## Appendix To Chapter 16

In this chapter, we studied external wealth, but individuals and countries care about their total wealth. How does external wealth relate to total wealth?

External wealth is only part of a country’s total wealth, the sum of the home capital stock (all nonfinancial assets in the home economy, denoted K) plus amounts owed to home by foreigners (A) minus amounts owed foreigners by home (L):

In this definition, note that we deliberately exclude financial assets owed by one home entity to another home entity because in the aggregate these cancel out and form no part of a country’s total wealth.

Changes in the value of total wealth can then be written as follows:

There are two kinds of terms in this expression. The total value of wealth (of a person or a country) may change due to additions of assets (such as purchases, sales, or net gifts) or due to valuation effects (capital gains—or, if they are negative, capital losses—arising from changes in the prices of assets).

The previous equation can be simplified by two observations. First, additions to the domestic capital stock K have a simpler expression: they are known as investment, denoted I. (Strictly, this is the gross addition to the capital stock; the net addition would require the subtraction of depreciation, and in the previous notation that would be accounted for under valuation effects since depreciating assets fall in value.)

Second, additions to external wealth, AL, also have a simpler expression: they are equal to net additions to external assets minus net additions to external liabilities, and as we saw in the main chapter, these are equal to minus the financial account, −FA.

Substituting, we can rewrite the last equations as

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Now, using the BOP identity, we know that CA + KA + FA = 0 so that minus the financial account −FA must equal CA + KA; hence, we can rewrite the last equation as

Notice what has happened here. The BOP identity makes the connection between external asset trade and activity in the current account. We take the connection one step further using the current account identity, S = I + CA, which allows us to write

The message of this expression is clear. As we all probably know from personal experience, there are only three ways to get more (or less) wealthy: do more (or less) saving (S), receive (or give) gifts of assets (KA), or enjoy the good (bad) fortune of capital gains (losses) on your portfolio. What is true about individuals’ wealth is also true for the wealth of a nation in the aggregate.