Balance of Payments — Complete: From Identity to Israel's Real Case

Added: 2026-06-03

[00:00:00]Welcome to the explainer. Have you ever  wondered how an entire country, you know, keeps its finances straight with the rest of  the world? Well, today we're going to build a nation's balance sheet right from the ground up.  From a single shipment of goods all the way to a massive international loan. Let's get into  it. So, how does a country balance its books with everyone else? I mean, every single day,  billions of dollars are zipping across borders for everything imaginable. Cars, coffee, investments,  even foreign aid. How does anyone possibly track all of that to figure out if a country is actually  ahead or falling behind financially? Well, believe it or not, there's an official system for this  whole thing. It's called the balance of payments.

[00:00:40]The best way to think about it is like the  ultimate financial statement for a country.

[00:00:44]Its job is to track every single dollar that comes  in and every single dollar that goes out. So, let's break down exactly how it works. Okay, we're  going to start with the part that's probably most familiar to all of us, the commercial balance.  And it's pretty much exactly what it sounds like.

[00:01:00]It just tracks all the goods and services a  country buys from and sells to the rest of the world. It's basically the nation's international  shopping list. Now, before we get to any numbers, we have got to get two key terms straight. On one  side of the ledger, you have credits. That's any transaction that brings money into the country.  Just think of it as income. And on the other side, you have debits. That's any money leaving the  country. Think of those as expenses. Simple, right? Every single transaction from here on out  will be one of these two. So let's plug in some simple numbers to see how this works. Let's say  our country exports $100 million worth of stuff.

[00:01:36]That's money coming in. So it's a credit. But at  the same time the country imports $150 million worth of products from other places. That's money  going out a debit. So after all that buying and selling, where does that leave us? We are in  the red. $50 million in the red to be exact.

[00:01:53]The country spent more on things from abroad  than it earned by selling its own things.

[00:01:58]And this negative number has a specific  name. It's a commercial deficit.

[00:02:04]It just means that when you only look at trade,  more money left the country than came in.

[00:02:09]But is that the whole story? Oh, not even close.  You see, trade is just one piece of this puzzle.

[00:02:16]To really get the bigger picture, we need to zoom  out a little to what's called the current account.

[00:02:20]So, what about all the money that moves between  countries that isn't for a product or a service?

[00:02:25]Think about things like foreign aid or donations  from charities or even money that people working abroad send back home to their families.  These are called unilateral transfers.

[00:02:35]And trust me, they can have a huge impact on  the final balance. Let's look at some real world examples to make this clear. When the US provides  aid to Israel, that's a credit for Israel. Dollars are flowing in. But when Israel provides aid to  say build a hospital in Ukraine or sends a relief mission to Turkey after an earthquake, that's  a debit for Israel, dollars are flowing out.

[00:02:58]Okay, so let's add these grants and aid figures  to our balance sheet. Let's imagine our country received a whopping $250 million in grants, but  only gave away about 20 million in aid. We just add those right on top of our trade numbers and  all of a sudden the total income is $350 million and the total expenses are $170 million.  Wow. The picture has completely flipped.

[00:03:22]And just like that, we're not in a deficit  anymore. After we account for all that aid, our country now has what's called a current account  surplus of $180 million. But hold on, we are not done yet. There's still one more major piece  to this puzzle. All right. Now we move to the financial account. This is where we track all the  money that's flowing across borders for investment purposes. We're talking about buying stocks, real  estate, or even making and repaying big loans.

[00:03:49]Let's walk through the numbers here. So for money  coming in, we had foreigners buy 50 million in local stocks and h 100 million in real estate.  Plus, the government took out a $300 million loan.

[00:04:00]Add that all up and you get $450 million in  credits. But look at the money going out.

[00:04:06]Our own citizens bought half a billion dollars  in foreign stocks and our government paid back an old half a billion dollar loan. That is  a full billion dollars going out the door.

[00:04:16]So when you look at just the financial world, our  country has a massive deficit of $550 million.

[00:04:23]Way more money left the country for investments  and loan payments than came in. All right, this is the moment of truth. We have our current account  balance and we have our financial account balance.

[00:04:33]It's time to put it all together and see where our  nation really stands with the rest of the world.

[00:04:38]Now, the calculation itself is actually pretty  simple. You just take the balance of the current account and you add the balance of the financial  account. But there's a really common trap here that's super easy to fall into. Here's the  crucial thing to remember. You never add the commercial balance separately at the end. And  why not? Because remember, it's already included inside the current account. If we added it again,  we'd be counting that initial trade deficit twice, and that would mess up the whole thing. Okay,  here they are, our two key numbers. A surplus of 180 million from the current account, and a  deficit of 550 million from the financial account.

[00:05:16]Let's add them together and get our grand total.  And the final result is an overall deficit of $370 million. when you account for absolutely  everything, all the buying, the selling, the aid, the investing, our country sent $370  million more out into the world than it took in.

[00:05:35]Now, this isn't just some abstract number  on a spreadsheet. This is a real shortfall.

[00:05:41]A country can't just end the year with a negative  balance, right? It actually needs to find $370 million from somewhere to make its books  balance. So, where does that money come from?

[00:05:53]This is where a nation's emergency fund comes  into play. It's foreign currency reserves.

[00:05:58]The easiest way to think about this  is like a giant savings account that the central bank holds and it's filled with  other currencies like US dollars or euros.

[00:06:06]Its main job is to cover shortfalls exactly like  the one we have right now. And this right here is the final step that makes everything balance out  perfectly to zero. The central bank just dips into those reserves and uses $370 million to cover that  deficit. The books are now officially balanced, but it came at a price. The nation's  savings account just got smaller.

[00:06:30]And that leads us to the really critical question,  doesn't it? I mean, balancing the books one time by using your savings, that's fine. But what  happens to a country's economy, to its currency, to its standing in the world? If it has to do this  year after year after year, just watching that emergency fund slowly drain away, that right there  is the real story behind the balance of payments.

[00:06:53]Today, we're going to do more than just talk about  economics. We're actually going to solve a puzzle, and we're going to use real numbers from  Israel's economy in 2022 to do it. Okay, let's dive right in. What you see here are seven  major financial events that happened in a single year. You can think of them as puzzle pieces. Our  job is to figure out how to arrange these pieces to tell the story of a nation's economy. So,  you're looking at all this, right? exports, loans, real estate. Where do you even begin to make sense  of it all? Well, to solve any puzzle, you need the right tool. And that tool is called the balance  of payments. It's basically a country's official scorecard for every single financial transaction  it has with the rest of the world. The simplest way to think about it is like a country's bank  statement with the whole world. Seriously, money coming in is a credit, like a deposit, and  money going out is a debit, like a withdrawal.

[00:07:46]That's it. Now, what's really interesting  is how we organize all these flows of money.

[00:07:52]We split them into two main buckets. The current  account, which is for day-to-day stuff like trade, and the financial account, which is for  bigger investments. So, let's build this thing out transaction by transaction  and put each piece where it belongs.

[00:08:05]All right, let's start slotting these  in. The government grant and the exports, that's money coming into the country, so that's  a credit in the current account. Imports are also in the current account, but that's money flowing  out. So, it's a debit. Now, things like repaying a loan or buying stocks and real estate in another  country, those are long-term investments. So, they go into the financial account, and since the money  is leaving Israel, they're all debits. But hold on a second. What about that last item? An Israeli  bank paying interest to Israeli investors. H, this is a classic misdirection you see in  problems like this. It's a huge amount of money, but where does it fit in our puzzle? And here is  the absolute number one rule you have to remember.

[00:08:45]Because this transaction happened completely  inside Israel between two Israeli parties, it doesn't belong on the balance of payments at all.  It's not money flowing in or out of the country.

[00:08:55]It's a distractor, a red herring, just to make  sure we're paying attention. Okay, now that we've tossed out that trick piece, we can finally get  to the answer. With all the real international transactions in place, it's time to do the math.  So, first we add up all the credits, all the money that came into Israel. That comes out to  $1.4 4 billion. Then we add up all the debits, all the money that left Israel, and that total  is $1.86 billion. So, what's the bottom line?

[00:09:24]Well, you take the money in and you subtract the  money out, and you get this number, $460 million.

[00:09:32]And that is the solution to our puzzle. So,  what does a negative number here actually mean?

[00:09:37]It means the country spent more foreign money  than it brought in. That's what we call a balance of payments deficit. And just like if you spend  more than you make in a month, you have to dip into your savings, right? A country does the same  thing. To cover that shortfall, Israel had to dip into its savings of foreign currency, which means  its reserves went down by $460 million that year.

[00:09:58]Okay, great. We solved the puzzle. We got the  number. But why should anyone care? Why does this actually matter to a normal person? Well, it  all connects to one of the most powerful forces in the entire economy, the exchange rate. And this  right here, this shows a fundamental economic tug-of-awar. Think about it. When the dollar is  strong, meaning it's worth more shekels, Israeli exporters are thrilled. A million dollar sale  overseas suddenly brings in way more shekels back home. But for importers and regular consumers,  it's bad news. All that stuff we buy from other countries, cars, phones, clothes, it all just got  more expensive. It's this constant balancing act.

[00:10:37]And this doesn't just happen in a vacuum. It  kicks off this powerful chain reaction like a set of dominoes falling through the whole economy.  A higher dollar exchange rate makes exporting more profitable. So what do those profitable companies  do? They expand. They grow. And to grow, they have to hire more people. And more people getting  hired means eventually the entire country's unemployment rate can go down. Now, because this  connection is so incredibly important, you can bet that most countries don't just sit back and  hope for the best. Oh, no. They have a strategy.

[00:11:10]Israel's strategy is something called a managed  float. The idea is to kickstart that exact chain reaction we just saw. So the Bank of Israel  doesn't just watch from the sidelines. It actively jumps into the market and buys up billions of US  dollars. All this buying creates artificial demand which pushes the dollar's value higher and gives  that allimportant boost to the nation's exporters.

[00:11:33]So what's the long-term result of this managed  float policy? Well, look at this number. Over the decades, Israel has built up a massive war chest  of foreign currency reserves. We're talking about $220 billion. This isn't an accident. It's the  financial firepower they've built up from years of strategically managing their currency. And that  brings us right back to where we started with a puzzle. That $460 million deficit we calculated  seems pretty small now, but we can see it's part of a much bigger, much more delicate picture. A  country can manage its currency to boost jobs, which is great. But the trade-off is that it often  makes things more expensive for its own citizens.

[00:12:09]So that leaves us with a final pretty  provocative question for you to think about.

[00:12:12]How much control is too much? And who  gets to decide on the right balance?

[00:12:20]Welcome. Today we are going to do something pretty  cool. We're going to crack open a nation's wallet and see exactly how the money flows. We're talking  every dollar, every euro, every yen that moves in and out of a country to really understand one of  the most important scorecards in all of economics.

[00:12:39]I mean, just stop and think about it for  a second. Every single day, you've got millions of transactions crossing borders. We're  buying cars from Japan, software from the US, tourists are spending money all over Europe, and  investors are snapping up property in London.

[00:12:54]How on earth does anyone keep track of all that?  Well, the starting point, the place where we begin to unravel this whole thing is a country's  total economic output, what we call GDP. And a huge part of that calculation is figuring out  what a country sells to the world, its exports, and what it buys from the world, its imports.  That relationship is really our gateway to understanding this global flow of money. And  the official tool that does all this tracking, it's called the balance of payments. The best  way to think of it is as a country's official financial scorecard with the rest of  the world. It's basically one giant comprehensive statement of all the money that  flowed in and all the money that flowed out.

[00:13:33]Now, at its core, this big fancy report is  just a simple accounting ledger. Seriously, it has two columns. Credits for any transaction  that brings money into the country and debits for any transaction that sends money out. That's it.  Every single international transaction you can think of will fall into one of these two buckets.  So let's break down how that actually works.

[00:13:57]All right, so the first major part of this  report is what's called the current account.

[00:14:03]And this part is all about the day-to-day  short-term stuff. You know, the easiest way to wrap your head around this is to just compare  it to your own personal finances. Think about it.

[00:14:13]Your paycheck is your income, right? And then  you've got your expenses, groceries, rent, going out. The current account is doing the  exact same thing just for an entire nation.

[00:14:24]Okay, so the biggest piece of the current account  is the trade of goods and services. And this part is super straightforward. When our country sells  something to another country, an export, money comes in. So we log that as a credit. And when  we buy something from another country, an import, money goes out. That gets logged as a debit.  Simple. Let's just throw some numbers in here to see it in action. Let's imagine in one year our  country exports $und00 million worth of stuff.

[00:14:52]That's a credit of 100. And let's say we import  $90 million worth. That's a debit of 90. So here's the crucial part. We just subtract the debits from  the credits. 100us 90 leaves us with a positive 10. This is what we call a trade surplus. It just  means we earned more from selling our stuff to the world than we spent on buying their stuff.  And of course, if that number were negative, we'd call it a trade deficit. And by the way,  it's not just about buying and selling things.

[00:15:24]Stuff like foreign aid also gets tracked here. So  if our country gets a grant from another nation, that's money coming in, a credit. And if we give  aid to someone else, that's money going out, a debit. Okay, so that covers the dayto-day money  flow. But now let's look at the second major part of our report, the financial account. This is  where we get into the big long-term investments.

[00:15:46]The analogy here is perfect. If the current  account was like our country's monthly budget, the financial account is like our national  investment portfolio. This is where we track all the buying and selling of financial assets. We're  talking stocks, bonds, factories, real estate, the whole shebang. So, how does this one work? Well,  when a foreign investor buys property or stocks here in our country, money flows in. We call that  an inward capital movement. And you guessed it, it's a credit. And on the flip side, when one of  our citizens buy stock in a foreign company, money flows out. That's an outward capital movement,  and it's a debit. Let's go back to our running example and add this in. Let's say foreigners  invested $200 million in our economy this year.

[00:16:28]That's a credit. And maybe our own investors sent  $300 million abroad to buy up foreign assets.

[00:16:33]That's a debit. But wait a minute, let's do the  math here. On the credit side, the money inside, we've got 100 from exports plus 200 from foreign  investment for a total of 300. Now, on the debit side, the money outside, we've got 90 for imports  plus 300 for our investments abroad, which is 390.

[00:16:52]The books don't balance. We've got more money  going out than coming in. So, what happens now?

[00:16:57]This is my favorite part. This is where the  real magic of macroeconomic accounting comes in because there is one final really critical piece  to this whole puzzle that makes everything balance out perfectly. Let me introduce you to the  secret ingredient. Foreign currency reserves.

[00:17:14]You can think of this as a giant national savings  account, but one that's full of foreign money.

[00:17:19]Dollars, euros, yen, you name it. It's held by  the country's central bank, and its number one job in this context is to be the ultimate balancing  item. And this is just brilliant. Check out how this works. We had a shortfall of 90, right? So  to cover that difference, the central bank simply sells 90 from its stash of foreign currency  reserves. That sale is counted as a credit.

[00:17:41]It's money coming into the domestic economy.  So we add that 90 to the credit side and voila, both sides now total 390. It's amazing. By  definition, the balance of payments always always balances to zero. Okay, I get it. That was a lot  of accounting. But this isn't just some numbers game for economists to play. So why should you  or me or anyone actually care about this reward?

[00:18:05]Because the balance of payments is like a nation's  financial health report card. It tells the entire world if a country is, you know, living within  its means. A big persistent deficit could make your currency weaker, which makes all the stuff  you buy from other countries more expensive.

[00:18:21]It signals to investors whether an  economy is a safe bet or risky one.

[00:18:25]It can even force a government to completely  change its economic policy. It's a huge deal.

[00:18:30]And at the end of the day, this isn't just some  interesting topic. It is absolutely essential.

[00:18:35]You just can't really get your head around the  bigger picture of macroeconomics from economic growth all the way to financial crisis without  first understanding how this fundamental flow of money works. So, I'll leave you with this to  chew on. Now that you know how this all works, how do you think a country that's constantly  spending more abroad than it earns, running a big trade deficit year after year, how might that  eventually impact the prices you pay at the store, the kind of job you have, or even the  value of your savings? It's all connected.