Exchange Rates, the Balance of Payments, and Trade Deficits

1. 19 Exchange Rates, the Balance of Payments, and Trade Deficits

2. Chapter Objectives • How Currencies of Different Nations are Exchanged When International Transactions Take Place • About the Balance Sheet the United States Uses to Account for the International Payments it Makes and Receives • How Exchange Rates are Determined in Currency Markets • The Difference Between Flexible Exchange Rates and Fixed Exchange Rates • The Causes and Consequences of Recent Record-High U.S. Trade Deficits

3. W19.1 Financing International Trade • U.S. Export Transactions • U.S. Import Transactions • Balance of Payments • The Current Account • Balance on Goods • Balance on Services • Trade Deficit • Trade Surplus • Balance on Current Account

4. GLOBAL PERSPECTIVE -160 -70 -60 -50 -40 -30 -20 -10 20 10 Financing International Trade U.S. Trade Balances in Goods and Services Select Nations, 2004 Good and Services Deficit Goods and Services Surplus +6.8 Australia Belgium +4.4 Canada -66.5 China -162 Germany -45.8 Japan -75.6 -45.1 Mexico +11.8 Netherlands Source: BEA

5. Capital and Financial Account • Capital Account • Financial Account • Balance on the Capital and Financial Account • Payments, Deficits, and Surpluses • Balance-of-Payments Deficits and Surpluses • Official Reserves

6. G19.1 Flexible Exchange Rates • Flexible or Floating Exchange Rates • Fixed Exchange Rate system • Depreciation and Appreciation • Determinants of Exchange Rates • Changes in Tastes • Relative Income Changes • Relative Price-Level Changes • Purchasing-Power-Parity Theory • Relative Interest Rates • Speculation

7. P $3 Dollar Price of 1 Pound $2 $1 0 Q Quantity of Pounds Flexible Exchange Rates The Market for Foreign Currency (Pounds) Sl Exchange Rate: $2 = £1 Dollar Depreciates (Pound Appreciates) Dollar Appreciates (Pound Depreciates) Dl Ql

8. P $3 Dollar Price of 1 Pound $2 $1 0 Q Quantity of Pounds Flexible Exchange Rates The Market for Foreign Currency (Pounds) Sl Exchange Rate: $3 = £1 c Balance Of Payments Deficit a x b D2 Exchange Rate: $2 = £1 Dl Q2 Ql

9. Flexible Exchange Rates • Flexible Rates and the Balance of Payments • Disadvantages of Flexible Exchange Rates • Uncertainty and Diminished Trade • Terms-of-Trade Changes • Instability

10. Fixed Exchange Rates • Use of Reserves • Currency Interventions • Trade Policies • Exchange Controls and Rationing • Distorted Trade • Favoritism • Restricted Choice • Black Markets • Domestic Macroeconomic Adjustments

11. International Exchange-Rate Systems • The Gold Standard: Fixed Exchange Rates • Devaluation • Gold Flows • Domestic Macroeconomic Adjustments • Collapse of the Gold Standard

12. International Exchange-Rate Systems • The Bretton Woods System • International Monetary Fund (IMF) • IMF and Pegged Exchange Rates • Official Reserves • Gold Sales • IMF Borrowing • Fundamental Imbalances: Adjusting the Peg • Demise of the Bretton Woods System

13. International Exchange-Rate Systems • The Current System: The Managed Float • Managed Floating Exchange Rates • In Support of the Managed Float • Concerns With the Managed Float

14. Recent U.S. Trade Deficits • Causes of Trade Deficits • Implications of U.S. Trade Deficits • Increased Current Consumption • Increased U.S. Indebtedness

15. Speculation in Currency Markets Last Word Negative or Positive Influence on Currency Markets and Trade • Currency Purchases to Purchase Goods and Services • Contributing to Currency Market Fluctuations • Speculator’s Role and Activities • Smoothing Short-Term Fluctuations • Absorbing Risk • Futures Market at Work • Positive Role Played Overall

16. balance of payments current account balance on goods and services trade deficit trade surplus balance on current account capital and financial account balance on capital and financial balance-of-payments deficits and surpluses official reserves flexible- or floating- exchange-rate system fixed-exchange-rate system purchasing-power-parity theory currency interventions exchange controls gold standard devaluation Bretton Woods system International Monetary Fund (IMF) managed floating exchange rates Key Terms

17. Course Review… Final Discussions… Thanks!