The Augmented Balance of Payments Identity
The traditional balance of payments identity does not take into account changes in asset prices and exchange rates. For example, the value of external assets or liabilities can change due to higher or lower stockmarket prices or a default/write-off on debt. Similarly, changes in exchange rates will affect the value of foreign assets and liabilities. An appreciation of a country's currency will decrease both the value of assets denominated in foreign currency and the burden of liabilities denominated in foreign currency. The value of assets and liabilities denominated in the home currency will not be affected by changes in the exchange rate.
Suppose the same country has some assets it owns abroad, and the value of these assets appreciates by $700 billion. The appreciation of asset prices, referred to as "positive valuation effects" in this case exactly offsets the current account deficit. At the end of the day, the country's net foreign asset position remains unchanged, despite the $700 billion current account deficit.
The effect will be the same if the value of the country's external liabilities falls by $700 billion, or the gains in value of its foreign assets minus the gains in value of its liabilities is $700 billion.
The net foreign asset position equals the current account plus valuation effects:
Read more about this topic: Net Foreign Assets
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