International Finance

International Finance

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 681,874 Goods Imported -1,164,746 Balance on goods (Net Goods Exports = Gds Exp – Gds Imp) -482,872 Services Exported 292,233 Services Imported -227,399 Balance on services (Net Serv Exports = Serv Exp – Serv Imp) 64,834 Balance on goods and services (Balance of Trade)-418,038 Income receipts 255,542 Income payments -259,512 Balance on income (Net Income) -3,970 Net transfers -58,853 Balance on Current Account -480,861 Capital account transactions, net -1,285 Financial account 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

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 Current Account: Goods Services Income receipts & payments (from investments) Transfers 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] --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Current account Goods Exported 681,874 Goods Imported -1,164,746 Balance on goods (Net Goods Exports = Goods Exp – Goods Imp) -482,872 Services Exported 292,233 Services Imported -227,399 Balance on services (Net Service Exports = Service Exp – Service Imp) 64,834 Balance on goods and services (Balance of Trade) -418,038 Income receipts 255,542 Income payments -259,512 Balance on income (Net Income) -3,970 Net transfers -58,853 Balance on Current Account -480,861

Balance of Trade difference between a country’s exports & imports

trade surplus: exports > imports More goods & services going out of the country than coming in. goods goods

trade deficit: imports > exports More goods & services coming into the country than going out. goods goods

To remember what is a surplus and what is a deficit, watch the money.

trade surplus positive balance of trade: more money coming into the country than going out money money

trade deficit negative balance of trade: more money going out of the country than coming in. money money

Current Account Surplus:positive balance on current accountmore money coming in than going out Current Account Deficit:negative balance on current accountmore 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 U.S.-owned assets abroad -178,985 Foreign-owned assets in the United States 706,983 Balance on Financial Account 527,998

Financial Account Surplus:positive balance on financial accountmore money coming in than going out Financial Account Deficit:negative balance on financial accountmore 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] ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Current account Goods Exported 681,874 Goods Imported -1,164,746 Balance on goods (Net Goods Exports = Goods Exp – Goods Imp) -482,872 Services Exported 292,233 Services Imported -227,399 Balance on services (Net Service Exports = Service Exp – Service Imp) 64,834 Balance on goods and services (Balance of Trade)-418,038 Income receipts 255,542 Income payments -259,512 Balance on income (Net Income) -3,970 Net transfers -58,853 Balance on Current Account -480,861------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Capital account transactions, net -1,285------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Financial account 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) • The conference at Bretton Woods, N.H. established the International Monetary Fund (IMF). • The IMF supervised a system of fixed exchange rates, 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.) • Problem: Again the gold supply couldn’t keep up with 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 D quantity of pounds

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 S quantity of pounds

Market for British Pounds exchange rate of dollars per pound or the price of a pound in dollars S D quantity of pounds

Market for British Pounds exchange rate of dollars per pound or the price of a pound in dollars S e* D q* quantity of pounds

Converting Currencies Recall that £ is the symbol for the British pound. Suppose that $1 is worth £0.75. You are in England and considering purchasing a sweatshirt with a picture of Buckingham Palace. The price is £30. You want to determine the 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.

International Finance