Balance of payments (or international balance of payments) is defined as a monetary difference between all transactions that have been executed between the residents of the country with all non-residents. There are four types of international transactions which are accounted in the balance of payments. They are 1) exchange of merchandise, 2) exchange of services, 3) exchange of IOUs, and 4) unilateral transfers.

Two major constituents of the balance of payments are current account and capital account (OECD 2001). Current account reflects the country’s net income and consists of balance of trade, net primary income (also known as factor income and net cash transfers. On the other hand, capital account reflects the net change in asset ownership for the country. According to some definitions, capital account has more narrow meaning, i.e. it is split onto capital account and financial account (see OECD 2001).

Exports generate payments into a country and these types of transactions are called a balance of payment credit. On the other hand, imports generate payments out of a country and these types of transactions are called a balance of payment debit (Heyne et al. 2002). Quite obviously, credits always must equal to debits, and when all the types of transactions within the balance of payment are included, they are summed to zero. If there is an imbalance along some transactions (let us say current account is negative), it is going to be compensated by the country positions taken in other transactions (positive capital account). As a matter of fact, there cannot be overall surplus or deficit.

On the other hand, there can be imbalance along some dimensions of the balance of payments. For example, in the US the merchandise imports have exceeded its exports since 1976, and since 1983, the situation was exactly the opposite, merchandise and service imports have exceeded exports. The prudent question to ask is whether the positive current account or capital account is a good thing? Or, in other words, does it imply that the US economy is strong (or weak)? The logical answer to that question is that the balance of payments is a reflection of the economic situation in the US, i.e. it is not its driving force. If foreigners do not invest in the US economy or – similarly – Americans do not invest abroad, disequilibrium will occur and the markets should adjust through the appropriate transactions made by Americans and foreigners.

In the long run, the existing disequilibrium can be adjusted in several ways. One of the simplest is the adjustment through the foreign exchange rates. In the language of economics, this is known as the purchasing power parity established among the national currencies. Its illustration is straightforward. Let us say 1 USD can buy 0.9 EUR. Then for 1 USD and for 0.9 EUR we can buy exactly the same amount of any good in the ideal world where there are no frictions. This holds for all national currencies without any exceptions.

Therefore, when a country performs poorly and no one wants to invest into its economy, the capital starts leaving the country (this phenomenon is known as the capital flight), and its national currency starts depreciating thus balancing the existing disequilibrium in the capital account. There are various reasons for capital flight to occur (such as increased taxes or lowe interest rates on investments). In 1997 and 1998 during the global financial crisis, this was observed in such countries as Thailand, Taiwan, Indonesia, Brazil, Malaysia, South Korea, Philippines and some others. Some forms of capital flight are illegal, and as it is noted by Kar and Cartwright‐Smith (2009), the volumes of illicit capital flight “out of developing countries are some $850 billion to $1 trillion a year.”