Econ people!!!!! question about flexiable Exchange rates?

Question

when the economoy has completely flexible exchange rates, why the sum of the current account and the capital account is zero?
i dont understand why Balance of Payment(BP)=0 is related to Exchange rate?
thanks

Answer 1

Money inflows must match outflows that is the Balance of Payment=0 so exchange rates adjust to make this true. The exchange rate is the price where supply=demand for currency. Before exchange rates were flexible, countries had to settle imbalances with payments in gold so a negative meant you would run out of gold and a positive meant that some one else would. The exchange rate was adjusted in steps by currency devaluation. Now currency markets do continuous adjustments. Because the US attracts a surplus of investment capital the trade balance is negative.