Transcript Net foreign investment

International Trade in Goods and Services
(Measures U.S. Exports and Imports of Goods and Sevices)
Web: http://www.bea.gov/newsreleases/international/trade/tradnewsrelease.htm
Monthly revisions going back several months. Annual revisions in June that go back several years.
As the U.S. economy has moved from a relatively closed economy (1950s–1960s) to one with more international commerce, foreign economic events
(1997 Asian financial crisis, 1998 Russian foreign loan default) are having are larger impact on the U.S. economy. World trade is an
important force shaping the U.S. economy, but unfortunately the trade data is not a good leading indicator. Trade patterns change slowly
because of the long lag time between signing a trade contract and shipping the goods. However, import and export flows can give clues
about domestic demand, industry earnings, pricing power, foreign demand and potential changes in currency values. U.S. firms have
responded to the rise in imports by increasing their efficiency, lowering prices, and pushing to open overseas markets.
Three key forces shaping the U.S. trade balance:
1. Relative economic growth rates between the U.S. and the rest of the world (ROW). Imports are a function of where the U.S. economy stands in
the business cycle. Exports are a function of where the ROW stands in their business cycle. If (DY/Y)U.S. > (DY/Y)ROW , then DM/M > DX/X
=>  trade deficit
2. The U.S. dollar exchange rate (E = euros-to-dollar)
 E =>  Price exports,  Price imports =>  quantity demand of exports,  quantity demand of imports =>  exports,  imports => worsening trade
balance. Research has shown that a 1% rise in the dollar leads to a $10-15 billion fall in the trade balance over 2 years.
3. Relative inflation rates between the U.S. and the rest of the world.
 (DP/P)U.S.=>  quantity demand of exports and an  quantity demand of imports => declining net exports
Three factors could decrease the U.S. trade deficit:
1.  (DY/Y)ROW =>  exports =>  net exports
2. Depreciating dollar =>  PX &  PM =>  X,  M =>  net exports.
(But we could also see rising inflation rates and interest rates with a falling dollar.
Recall Purchasing Power Parity;…. $/e = PLU.S./PL E.U.
Recall real exchange rate;…… r = (e/$) x (PLU.S. / PL E.U.)
3. U.S. households must increase savings and decrease consumption.
The inflation-adjusted numbers track the actual volume (quantity) of goods traded which impacts real GDP. Traded goods have much more volatility
than traded services. Separate tables are broken out for 2 volatile commodities: energy and motor vehicles. Falling oil prices => decrease
imports => increase net exports => increase discretionary spending => faster economic growth.
Data is published on 6 principal end-use categories: food & beverage, industrial supplies, capital goods, automotive vehicles, consumer goods, and
other goods. To analyze changes in trade patterns it is useful to study changes in the six components. For example, an increase in capital
goods =>  firm productivity and efficiency =>  jobs =>  inflation. But an increase in consumer goods => falling net exports and reduced
long-term health of economy.
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Market Analysis:
Bonds:  trade deficit => appreciating dollar =>  (DP/P)ET+1 =>  DBonds =>  iBonds
Stocks:  exports =>  net exports =>  domestic manufacturing =>  future profits =>  PStocks
Dollar:  trade deficit =>  Demand for dollars & de Supply of dollars => appreciating dollar
Exports
Goods and Services
150
150
Recession
140
140
Services
130
130
120
110
110
100
100
90
90
80
80
70
70
60
60
50
50
40
40
30
30
20
20
10
10
0
0
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
$ Billions
$ Billions
Goods
120
Recession
Services
Goods
$ Billions
200
190
180
170
160
150
140
130
120
110
100
90
80
70
60
50
40
30
20
10
0
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
200
190
180
170
160
150
140
130
120
110
100
90
80
70
60
50
40
30
20
10
0
$ Billions
Imports
Goods and Services
Trade Balance
Goods Exports minus Goods Imports
Service Exports minus Service Imports
20
20
10
10
0
0
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
-10
-10
-20
-20
-30
-30
-40
-40
-50
-50
-60
Recession
-60
Services
-70
-80
Goods
-70
-80
$ Billions
$ Billions
92
THE GREAT DEBATE:
Stimulus Vs Austerity
J.M. Keynes
F.A. Hayek
1883-1946
Father of Modern Macroeconomics
“The General Theory of Employment, Interest
and Money”
1899-1992
1974 Nobel Prize
“The Road to Serfdom”
Advocated the use of fiscal and monetary
measures to offset recessions.
Changing prices communicate signals to
enable individuals to coordinate their plans.
This leads to an efficient exchange and use
of resources.
AD determines the overall level of economic
activity.
The modern capitalist economy does not
automatically work at top efficiency, but can be
raised to that level by government intervention.
Leading critic of collectivism/socialism
because it required a central planner that
would eventually become totalitarianism.
The free price system is a spontaneous
order – the result of human action, but not
of human design.
Central banks do not possess the relevant
info to govern the money supply, nor the
ability to use it correctly.
“Fear the Boom and Bust”
Lyrics
Keynes’s Viewpoint
1. We’ve been going back and forth for a century
2. [Keynes] I want to steer markets,
3. [Hayek] I want them set free
4. There’s a boom and bust cycle and good reason to fear it
5. [Hayek] Blame low interest rates.
6. [Keynes] No… it’s the animal spirits
7. [Keynes Sings:]
8. John Maynard Keynes, wrote the book on modern macro
9. The man you need when the economy’s off track, [whoa]
10. Depression, recession now your question’s in session
11. Have a seat and I’ll school you in one simple lesson
12. BOOM, 1929 the big crash
13. We didn’t bounce back—economy’s in the trash
14. Persistent unemployment, the result of sticky wages
15. Waiting for recovery? Seriously? That’s outrageous!
16. I had a real plan any fool can understand
17. The advice, real simple—boost aggregate demand!
18. C, I, G, all together gets to Y
19. Make sure the total’s growing, watch the economy fly
20. We’ve been going back and forth for a century
21. [Keynes] I want to steer markets,
22. [Hayek] I want them set free
23. There’s a boom and bust cycle and good reason to fear it
24. [Hayek] Blame low interest rates.
25. [Keynes] No… it’s the animal spirits
26. You see it’s all about spending, hear the register cha-ching
27. Circular flow, the dough is everything
28. So if that flow is getting low, doesn’t matter the reason
29. We need more government spending, now it’s stimulus season
30. So forget about saving, get it straight out of your head
31. Like I said, in the long run—we’re all dead
32. Savings is destruction, that’s the paradox of thrift
33. Don’t keep money in your pocket, or that growth will never lift…
because…
34. Business is driven by the animal spirits
35. The bull and the bear, and there’s reason to fear its
36. Effects on capital investment, income and growth
37. That’s why the state should fill the gap with stimulus both…
38. The monetary and the fiscal, they’re equally correct
39. Public works, digging ditches, war has the same effect
40. Even a broken window helps the glass man have some wealth
41. The multiplier driving higher the economy’s health
42. And if the Central Bank’s interest rate policy tanks
43. A liquidity trap, that new money’s stuck in the banks!
44. Deficits could be the cure, you been looking for
45. Let the spending soar, now that you know the score
46. My General Theory’s made quite an impression
47. [a revolution] I transformed the econ profession
48. You know me, modesty, still I’m taking a bow
49. Say it loud, say it proud, we’re all Keynesians now
50. We’ve been goin’ back n forth for a century
51. [Keynes] I want to steer markets,
52. [Hayek] I want them set free
53. There’s a boom and bust cycle and good reason to fear it
54. [Keynes] I made my case, Freddie H
55. Listen up , Can you hear it?
Hayek sings:
“Fear the Boom and Bust”
Lyrics
Hayek’s Viewpoint
56. I’ll begin in broad strokes, just like my friend Keynes
57. His theory conceals the mechanics of change,
58. That simple equation, too much aggregation
59. Ignores human action and motivation
60. And yet it continues as a justification
61. For bailouts and payoffs by pols with machinations
62. You provide them with cover to sell us a free lunch
63. Then all that we’re left with is debt, and a bunch
64. If you’re living high on that cheap credit hog
65. Don’t look for cure from the hair of the dog
66. Real savings come first if you want to invest
67. The market coordinates time with interest
68. Your focus on spending is pushing on thread
69. In the long run, my friend, it’s your theory that’s dead
70. So sorry there, buddy, if that sounds like invective
71. Prepared to get schooled in my Austrian perspective
72. We’ve been going back and forth for a century
73. [Keynes] I want to steer markets,
74. [Hayek] I want them set free
75. There’s a boom and bust cycle and good reason to fear it
76. [Hayek] Blame low interest rates.
77. [Keynes] No… it’s the animal spirits
78. The place you should study isn’t the bust
79. It’s the boom that should make you feel leery, that’s the thrust
80. Of my theory, the capital structure is key.
81. Malinvestments wreck the economy
82. The boom gets started with an expansion of credit
83. The Fed sets rates low, are you starting to get it?
84. That new money is confused for real loanable funds
85. But it’s just inflation that’s driving the ones
86. Who invest in new projects like housing construction
87. The boom plants the seeds for its future destruction
88. The savings aren’t real, consumption’s up too
89. And the grasping for resources reveals there’s too few
90. So the boom turns to bust as the interest rates rise
91. With the costs of production, price signals were lies
92. The boom was a binge that’s a matter of fact
93. Now its devalued capital that makes up the slack.
94. Whether it’s the late twenties or two thousand and five
95. Booming bad investments, seems like they’d thrive
96. You must save to invest, don’t use the printing press
97. Or a bust will surely follow, an economy depressed
98. Your so-called “stimulus” will make things even worse
99. It’s just more of the same, more incentives perversed
100. And that credit crunch ain’t a liquidity trap
101. Just a broke banking system, I’m done, that’s a wrap.
102. We’ve been goin’ back n forth for a century
103. [Keynes] I want to steer markets,
104. [Hayek] I want them set free
105. There’s a boom and bust cycle and good reason to fear it
106. [Hayek] Blame low interest rates.
107. [Keynes] No it’s the animal spirits
“Fight of the Century” Lyrics
Written by John Papola and Russ Roberts
KEYNES
Here we are… peace out! great recession
thanks to me, as you see, we’re not in a depression
Recovery, destiny if you follow my lesson
Lord Keynes, here I come, line up for the procession
HAYEK
We brought out the shovels and we’re still in a ditch…
And still digging. don’t you think that it’s time for a switch…
From that hair of the dog. Friend, the party is over.
The long run is here. It’s time to get sober!
KEYNES
Are you kidding? my cure works perfectly fine…
have a look, the great recession ended back in ’09.
I deserve credit. Things would have been worse
All the estimates prove it—I’ll quote chapter and verse
HAYEK
Econometricians, they’re ever so pious
Are they doing real science or confirming their bias?
Their “Keynesian” models are tidy and neat
But that top down approach is a fatal conceit
REFRAIN
Which way should we choose?
more bottom up or more top down
…the fight continues…
Keynes and Hayek’s second round
it’s time to weigh in…
more from the top or from the ground
…lets listen to the greats
Keynes and Hayek throwing down
KEYNES
We could have done better, had we only spent more
Too bad that only happens when there’s a World War
You can carp all you want about stats and regression
Do you deny World War II cut short the Depression?
HAYEK
Wow. One data point and you’re jumping for joy
the Last time I checked, wars only destroy
There was no multiplier, consumption just shrank
As we used scarce resources for every new tank
Pretty perverse to call that prosperity
Rationed meat, Rationed butter… a life of austerity
When that war spending ended your friends cried disaster
yet the economy thrived and grew faster
KEYNES
You too only see what you want to see
The spending on war clearly goosed GDP
Unemployment was over, almost down to zero
That’s why I’m the master, that’s why I’m the hero
HAYEK
Creating employment’s a straightforward craft
When the nation’s at war, and there’s a draft
If every worker was staffed in the army and fleet
We’d have full employment and nothing to eat
REFRAIN REPEATS
“Fight of the Century”
Lyrics
HAYEK
jobs are a means, not the ends in themselves
people work to live better, to put food on the shelves
real growth means production of what people demand
That’s entrepreneurship not your central plan
KEYNES
My solution is simple and easy to handle..
its spending that matters, why’s that such a scandal?
The money sloshes through the pipes and the sluices
revitalizing the economy’s juices
it’s just like an engine that’s stalled and gone dark
To bring it to life, we need a quick spark
Spending’s the life blood that gets the flow going
Where it goes doesn’t matter, just get spending flowing
HAYEK
You see slack in some sectors as a “general glut”
But some sectors are healthy, only some in a rut
So spending’s not free – that’s the heart of the matter
too much is wasted as cronies get fatter.
The economy’s not a car, there’s no engine to stall
no expert can fix it, there’s no “it” at all.
The economy’s us, we don’t need a mechanic
Put away the wrenches, the economy’s organic
REFRAIN REPEATS
KEYNES
so what would you do to help those unemployed?
this is the question you seem to avoid
when we’re in a mess, would you just have us wait?
Doing nothing until markets equilibrate?
HAYEK
I don’t want to do nothing, there’s plenty to do
The question I ponder is who plans for whom?
Do I plan for myself or leave it to you?
I want plans by the many, not by the few.
Let’s not repeat what created our troubles
I want real growth not a series of bubbles
Stop bailing out loser, let prices work
If we don’t try to steer them they won’t go berserk
KEYNES
Come on, Are you kidding? Don’t Wall Street’s gyrations
Challenge your world view of self-regulation?
Even you must admit that the lesson we’ve learned
Is more oversight’s needed or else we’ll get burned
HAYEK
Oversight? The government’s long been in bed
With those Wall Street execs and the firms that they’ve bled
Capitalism’s about profit and loss
you bail out the losers there’s no end to the cost
the lesson I’ve learned? It’s how little we know,
the world is complex, not some circular flow
the economy’s not a class you can master in college
to think otherwise is the pretense of knowledge
REFRAIN REPEATS
“Fight of the Century”
Lyrics
Continued
KEYNES
You get on your high horse and you’re off to the races
I look at the world on a case by case basis
When people are suffering I roll up my sleeves
And do what I can to cure our disease
The future’s uncertain, our outlooks are frail
Thats why free markets are so prone to fail
In a volatile world we need more discretion
So state intervention can counter depression
HAYEK
People aren’t chessmen you move on a board
at your whim–their dreams and desires ignored
With political incentives, discretion’s a joke
Those dials you’re twisting… just mirrors and smoke
We need stable rules and real market prices
so prosperity emerges and cuts short the crisis
give us a chance so we can discover
the most valuable ways to serve one another
FINAL REFRAIN
Which way should we choose?
more bottom up or more top down
the fight continues…
Keynes and Hayek’s second round
it’s time to weigh in…
more from the top or from the ground
…lets listen to the greats
Keynes and Hayek throwing down
Chapter 17: Macroeconomics in an Open Economy
Trade between countries involves the mutual exchange of different currencies
(bank deposits denominated in different currencies)
When American firms buy foreign goods, services and assets => U.S. $ exchanged
for foreign currency
Bank deposits denominated in U.S. $  bank deposits denominated in foreign
currency
This trade takes place in foreign exchange markets
Definitions:
Exchange Rate - price of one currency in terms of another
Spot exchange rate – exchange rate for the immediate (2-day) exchange of bank
deposits
Forward exchange rate – exchange rate for the exchange of bank deposits at
some specified future date
Appreciation – currency increases in value
Depreciation – currency decreases in value
The Circular Flow Diagram
U.S. Dollar Versus Euro
Exchange Rate
$/Euro
Euro/$
$1.70
1.70
$1.60
1.60
$1.50
1.50
$/Euro
$1.40
1.40
$1.30
1.30
$1.20
1.20
$1.10
1.10
$1.00
1.00
$0.90
0.90
$0.80
0.80
$0.70
0.70
Euro/$
$0.60
0.60
$0.50
0.50
99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
Exchange rates are important because they affect the relative price of domestic and
foreign goods.
Example:
The $ price of a German BMW to an American is a function of the interaction of
2 factors:
1.The price of BMWs in Euros (50,000 euros)
2.The exchange rate E = $/euro,
If E = $1/1euro => 50,000 euro x ($1/1euro) = $50,000
If euro appreciates to ($1.20/1euro) => $ depreciates =>
50,000euro x ($1.20/1euro) = $60,000
Currency appreciates => country’s goods prices  abroad and foreign goods prices
 in that country
1. Makes domestic businesses less competitive
2. Benefits domestic consumers
U.S. International Transactions
Balance of Payments
(Comprehensive Measure of U.S.’s Trade and Investment with the Rest of the World)
Web: http://www.bea.gov/international/index.htm#bop
Moderate quarterly revisions. Annual benchmark changes make in June.
International commerce now makes up more than a quarter of all U.S. business activity. The International Transactions Report tracks cross-border movements in trade in goods and services,
imports and exports of investment capital (stocks, bonds, physical assets) and investment income (interest/dividends). Data is seasonally adjusted but not annualized or adjusted for
inflation. Data measures quarterly changed in trade and investment flows.
The International Transaction Release contains 3 sections.
1. Current Account:
Merchandise Trade Account – goods or visible trade. Trade balance = $X -$M
Service Trade Account – Invisible trade (investment banking, insurance, engineering, public relations, accounting, advertising, patent/copyright/movie fees).
Investment Income Account – interest and dividends. Subcategory of service account. Income receipts are classified as export income because earnings are from overseas
investments. Income payments to foreignors are classified as import payments because they are based on capital shipped to the U.S.
Unilateral Transfers – One way transfers (foreign aid, government grants, pension payments, worker remittances)
2. Financial Account:
Movement of investment capital and loans into and out of U.S.
Measures changes in U.S. ownership of foreign stocks, bonds and other assets.
Measures changes in foreign ownership of U.S. securities and private assets.
Measures changes in central bank’s holdings of foreign currencies and securities.
3. Capital Account: uncommon flows of money. Example includes U.S. residents who emigrate and take assets with them.
Balance of Payments = Current account + Financial Account + Capital Account = 0
- represents all economic transactions between U.S. and R.O.W.
Since the 1980s, the U.S. current account balance has been negative, indicating Americans have consumed more than they produced (lived beyond their means) They accomplished this feat
by borrowing money from the rest of the world (ROW) to finance their spending. Americans borrow $2 billion per day to finance their spending. The U.S. in now the largest debtor
nation. The debt buildup cannot go on forever and could destabilize the U.S. and global economy.
Current account data is found on lines 71-76 of the report. A negative figure reflects how much the U.S. has to borrow from the ROW to finance spending by American consumers, businesses
and government.
What is the possibility of a reversal of foreign investor sentiment against the dollar? An  in external debt =>  concentration risk of U.S. assets on foreign balance sheets =>  foreign investor’s
appetite for U.S. stock and bonds =>  dollar exchange rate =>  import prices => domestic prices =>  inflation =>  interest rates. To compensate for the concentration risk,
foreign investors will have to be compensated with higher interest rates.
Does the trade deficits and capital surplus reflect the strength of the U.S. economy? The U.S. has a stable and attractive investment environment (liquid markets, creditworthy borrowers, strong
productivity growth)
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Market Analysis:
Bonds:  current account deficit => appreciating dollar =>  (DP/P)ET+1 =>  DBonds =>  iBonds
Stocks:  exports =>  net exports =>  domestic manufacturing =>  future profits =>  PStocks
Dollar:  current account deficit =>  Demand for dollars &  Supply of dollars => appreciating dollar
Current Account Balance
$100
1%
$18
$4
$0 $2 $5
$3
$0
0%
75
-$100
-$200
77-$1579
-$14
81 -$6 83
-$39
85
87
89
91
-$79
-$99
-$121
-$94
-$118
-$147
-$161
93
95
97
99
01
03
05
07
09
11
-$52
-$85
-1%
-$114
-$122
-$125
-$141
-2%
-$300
-3%
$ Billions
-$302
-$400
-$377
-$397
-$416
-$457
-$500
-$471
-4%
-5%
-$519
-$600
-6%
-$629
-$700
-$677
-$710
-7%
-$746
-$800
-8%
-$801
Dollar Amount
-$900
% of GDP
-9%
Percent of GDP
-$215
U.S. Dollar Exchange Rate
Major Currency Index
Nominal & Real (1973 = 100)
150
150
140
140
130
130
120
120
110
110
100
100
90
90
80
80
70
70
60
60
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Source: FRB: Exchange Rates G.5 (405)
Nominal
Real
How Movements in the Exchange Rate Affect Exports
U.S Exports
115
14
110
9
105
4
100
-1
95
-6
90
-11
85
-16
80
(Percent)
19
1999
2000
2001
Source: Bureau of Census
2002
2003
2004
Export Growth
2005
Exchange Rate
(Year-Over-Year % Change)
2006
Exchange Rate
Balance of payments The record of a country’s trade with other countries in
goods, services, and assets.
Current account The part of the balance of payments that records a country’s
net exports, net investment income, and net transfers.
Balance of trade The difference between the value of the goods a country
exports and the value of the goods a country imports.
Financial account The part of the balance of payments that records purchases
of assets a country has made abroad and foreign purchases of assets in the
country.
Net foreign investment The difference between capital outflows from a
country and capital inflows, also equal to net foreign direct investment plus net
foreign portfolio investment.
Capital Account The part of the balance of payments that records relatively
minor transactions, such as migrants’ transfers, and sales and purchases of
nonproduced, nonfinancial assets.
2008 International Trade
Current Account Balance = - Financial Account Balance
Current Account ($ bil)
Goods
Services
Exports
$1,291
$544
Imports
-$2,112
-$404
Balance on Goods/Services
-$821
$140
Income receipts
$755
Income payments
-$628
Net unilateral transfers
-$119
Current Account Balance -$673 ($ outflow)
(4.72% of GDP)
Financial Account ($ bil)
Increase in U.S. owned assets abroad
Increase in foreign owned assets in U.S
Statistical discrepancy
Financial Account Balance
$-52 (outflow)
$599
$129
$676 ($ inflow)
Capital Account ($ -3 bil)
Balance of Payments = Current Account Deficit + Financial Account Surplus + Capital Acct = 0
Net Exports = Net Foreign Investment = (-Net Capital Inflow)
Current Account Balance
(mil $, SA)
$25,000
$0
-$25,000
-$50,000
-$75,000
-$100,000
-$125,000
-$150,000
-$175,000
-$200,000
-$225,000
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
2010
2013
Domestic Saving, Domestic Investment,
and Net Foreign Investment
Saving and investment equation An equation showing that national saving is
equal to domestic investment plus net foreign investment.
National Saving = Private Saving + Public Saving
S = Sprivate + Spublic
where
Sprivate = Y – C – T
Spublic = T – G
S = (Y – C – T) + (T – G)
S=Y–C–G
Substitute for Y
S = (C + I + G + NX) – C - G
S = I + NX
Recall Net Exports = Net Foreign Investment
S = I + NFI