proceeds of foreign security flotations in this market and the use of dollar balances to purchase long-term obligations from domestic holders. These transfers of funds entail no conversions of dollars into foreign currencies, but they clearly involve payments between residents of the United States and residents of foreign countries. In each case a debit or credit entry on long-term capital account is counterbalanced by a credit or debit entry on short-term capital account. It should be emphasized in this connection that changes in the market values of United States investments in foreign countries and of foreign investments in this country do not enter the balance of payments, nor do earnings on investments which are not transferred. In neither case are payments made between residents of the United States and residents of other countries. Fluctuations in the market values of international investments are, of course, not entirely unrelated to changes in balance-of-payments entries. For example, a rise or a fall in market values may reflect changes in general economic conditions which will bring receipts and payments of income on investments to higher or to lower levels, respectively.

The uses to which a summary statement of the balance of international payments of a country may be put are so varied that it is difficult to devise a method of presentation which suits every purpose and convenience. Interest in the balance of payments of the United States centers in some instances upon the trend of individual items; in other cases, attention is directed principally to the significance of the statement for various aspects of the theory of international trade. The elaboration of the tourist account in the text of this bulletin is an example of the effort to meet an interest in particular items. To satisfy broader purposes, the items are classified in a conventional fashion. Transactions involving the exchange of goods and services are grouped together in a commodity and service account. This category of international payments comprises what is generally called the current account, as distinguished from the capital account and from movements of the money metals.5 Many students of the balance of payments justify the segregation of trade and service items upon the ground that they constitute final payments, whereas international capital movements are reversible lending operations and transfers of gold and silver constitute transactions of especial monetary significance. A more compelling justification, perhaps, inheres in the fact that merchandise and service transactions in the balance of payments of a country usually display a certain continuity and conform to a definite pattern, the relatively permanent outlines of which are fixed by the habits of its people, by its natural resources and productive capacities, by its laws, and by demographic factors such as the presence of large numbers of foreign-born persons with relatives abroad, and the shifting lines of which are traced by cyclical fluctuations in busi

For these and related reasons, the capital account in the balance of payments cannot be used as the basis of revisions in estimates of international investments (see below, pp. 53 and 63).

There are dissents from even this widely accepted classification. A distinction between the exchange of goods and services and receipts and payments of interest and dividends, which arise in part from contractual relationships between debtors in one country and creditors in another and which are functionally related to antecedent movements of capital, has been advanced as a reason for excluding interest and dividend items from current account. The segregation of current items, from capital transactions in particular, is in any case not entirely precise. For example, personal remittances to foreign countries, classified as immigrant remittances and as a service item, embrace the transfer of individual savings from domestic banks (or hoards) to foreign depositories, which is a movement of capital rather than a gratuity bestowed upon a foreign beneficiary. Some government transactions are likewise in the nature of capital movements, and, under certain conditions, an outflow of capital may take the form of exports of readily salable mer. chandise.

ness activity. Capital movements and shifts of the money metals, on the other hand, are often extremely volatile and respond quickly to political developments and to economic circumstances which may be of a purely temporary or erratic character.

Some observers have contended that transactions in gold and silver should be classified as trade in merchandise upon the ground that both are purchased and sold on a commodity basis. Although this is generally true in the case of shipments from producing countries, the conceptual distinction between movements of gold and silver as commodities and their movements as money metals cannot be carried into practice. Furthermore, to classify gold, or, under present circumstances, silver, as merchandise would tend to obscure the peculiar functions of the money metals in international finance.

It should not be inferred from these comments that the present classification of the various items entering the balance of payments of the United States is fixed and final. For example, movements of United States paper currency have been twice reclassified. Originally grouped with capital transactions, they were subsequently placed with gold as a "pure cash" item and, more recently, returned to the capital account. As another example, exports and imports of silver were listed with merchandise trade as long as they were of small magnitude and of no monetary significance; but, with the provision for the purchase of silver until the proportion of silver in the stocks of gold and silver reached one-fourth of the monetary value of such stocks, under the terms of the Silver Purchase Act of 1934, they have been included in the same category with gold. In any case, the items shown in the summary statement are reported elsewhere in sufficient detail to make possible almost any conceivable reclassification of items for virtually any possible purpose.

Perhaps the most frequent source of confusion arising out of balanceof-payments terminology is in the treatment of gold and of capital transactions. An export of gold (or gold placed under earmark for foreign account in the United States or gold released from earmark for American account abroad), although a "loss of gold," is entered in the balance of payments as a credit because it involves payment to this country by foreigners; an import of gold (or gold released from earmark for foreign account here or gold placed under earmark for American account abroad), although a "gain of gold," is a debit transaction since it requires payment by the United States to foreign countries. The confusion often attending the treatment of capital flows may be eliminated if emphasis be placed on the fact that a socalled export of capital represents an import of evidences of indebtedness or the creation of claims upon foreigners (or the extinction of foreign claims upon this country), for which payment must be made by the United States. Similarly, a so-called import of capital represents an export of evidences of indebtedness or the creation of foreign claims upon this country (or the extinction of American claims upon foreigners), for which payment is received. Thus, from the point of view of balance-of-payments itemization, the sale of a security to a foreigner by a domestic holder or the creation of a dollar balance in favor of a foreigner is similar to the sale abroad of merchandise or services, and the purchase of securities from foreign holders or the

82138-38- 2

deposit of liquid funds in foreign countries by residents of the United States is similar to the purchase of goods or services from foreigners. For general purposes, it seems preferable to speak simply of an inflow or an outflow of capital funds involving, respectively, receipts from foreigners and payments to foreigners.

The terms "visible" and "invisible" trade, historically related to the fact that tangible articles are generally subject to official scrutiny and evaluation at the time of crossing a national boundary, have become archaic and meaningless. There are few types of international transactions which leave no trace, although by no means all are the concern of the customs authorities. No tenable distinction can be made upon the basis of relative accuracy, for the estimates of some "invisible" service items are perhaps more accurate approximations for balanceof-payments purposes than recorded exports and imports of merchandise. Finally, the importance of international transactions which do not appear in the trade returns no longer needs emphasis by special designation.

In itself, the statistical summary of the balance of international payments of a country indicates no functional or causal relationships among the items which compose it. These must be established upon the basis of collateral facts, of quantitative comparisons over relatively short periods of time in series, or of theoretical demonstrations. Certain interrelationships are evident, although not necessarily simple. For example, exports and imports of merchandise are functionally related, in the balance of international payments of the United States, to receipts and payments on freight and shipping account. Receipts for shipping services generally increase or decrease with increases or decreases in commodity exports; and payments for shipping services usually vary directly with changes in merchandise imports, provided that there are no violent shifts from year to year in the relative proportions of exports and imports transported by domestic and foreign carriers and provided also that there are no drastic changes in the types of goods exported and imported or carried respectively by domestic and foreign carriers.

Another functional relationship exists between interest and dividend receipts and payments and movements of capital funds. Transactions tending to increase United States investments abroad in any year may increase receipts from foreigners on interest and dividend account in the same or in subsequent years; but this result depend obviously upon the nature of the new investments, as well as upon the rate of return from a far larger volume of accumulated investments in

Receipts consist largely of freight and shipping charges on exports transported by domestic carriers and payments principally of charges on imports transported by foreign carriers, charges which are not included in export and import entries.

7 The relationship, in the case of exports, is one chiefly between the quantity of trade and receipts for shipping services and, through the influence of changes in quantity upon value, between the value of exports and receipts on freight and shipping account. The improbable circumstance of an increase in the quantity of exports more than offset by a decline in unit values might result in an increase in shipping receipts at the same time that the value of exports was falling. Or, an increase in exports might occur conceivably at a time when shipping rates were rapidly declining, with the consequence that the receipts of domestic carriers for the carriage of exports would also decline in spite of the expansion of export trade. Similar qualifications might be made to the proposition concerning the relation between merchandise imports and payments for freight and shipping services. However, the apparent exceptions to these generalizations in the post-war history of the balance of payments of the United States reflect, with perhaps a few exceptions, merely the lack of comparability in the estimates of freight and shipping receipts or payments in a number of consecutive years. It does not follow, however, that a relatively greater increase in exports than in imports will result in reduced net payments to foreigners on freight and shipping account. Unless the percentage change in export trade is very considerably higher, the contrary may be true, as in 1937, because of the greater magnitude of gross payments to foreigners. Obviously, too, under the same circumstances, an increase in shipping rates affecting receipts and payments proportionately would result in larger net payments.

foreign countries. On the other hand, transactions tending to decrease United States investments abroad may have the effect of decreasing receipts from foreigners on interest and dividend account. Thus, the steady decrease, through redemption and repurchase, in foreign dollar bonds held in this country has contributed to the decrease in receipts of interest from this source in recent years. Similarly, the movement of foreign funds to the United States for investment in securities or properties may increase payments to foreigners, and liquidation may reduce them. However, if the funds move principally into or out of liquid balances upon which no interest is allowed, the effect upon interest and dividend payments may be negligible or nil or may be offset by other influences bearing upon the item.

Among the relationships (perhaps of temporary significance) which may be established upon the basis of data for relatively short periods of time is that between the heavy inflow of capital to the United States and the correspondingly heavy imports of gold in the years 1935-37. Comparative monthly data show clearly that gold was the medium by which the transfer of capital was effected-a fact which could have been postulated, of course, upon a priori grounds in view of the extraordinary size of the movement.

Relationships of these types should be sharply distinguished from the merely fortuitous equivalence of credit and debit items in the balance of payments. Such coincidental similarities in magnitudes may be properly cited in order to emphasize the relative significance of various classes of international payments, provided that there is no imputation of a necessary causal connection. That arithmetical demonstrations of causal relationships between individual balance-of-payments items are usually fallacious follows directly from the fact that any particular credit transaction gives rise to a claim upon a foreign country which, through the operation of the foreign-exchange market, becomes a part of the mass of claims available, without distinction as to origin, for purchase by persons with commitments to meet in foreign countries. Beyond the more evident functional relationships or, under certain conditions, relationships deduced from the comparison of time series,10 resort must be had to theoretical proof of the connection between particular types of balance-of-payments transactions.

Clarity in the interpretation of changes in the balance-of-payments position of a country is promoted by distinguishing carefully between influences which originate outside the balance of payments and influences which arise within the balance of payments that is, in the latter instance, influences arising out of balance-of-payments transactions themselves. For example, the threat of confiscatory taxation, a factor extraneous to the balance of payments, may cause liquid funds to flow out of a country. The outward movement of capital may affect, in turn, through the mechanism of the exchanges, other international transactions. If the movement is extensive and concentrated within a relatively short period of time, it will probably produce an outflow of gold of similar proportions." Or, if the ex

These relationships are of a long-term character; short-term fluctuations in interest and dividend re. ceipts and payments are determined primarily by influences only distantly connected with movements of capital. For example, the returns from direct investments are affected chiefly by the state of business at home and abroad.

10 The correlation, however close, of annual data pertaining to presumably related balance-of-payments tems may demonstrate nothing beyond the pervasive character of cyclical influences.

This may happen whether or not the authorities of the country are committed by statute or by policy to a stable exchange.

changes are free, the transfer of capital may so depress the exchange value of the currency that a counterbalancing inward movement of short-term funds will occur.12 As another possibility, the cheapening of the currency may stimulate an anticipatory commercial demand for it in foreign centers and perhaps increase marginal sales of domestic goods to foreign buyers and curtail marginal purchases of foreign commodities. Again, if the movement of the exchange rate is pronounced and if the consequent low cost of travel in the country is well publicized, the expenditures of tourists from foreign countries may be affected.13

One of the more prevalent misconceptions regarding the capital account in the balance of payments is the belief that it provides the necessary data for a close calculation of the change during the year in the international investment position of a country. This is substantially true, of course, in the case of movements of short-term capital. In the case of long-term capital movements, on the other hand, changes in the value of a relatively large mass of existing investments may be much more important than, and may more than offset, the reported annual transfer of funds. For example, despite substantial net purchases during the year, the common shares of United States corporations held by foreigners had clearly a smaller aggregate market value at the end of 1937 than at the end of 1936. This lack of correspondence between capital flows and investment position is illustrated also by the plowing in of earnings and by appraisal surpluses and deficits in the case of direct investments and by the repudiation of bonds and by the purchase or repurchase of bonds at discounts or premiums in the case of portfolio investments.

Other misapprehensions concerning the balance of payments often represent deductions from the comparatively simple international relationships of a century ago. Propositions based upon a balance of payments consisting primarily of an exchange of goods, possibly also of lending operations and of the attendant payments of interest and repayments of capital sums, and of movements of gold under the conditions associated with the "old" gold standard cannot be applied to the exceedingly complex international transactions of a modern commercial country. Among these are the assertion that an excess of commodity exports or imports is balanced by imports or exports of gold, the contention that a mature creditor country must buy more goods from foreign countries than it sells to them, and the generalization that foreign loans take the form of merchandise exports. Attempts to demonstrate the necessity of any particular balance-of-payments structure become especially futile in the light of the variety and quantitative importance of service transactions and the extraordinary magnitude of contemporary capital movements.

RESIDUAL ITEM

Since, by definition, the balance of international payments of a country consists of payments effected, within a stated period of time,

1 For example, this may be the result of profit taking on earlier speculative positions. Or, even though the spot rate shows acute weakness, the currency may be quoted forward at a premium. Under these conditions, it would be profitable for banks to place funds in the country concerned and to buy back foreign currencies at a discount in the forward market.

13 That the relative cheapness or dearness of travel as a result of exchange and internal price situations are powerful influences upon the volume and the direction of the international tourist traffic cannot be doubted in view of the evidence accumulated during recent years.