International finance 4

goods trade surplus: exports > imports More goods & services going out of the country than coming in... trade deficit negative balance of trade: more money going out of the country th

tional Financ

e

Balance of Payments

the record of all transactions

between the people of one

nation and the people of all

other nations.

U.S International Transactions 2002 [Millions of dollars]

current account

Goods Exported 681,874Goods Imported -1,164,746Balance on goods (Net Goods Exports = Gds Exp – Gds Imp) -482,872Services Exported 292,233Services Imported -227,399Balance on services (Net Serv Exports = Serv Exp – Serv Imp) 64,834

Balance on goods and services (Balance of Trade) -418,038

Income receipts 255,542Income payments -259,512Balance on income (Net Income) -3,970Net transfers -58,853

Balance on Current Account -480,861 Capital account transactions, net -1,285 Financial account

U.S.-owned assets abroad -178,985Foreign-owned assets in the United States 706,983

Balance on Financial Account 527,998 Statistical discrepancy -45,852 Balance of Payments Total 0

In 1999, the Bureau of Economic Analysis (BEA) made some changes in the way the balance of payments is presented in order to bring it into closer alignment with

international guidelines

(Some books still use the old definitions.)

Parts of the Balance of Payments

Capital Account (Prior to 1999, this was part of Current Account.)

This is a very small account that includes debt forgiveness, and goods and financial assets accompanying migrants when they enter or leave the country Financial Account (Prior to 1999, this was called the Capital Account.):

U.S.-owned assets abroad

Foreign-owned assets in the U.S

U.S International Transactions 2002 [Millions of dollars]

Balance on services (Net Service Exports = Service Exp – Service Imp) 64,834

Balance on goods and services (Balance of Trade) -418,038

Balance of Trade

difference between a country’s exports & imports

goods

trade surplus:

exports > imports

More goods & services going out of

the country than coming in.

goods

trade deficit:

imports > exports

More goods & services coming into

the country than going out.

To remember what is a surplus and what is a deficit,

watch the money.

money

trade surplus

positive balance of trade:

more money coming into the country than going out

trade deficit

negative balance of trade:

more money going out of the country than coming in.

money

Current Account Surplus:

positive balance on current account

more money coming in than going out

Current Account Deficit:

negative balance on current account more money going out than coming in

U.S International Transactions 2002 [Millions of dollars]

Balance on Capital Account -1,285

U.S International Transactions 2002 [Millions of dollars]

Financial Account Surplus:

positive balance on financial account

more money coming in than going out

Financial Account Deficit:

negative balance on financial account

more money going out than coming in

In theory, the sum of the current and capital accounts should balance with the financial account The

sum of the balance of payments should be zero.

When a country buys more goods and services than it sells (a deficit on the combined current and capital accounts), it must finance the difference by

borrowing or selling more assets than it buys (a

surplus on the financial account).

When a country sells more goods and services than it buys (a surplus on the combined current and

capital accounts), it uses the earnings of foreign

money to buy foreign assets or make loans to other countries (a deficit on the financial account).

In reality, the accounts do not exactly offset

each other because of statistical discrepancies, accounting conventions, and exchange rate

movements that change the recorded value of transactions

U.S International Transactions 2002 [Millions of dollars]

-Balance on Current Account -480,861 Balance on Capital Account -1,285 Balance on Financial Account 527,998 Statistical discrepancy -45,852

-Balance of Payments Total 0

U.S International Transactions 2002 [Millions of dollars]

Balance on services (Net Service Exports = Service Exp – Service Imp) 64,834

Balance on goods and services (Balance of Trade) -418,038

U.S.-owned assets abroad -178,985

Foreign-owned assets in the United States 706,983

Balance on Financial Account 527,998

-Statistical discrepancy -45,852

Balance of Payments Total 0

Exchange Rate Systems

Gold Standard (1879-1934 excluding WWI years)

◆ A nation’s currency is defined in terms of a fixed

amount of gold (Example: U.S dollar might be worth

25 grams of gold & British pound might be worth 50 grams of gold.)

◆ A country must maintain a stock of gold to back up its currency.

◆ The system implies a fixed rate of exchange between the currencies of two countries (Example: British

pound might be worth two U.S dollars.)

◆ Problem: Gold supply must increase as quickly as the world’s need for money.

Bretton Woods System (1934-1973)

International Monetary Fund (IMF).

which were based on the U.S dollar, which was based

on gold

(The U.S dollar was used because the U.S had the

largest stock of gold, and the largest and strongest

economy in the world.)

the world’s need for money.

Freely Floating Exchange Rate System

(1973 - present)

The exchange rates of currencies are based

on supply and demand for currencies.

(We’ll examine the ideas using the British pound and the American dollar.)

The Demand Curve

As the price of a British pound in dollars falls, British goods & services become cheaper to Americans

So the quantity of pounds demanded by Americans to purchase those goods & services increases.

So we have an inverse relation between the price of a pound and the quantity demanded of pounds.

So, the demand curve slopes downward.

Demand for British Pounds

exchange rate of dollars per pound

or the price of a pound in dollars

quantity of pounds

D

The Supply Curve

As the price of a British pound in U.S dollars rises,

the British get more dollars for their pound.

So American goods & services become cheaper to the British.

So the British are willing to supply more pounds to get American goods & services.

We then have a direct relation between the price of a pound and the quantity supplied of pounds.

So, the supply curve slopes upward.

Supply of British Pounds

exchange rate of dollars per pound

or the price of a pound in dollars

quantity of pounds

S

Market for British Pounds

exchange rate of dollars per pound

or the price of a pound in dollars

quantity of pounds

D S

Market for British Pounds

exchange rate of dollars per pound

or the price of a pound in dollars

quantity of pounds

D

S e*

q*

equivalent price in U.S dollars.

Instead of trying to remember whether you should multiply or divide to determine the answer to this sorts of question, just remember to set up the

problem so the currencies cancel appropriately

Problem: If $1 is worth £ 0.75, how many U.S dollars is £30 worth?

You start with £’s and want to finish with $’s

So, set up the problem like this:

Notice that you have a £ in the numerator and

denominator So the £’s cancel and you’re left with your $ in the numerator for your answer.

What if you were given the problem like this?

If $1 is worth £ 0.75, how many British pounds is $40 worth?

Now you start with $’s and want to finish with £’s

So, set up the problem like this:

Notice that you have a $ in the numerator and

denominator So the $’s cancel and you’re left with your £ in the numerator for your answer.