Transcript Chapter 9 - BCCBUSINESSSTUDIES

Chapter 9
The Balance of Payments
• Balance of Payments (BOP):
measures all international economic
transactions b/n residents & foreign
residents.
– Monetary and fiscal policy must take the BOP
into account at the national level
– BOP data may be important
• Indicates pressure on exchange rate
• Helps forecast country’s market potential
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For example…
• BOP transactions (US side)
– Daimler-Chrysler (German) purchases
manufacturer in Chicago.
– GM China pays dividends to parent in US.
– An American tourist purchases a necklace in India.
– A Mexican lawyer purchases US bond via
investment broker in Cleveland.
• Rule of thumb: “follow the cash flow”
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B of P
A.
B.
Current Account
A.
Net exports/imports goods&services (Balance of Trade)
B.
Net Income (investment income from direct portfolio investment plus employee
compensation
C.
Net transfers (sums sent home by migrant abroad)
Capital Account
Capital transfers related to purchase and sale of fixed assets such as real estate
C.
D.
Financial Account
A.
Net foreign direct investment
B.
Net portfolio investment
C.
Other financial items
Basic Balance = A+B+C
Net Errors and Omissions
Overall Balance = A+B+C+D
Missing data such as illegal transfers
E.
Reserves and Related Items
Changes in official monetary reserves including gold and foreign exchange reserves
Σ (A:E) = Overall Balance
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The Current Account
• Goods Trade or Balance of Trade (BOT) – export/import of
goods. VISIBLE TRADE
• Services Trade – export/import of services (financial,
construction, and tourism). INVISIBLE TRADE
• Income – predominately current income associated with
investments made in previous periods, + wages & salaries
paid to non-resident workers.
• Current Transfers – financial settlements due to change in
ownership of real resources or financial items. Any transfer
b/n countries which is one-way, a gift or a grant.
• CA typically dominated by export/import of goods, for this
reason Balance of Trade (BOT) is widely quoted.
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For example…
•Trade balance
•Debit: Sun Microsystems buys LCDs from Hong Kong. (Going out)
•Credit: Singapore Airlines buys Boeing jet. (Coming in)
•Trade in services
•Debit: American rents an apartment in Singapore.
•Credit: TUI - Germany places an ad in the NYT.
•Income payments
•Debit: Honda US pays dividend to Honda Japan.
•Credit: Bank Austria pays salary to rep in NY office.
•Unilateral Current Transactions
•Debit: Peace Corps pays US volunteer teachers in Bosnia.
•Credit: TotalFina pays tuition of employee for Stern MBA USA.
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Current Account
Current Account Surplus and Deficit
• A current account surplus means exports
of goods and services, investment income
and transfers exceed imports and
outflows.
• A current account deficit means imports of
goods and services, and outflows are
greater than exports and inflows; must be
financed by borrowing (capital account
inflows).
The Capital/Financial Account
• Capital account: transfers of fixed assets, real
estate, acquisitions/disposal of nonproduced/non-financial -assets leaving the
country.
• Financial account: three components; classified
by degree of control,
– Direct Investment – Net balance of capital which is
dispersed from and into US for the purpose of
exerting control over assets.
• E.g. US company acquires foreign company stake (-)
• Foreign company acquires US company stake (+)
• foreign direct investment (FDI): 10%+ of voting shares
acquired.
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The Capital/Financial Account
– Portfolio Investment – Net balance of capital
which flows in/out of US but does not reach 10%
ownership.
• No voting or control rights over the asset.
• Purchase/sale of equity securities.
• Purchase/sale of debt securities.
– E.g. T-bill purchases by foreigners (net portfolio investment)
– E.g. US$ debt issues by foreign companies/ governments.
• Risk/Return motivated.
– Other Investment Assets/Liabilities –Short & longterm trade credits, cross-border loans, currency &
bank deposits, & other accounts receivable and
payable in cross-border trade.
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Chapter 9.2
Exchange Rates
Exchange Rates
• Nominal exchange rate: price of one currency in terms of
another currency (bilateral exchange rate)
–
–
–
–
example: 1.30 dollars per euro or .76 euros per dollar
determines price of imports
foreign exchange market
foreign currency per unit of domestic currency
• Nominal effective exchange rate: average nominal
exchange over several other important trade-related
currencies
Exchange Rates
• Real Exchange Rate (RER): the price of
domestic goods relative to foreign goods
– says how much foreign good you could get for
domestic good
• The price of the average domestic good or
service relative to the price of the average
foreign good or service, when the prices are
expressed in terms of a common currency
Exchange Rates
• RER Example
– Should you buy a Japanese or American computer for your
company?
• Price of U.S. computer = $2,400
• Price of Japanese computer = 242,000 yen
• Exchange rate = 110 yen/dollar
• Price in dollars = price in yen/yen-dollar exchange rate
– Price in yen = price in dollars x value of dollar in terms of yen
– Price in dollars = 242,000 yen/110 = $2,200
– Japanese computer is cheaper.
– Real exchange rate = $2,400/$2,200 = 1.09
Exchange Rates
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U.S. Nominal and Real Exchange Rates
140
120
100
80
60
Nominal Effective Exchange Rate
Real Effective Exchange Rate
Jan-05
Jan-03
Jan-01
Jan-99
Jan-97
Jan-95
Jan-93
Jan-91
Jan-89
Jan-87
Jan-85
Jan-83
Jan-81
Jan-79
Jan-77
Jan-75
Jan-73
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Purchasing Power Parity
Law of One Price and Purchasing Power
Parity
• Identical goods & services should sell at same price no matter
where they are sold…otherwise opportunity for profits (i.e.
arbitrage)
– Law of one price: same price for a commodity
• Candy bar in Port-of-Spain versus San Fernando
• Purchasing Power Parity (PPP)
– The theory that nominal exchange rates are determined as necessary
for the law of one price to hold
– Exchange rates should move to equalize prices across countries
Purchasing Power Parity
• Example
– How many Indian rupees equal to one Australian
dollar?
• Bushel of grain cost 5 Australian dollars or 150 rupees
• 5 Australian dollars = 150 rupees
– Or, a 30 rupee to 1 Aus. Dollar ratio
• Nominal exchange rate should equal 30
rupees/Australian dollar
Purchasing Power Parity
– How many Indian rupees equal one Australian
dollar?
• Suppose price of grain in India increases from 150 to 300
rupees
• Price of grain in Australia still equals 5 Australian dollars
– Originally: implied exchange rate 5:150 or 1:30
– Now: implied exchange rate 5:300 or 1:60
• 1 Australian dollar = 60 rupees
• Nominal exchange rate increased from 30 to 60
rupees/Australian dollar
• Indian currency depreciated
• Australian currency appreciated
Purchasing Power Parity
• Does not hold up well in short run
– Transportation costs
– Border effect – tariffs, technical requirements, regional
monopoly power
– Pricing to market
• Goods prices are “sticky”
• Reduces exchange rate “pass through”
– Nontradable sector
• Higher productivity, higher nontradable wages, higher
nontradable inflation
• non-tradable goods include such items as electricity, water
supply, all public services, hotel accommodation, real estate,
construction, local transportation; goods with very high
transportation costs such as gravel; and commodities produced to
meet special customs or conditions of the country.
• Works better in the long run. Prices have time to
change.
Exchange Rate Mechanism
• Is a system which was set up by a group of
European countries in 1979 with the objective
of keeping member countries currencies
relatively stable against each other.
Hot Money
• Hot money: stocks of funds that are moved
around the globe from country to country in
search of the best returns.
Balance of Payments Problems
• A government has to be committed to a fixed
exchange rate.
• A floating exchange rate the economy if the
economy has a sustained deficit on the
current account it will not be able to continue
forever.
• If you have a deficit you have to make sure
that your home assets remain attractive to
foreign investors.