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My book states a higher CAD necessarily increases net foreign debt/net foreign equity, and I'm a bit confused by this assertion. See, I can understand how a higher current account deficit may sometimes be due to higher deficits in net primary incomes, which would signal increased dependence on foreign capital, which would increase net foreign debt. HOWEVER, a CAD could be caused by higher deficits in the goods and services sub-account - this in itself wouldn't cause the net foreign debt/equity to increase as theres no lending of capital going on, just the purchase of imports (right?). So this contradicts the book's assertion that CAD raises NFD/NFE always... can someone please clear up the confusion here? Thanks.

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The balance of payments identity states that the current account and financial account sum to zero: if you have a current account deficit, you have a financial account surplus. This identity comes directly from the simple accounting principle of double-entry bookkeeping, whereby each transaction show up in the balance of payments as a debit and as a credit. A financial account surplus means that you have positive "net exports" in assets: you are issuing new debt to foreigners and/or reducing your holdings of foreign assets, both of which reduce your net foreign assets.

By way of example, when Canada imports an F-150 truck from the US, that reduces Canada's trade balance and shows up in the current account as a debit. But that is only half of the story, as you have to pay for the truck. Whether you pay cash or take out a loan from Ford US, that shows up as a credit in the financial account and reduces your net foreign assets.

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  • $\begingroup$ "Whether you pay cash or take out a loan from Ford US, that shows up as a credit in the financial account and reduces your net foreign assets." Sorry but I dont quite follow. If you pay for it in cash how are you reducing your net foreign assets exactly? You're just giving them cash, not giving them assets...? $\endgroup$
    – Sam
    Jun 4 at 23:06

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