In essence, the capital account tracks investment by the domestic sector in foreign assets going in one direction and investment by the foreign sector in domestic assets going in the other direction. These investments are for the purchase of physical capital, such as factories and equipment, or financial capital, such as currency and bonds.

The two primary players in the capital account are businesses and governments. Businesses undertake the bulk of the investment in physical capital, which is used for the obvious purpose of engaging in production. Governments purchase a lot of currency, which is used by their central banks to undertake exchange rate policies.

Balance of Payments for Northwest Queoldiola

Capital Account, Balance of Payments

The chart to the right presents the hypothetical balance of payments for Northwest Queoldiola stated in terms of queolds, the hypothetical Queoldiolan currency. The balance of payments for real world countries is generally stated in terms of their domestic currencies (such as dollars for the United States or reals for Brazil).

First note that this chart contains two major sections, Current Account and Capital Account. Near the bottom of the chart is a summary Balance of the Current and Capital Accounts, which combines the two sections. At the very bottom is the overall Balance of Payments.

Two Capital Account Components

• Domestic Investment in Foreign Sector: A click of the [Dom Inv] button highlights this portion of the Capital Account. This is the net flow of payments used by those in the domestic economy to purchase financial and physical assets in other nations. The bulk of this category is purchases of foreign assets, especially physical capital, made by private domestic businesses. However, it also includes purchases of foreign assets, primarily financial assets, made by the domestic government (usually the central bank and usually in the conduct of exchange rate policies).


• Foreign Investment in Domestic Sector: A click of the [For Inv] button highlights this portion of the Capital Account. This is the net flow of payments used by those in the foreign sector to purchase financial and physical assets in the domestic economy. Once again, the majority of these payments is for the purchase of domestic physical capital by foreign sector businesses. However, purchases of financial capital issued by the domestic government, especially currency, is notable.

Exchange Rate Policies

Current Account

The sum of the balance on merchandise trade and the balance on services (excluding unilateral transfers) is technically termed the balance on goods and services and is more commonly termed the balance of trade. This value is positive if the exports of goods and services exceeds the imports of goods and services, which is a balance of trade surplus. A balance of trade deficit occurs if the exports of goods and services falls short of the imports of goods and services, and the resulting value is negative.

A Balance of Accounts

Hardly. Summing the balance on the current account and the balance on the capital should, in theory at least, equal zero. That's what the "balance" in balance of payments is all about. Any net flow of payments for goods and services is offset by an equal but opposite net flow of payments for capital investments. In the balance of payments, the current account and capital account balance out to zero (in theory).