount of money in a financial repository, such as a checking ...
  3. Minimum Balance

    The minimum dollar amount that a customer must have in an account ...
  4. Balance Of Trade - BOT

    The balance of trade is the difference between a country's import ...
  5. Ledger Balance

    The balance of a customer account as shown on the bank statement. ...
  6. Average Daily Balance Method

    A credit card accounting method where interest charges are based ...
Hot Definitions
  1. Intrinsic Value

    Intrinsic value is the actual value of a company or an asset based on an underlying perception of its true value including ...
  2. Bubble

    1. An economic cycle characterized by rapid expansion followed by a contraction. 2. A surge in equity prices, often more ...
  3. Swap

    A swap is a derivative contract through which two parties exchange financial instruments, such as interest rates, commodities, ...
  4. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  5. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  6. Risk Tolerance

    The degree of variability in investment returns that an individual is willing to withstand. Risk tolerance is an important ...
Trading Center