Transcript ap38pp - woodlandecon

38
The Balance of Payments, Exchange Rates,
and Trade Deficits
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
In chapter 37 we examined comparative
advantage as the underlying economic
basis of world trade and discussed the
effects of barriers to free trade. Now we
introduce the highly important monetary
and financial aspects of international
trade.
International Transactions
This chapter focuses on international
financial transactions, the vast majority of
which fall into two broad categories:
international trade and international asset
transactions.
LO1
38-3
International Trade
International trade involves either
purchasing or selling currently produced
goods or services across an international
border. Examples include an Egyptian firm
exporting cotton to the U.S. and an
American company hiring an Indian call
center to answer its phones.
International Asset Transactions
International asset transactions involve the
transfer of the property rights to either
real or financial assets between the citizens
of one country and the citizens of another
country. It includes activities like buying
foreign stocks or selling your house to a
foreigner.
In either case, money flows from the
buyers of the goods, services, or assets to
the sellers of the goods, services, or assets.
When the people engaged in any
transactions are both from places that use
the same currency, what type of money to
use is not an issue.
However, when the people involved in an
exchange are from places that use different
currencies, intermediate asset transactions
have to take place: the buyers must
convert their own currencies into
currencies that the sellers use and accept.
Balance of Payments
A nation’s balance of payments is the sum
of all the financial transactions that take
place between its residents and the
residents of foreign nations. Most of these
transactions fall into the two main
categories that we have just discussed.
LO2
38-8
But the balance of payments also includes
international transactions that fall outside
of these main categories, things such as
tourist expenditures, interest and
dividends received or paid abroad, debt
forgiveness, and remittances made by
immigrants to their relatives back home.
Table 38.1 is a simplified balance of
payments statement for the United States
in 2009. The balance of payments
statement is organized into two broad
categories; the current account and the
capital and financial account.
Current Account
1.Current Account- summarizes U.S. trade in
currently produced goods and services.
Items 1 and 2 show U.S. exports and
imports of goods. Exports have a (+) sign
because they are a credit; they generate
flows of money to the United States.
Imports have a (-) sign because they are a
debit; they cause flows of money out of
the U.S.
LO2
38-11
3 Parts to Current Account
Balance on Goods- A country’s balance of
trade on goods is the difference between
its exports and its imports of goods. If
exports exceed imports, the result is a
trade surplus. If imports exceed exports,
there is a trade deficit on the balance of
goods. We note in item 3 that in 2009 the
U.S. incurred a trade deficit on goods of
$517 billion.
Balance on Services- the U.S. exports not
only goods such as airplanes and computer
software, but also services, such as
insurance, consulting, travel, and
investment advice to residents of foreign
countries. Summed together, items 4 and 5
indicate that the balance on services, item
6, was $138 billion.
Trade Deficit
The balance on goods and services shown
in item 7 is the difference between U.S.
exports of goods and services, and imports
of goods and services. In 2009, U.S.
imports of goods and services exceeded
U.S. exports of goods and services by $379
billion. So a trade deficit of that amount
occurred.
Trade Surplus
In contrast, a trade surplus occurs when
exports of goods and services exceed
imports of goods and services. Global
Perspective 38.1 shows U.S. trade deficits
and surpluses with selected nations.
Net Investment Income
Balance on Current Account- items 8 and 9 are
listed as part of the current account because
they are international financial flows. For
instance, item 8, net investment income
represents the difference between the interest
and dividend payments foreigners paid U.S.
citizens and companies for services provided by
U.S. capital invested abroad, and the interest
and dividends the U.S. citizens and companies
paid for the services provided by foreign capital
invested here.
Net Transfers
Observe that in 2009 U.S. net investment
income was a positive $89 billion. Item 9
shows net transfers, both public and
private, between the U.S. and the rest of
the world. Included here is foreign aid,
pensions paid to U.S. citizens living abroad,
and remittances by immigrants to relatives
abroad.
These $130 billion of transfers are net U.S.
out-payments, and therefore listed as a
negative number. By adding all transactions
in the current account, we obtain the
balance on current account, shown in item
10. In 2009 the U.S. had a current account
deficit of $420 billion. This means these
transactions created out-payments from
the United States greater than in-payments
to the United States.
Capital & Financial Account
2.Capital and Financial Account- summarizes
U.S. international asset transactions which
consist of two separate accounts.
Capital Account- mainly measures debt
forgiveness. It is a net account or one that
can be either + or -. The $3 billion listed in
item 11 tells us that in 2009 Americans
forgave $3 billion more of debt owed to
them by foreigners than foreigners forgave
debt owed to them by Americans. The (-)
sign indicates a debit, or out-payment.
Financial Account- summarizes
international asset transactions having to
do with purchases and sales of real or
financial assets. Line 12 lists the amount of
foreign purchases of assets in the U.S. It
has a (+) sign because any purchase of an
American owned asset by a foreigner
generates a flow of money toward the
American who sells the asset.
Line 13 lists U.S. purchases of assets
abroad. These have a (-) sign because such
purchases generate a flow of money from
the Americans who buy foreign assets
toward the foreigners who sell them those
assets. Items 12 and 13 combined yielded a
$423 billion balance on the financial
account for 2009, line 14.
2 Accounts Must Balance
The balance on the capital and financial
account, line 15, is $420 billion. It is the
sum of the $3 billion deficit on the capital
account and the $423 billion surplus on the
financial account. Observe that this $420
billion surplus in the capital and financial
account equals the $420 billion deficit in
the current account. The two numbers
always equal, or balance.
Balance of Payments
LO2
38-24
Why the Balance?
The balance on the current account and
the capital and financial account must
always sum to zero because any deficit or
surplus in the current account
automatically creates an offsetting entry in
the capital and financial account. People
can only trade one of two things with each
other: currently produced goods and
services or preexisting assets.
LO2
38-25
Therefore, if trading partners have an
imbalance in their trade of currently produced
goods and services, the only way to make up
for that imbalance is with a net transfer of
assets from one party to another. Specifically,
current account deficits simultaneously
generate transfer of assets to foreigners,
while current account surpluses automatically
generate transfers of assets from foreigners.
U.S. Trade Balances
LO2
38-27
Flexible Exchange Rates
There are two pure types of exchange rate
systems.
• A flexible or floating exchange rate systemthrough which demand and supply determine
exchange rates and in which no government
intervention occurs.
• A fixed exchange rate system- through which
governments determine exchange rates and
make necessary adjustments in their
economies to maintain those rates.
LO3
38-28
Flexible Exchange Rates
We will be looking at flexible exchange rates.
Let’s examine the rate, or price, at which U.S.
dollars might be exchanged for British
pounds. In figure 38.1 we show demand Dl of
pounds and supply Sl of pounds in the
currency market. The demand for pounds
curve is down-sloping because all British
goods and services will be cheaper to the U.S.
if pounds become less expensive to the U.S.
That is, at lower dollar prices for pounds,
the U.S. can obtain more pounds and
therefore more British goods and services
per dollar. The supply of pounds curve is
up-sloping because the British will
purchase more U.S. goods when the dollar
price of pounds rises.
Equilibrium Exchange Rate
The intersection of the supply curve and
the demand curve will determine the
dollar price of pounds. Here, that price, or
exchange rate, is $2 = 1£.
Flexible Exchange Rates
The Market for Foreign Currency
(Pounds)
P
Dollar Price of 1 Pound
S1
$3
$2
Dollar
Depreciates
(Pound
Appreciates)
Exchange
Rate: $2 = £1
Dollar
Appreciates
(Pound
Depreciates)
$1
D1
0
Q1
Q
Quantity of Pounds
LO3
38-32
Depreciation & Appreciation
An exchange rate determined by market
forces can, and often does, change daily
like stock and bond prices. These exchange
rates can be found in a good daily
newspaper or on the internet. When the
dollar price of pounds rises, for example,
from $2 =1£ to $3 = 1£, the dollar has
depreciated relative to the pound, and the
pound has appreciated relative to the
dollar.
When a currency depreciates, more units of
it (dollars) are needed to buy a single unit
of some other currency (pounds). When
the dollar price of pounds falls, for
example, from $2=1£ to $1=1£, the dollar
has appreciated relative to the pound.
When a currency appreciates, fewer units
of it (dollars) are needed to buy a single
unit of some other currency (pounds).
1 Appreciates, the other Depreciates
In our U.S.-Britain example, depreciation of
the dollar means an appreciation of the
pound, and vice versa. When the dollar
price of a pound jumps from $2 = 1£ to $3=
1£, the pound has appreciated relative to
the dollar because it takes fewer pounds to
buy $1. At $2=1£, it took £½ to buy $1; at
$3=1£, it takes only £⅓ to buy $1.
Key Point
In general, the relevant terminology and
relationships between the U.S. dollar and
another currency are as follows.
If the demand for pounds increases or the
supply of pounds decreases, the pound will
appreciate. This means that anything
which raises the dollar price of a pound will
cause it to get stronger.
If the demand for pounds decreases or the
supply of pounds increases, the pound will
depreciate. This means that anything
which lowers the dollar price of a pound
will cause it to get weaker.
Determinants of Exchange Rates
What factors would cause a nation’s
currency to appreciate or depreciate in the
market for foreign exchange? These factors
will shift the demand or supply curve for a
certain currency.
LO3
38-38
Tastes
1.Changes in Tastes- Any change in consumer
tastes or preferences for the products of a
foreign country may alter the demand for that
nation’s currency and change its exchange
rate. For example, if technological advances in
U.S. wireless phones make them more
attractive to British consumers and
businesses, then the British will supply more
pounds in the exchange market to purchase
more U.S. wireless phones.
The supply of pounds will shift right,
causing the pound to depreciate and the
dollar to appreciate. In contrast, the U.S.
demand for pounds curve will shift to the
right if British woolen apparel becomes
more fashionable in the United States. So
the pound will appreciate and the dollar
will depreciate.
Income Changes
2.Relative Income Changes- A nation’s
currency is likely to depreciate if its growth
of national income is more rapid than that
of other countries. As total income rises in
the U.S., people there buy both more
domestic goods and more foreign goods.
If the U.S. economy is expanding rapidly
and the British economy is stagnant, U.S.
imports of British goods, and therefore U.S.
demands for pounds will increase. The
dollar price of pounds will rise, so the dollar
will depreciate.
Inflation Rate Changes
3.Relative Inflation Rate Changes- Other
things equal, changes in the relative rates
of inflation of two nations change their
relative price levels and alter the exchange
rate between their currencies. The
currency of the nation with the higher
inflation rate tends to depreciate.
For example, if inflation is zero in Britain
and 5% in the U.S., American consumers
will seek out more of the now relatively
lower-priced British goods, increasing the
demand for pounds. British consumers will
buy less of the now relatively higher-priced
U.S. goods, reducing the supply of pounds.
This combination of increased demand for
pounds and reduced supply of pounds will
cause the pound to appreciate and the
dollar to depreciate.
Interest Rates
4.Relative Interest Rates- Changes in relative
interest rates between two countries may
alter their exchange rate. Suppose that real
interest rates rise in the U.S. but stay
constant in Britain. British citizens will then
find the U.S. a more attractive place in
which to loan money directly or loan
money indirectly by buying bonds.
To make these loans, they will have to
supply pounds in the foreign exchange
market to obtain dollars. The increase in
the supply of pounds results in
depreciation of the pound and appreciation
of the dollar.
Expected Returns on Investments
5.Changes in Relative Expected Returns on
Stocks, Real Estate, and Production
Facilities- International investing extends
beyond buying just foreign bonds. To make
the investments, investors in one country
must sell their currencies to purchase the
foreign currencies needed for the foreign
investments.
Suppose investing in England suddenly
becomes more popular due to a more
positive outlook regarding expected
returns on stocks, real estate, and
production facilities there. U.S. investors
will sell U.S. assets to buy more assets in
England.
U.S. investors will exchange their dollars for
pounds, which are then used to purchase
the British assets. The increased demand
for pounds will cause it to appreciate and
therefore the dollar will depreciate relative
to the pound.
Speculation
6.Speculation- Currency speculators are
people who buy and sell currencies with an
eye toward reselling or repurchasing them
at a profit. Suppose speculators expect the
U.S. economy to grow more rapidly than
the British economy and to experience
more rapid inflation as a result.
These expectations translate into the
anticipation that the pound will appreciate
and the dollar will depreciate. Speculators
who are holding dollars will therefore try
to convert them into pounds. This effort
will increase the demand for pounds and
cause the dollar price of pounds to rise.
A self-fulfilling prophecy occurs. The pound
appreciates and the dollar depreciates
because speculators act on the belief that
these changes will in fact take place.
Table 38.2 has more illustrations of the
determinants of exchange rates.
Recent U.S. Trade Deficits
As shown in figure 38.4a, the United States
has experienced large and persistent trade
deficits in recent years. These deficits rose
rapidly between 2001 and 2006 before
declining when consumers and businesses
greatly curtailed their purchase of imports
during the recession of 2007-2009.
Economists expect the trade deficits to
expand, absolutely and relatively, toward
prerecession levels when the economy
recovers and U.S. income and imports
again rise.
Billions of Dollars
U.S. Trade Deficits
0
-50
-100
-150
-200
-250
-300
-350
-400
-450
-500
-550
-600
-650
-700
-750
-800
-850
-900
Goods and Services
Balance of
Trade
Goods
Billions of Dollars
2001
2003
2004
2005
2006
2007
2008
2009
0
-50
-100
-150
-200
-250
-300
-350
-400
-450
-500
-550
-600
-650
-700
-750
-800
-850
-900
Balance
on Current
Account
2001
LO5
2002
2002
2003
2004
2005
2006
2007
2008
2009
38-56
Causes of Trade Deficits
First, the U.S. economy expanded more
rapidly between 2001 and 2007 than the
economies of several U.S. trading partners.
The strong income growth enabled
Americans to greatly increase their
purchases of imported products.
Another factor explaining large trade deficits
is the enormous U.S. trade imbalance with
China. In 2007 the U.S. imported $257 billion
more than it exported to China. The U.S. is
China’s largest export market, and although
China has greatly increased its imports from
the U.S., its standard of living has not yet risen
sufficiently for its households to afford large
quantities of U.S. goods.
Adding to the problem, China’s
government has fixed the exchange rate of
its currency, the yuan, to a basket of
currencies that includes the U.S. dollar.
Therefore, China’s large trade surpluses
have not caused the yuan to appreciate
much against the dollar.
Another factor underlying the large U.S.
trade deficits is a continuing trade deficit
with oil-exporting nations, or OPEC.
A declining savings rate has also
contributed to the large trade deficits.