jmherbenerA Balance of Payments Account simply records the transactions between people in one country and people in other countries. In the unhampered market, such accounts would indicate the differing preferences of people. For example, if Americans preferred foreign made goods relative to Chinese preferences for American made goods, then the BoP Account would show a Trade Deficit (i.e., net inflow) for the U.S. and a Trade Surplus (i.e., net outflow) for China. To take another example, if Americans have high time preferences and the Chinese low time preferences, then the BoP Account for the U.S. would show a net inflow in the Capital Account and the BoP Account for China would show a net outflow in the Capital Account for China. These are examples of natural and healthy results of the division of labor.
A BoP Account always balances. The account is split into the Current Account and the Capital Account. Any deficit in the Current Account is balanced exactly by a surplus in the Capital Account. Here is a brief discussion of the BoP:
http://www.econlib.org/library/Enc/BalanceofPayments.html
The problems we face are created by government policy, at most the BoP are a symptom of bad policy. The BoP are always “settled,” i.e., always in balance. The government has to settle its own financial affairs, not the BoP.
If interest rates rise back to historical levels, capital values will collapse. This will reveal the extent of mal-investments and set in motion a liquidation and reallocation process. Whether this process is smooth and quick or rough and prolonged depends on the extent of government interference with it.
If the dollar were redeemable for gold again, foreigners would have incentive to drain our gold reserves if the government undervalued the dollar in terms of gold. If the government redeemed an ounce of gold for $35, then its gold hoard would be quickly redeemed. But if the government redeemed the dollar at the current ratio of currency outstanding (which is around $1 trillion) to its gold hoard (which is 250 million ounces), then an ounce of gold would be redeemable at $4,000. Given gold’s current price of around $1,600 an ounce, it would be ruinous to redeem.
Take a look at Joe Salerno’s article on BoP: