Presentation Transcript

1. Unit 4: The Global Economy: International Trade and Development

   Chapter 12: Trade Theory, Agreements, and Patterns Chapter 13: Financing International Trade Chapter 14: International Economic Issues
2. Buying and Selling Internationally We learned in Chapter 12 how important international trade is to the Canadian economy Makes up one-third of GDP More than 50% of all good produced by private sector are exported Exports provide income for Canadians, produce tax revenues for our federal and provincial governments, and pay for our imports This chapter will examine how these massive amounts of goods and services flowing in and out of Canada are financed
3. Buying and Selling Internationally The major difference in buying and selling internationally, as opposed to domestically, is the necessity of using different currencies Exporters demand payment for their goods in their own countries’ currencies Can’t pay for raw materials and employees’ wages using foreign currency
4. Buying and Selling Internationally Suppose a Canadian manufacturer is selling $10 million worth of industrial machinery to a British company The British importer would have to exchange pounds for Canadian dollars in order to complete the sale If the exchange rate is £1 = Can$2.30… The importer would pay a British bank £4,347,826 (10,000,000 ÷ $2.30) to obtain the $10 million necessary to pay the Canadian exporter
5. Buying and Selling Internationally But where would the British bank obtain the Canadian funds? Let’s suppose that Canadian importers want to buy $10,000,000 worth of fine china from Britain Would have to exchange $10,000,000 for £4,347,826 at a Canadian bank in order to pay the British exporter The British bank has pounds and needs dollars, and the Canadian bank has dollars and needs pounds Both banks can meet their customers’ needs by getting together and completing a transaction
6. Buying and Selling Internationally In the past, currency exchanges were carried out on a bank-bank basis Today, either bank can obtain foreign currency from the foreign exchange market A computerized global network of banks, investment dealers, and financiers The conversion of currencies is a service provided for a fee, or commission
7. Buying and Selling Internationally There are a number of intangible transactions that are also defined as either exports or imports Known as invisible, or non-merchandise trade Includes exchange of services, tourism, and interest and profits earned abroad i.e. all the payments and receipts that occur between two countries and that necessitate a conversion of one currency into another
8. Buying and Selling Internationally A Canadian export (or receipt) is an international transaction in which a foreign currency must be converted into Canadian dollars Ex: An American tourist who converts US dollars into Canadian dollars to pay for hotels, meals, etc. A Canadian import (or payment) is an international transaction in which Canadian dollars must be converted into foreign currency Ex: Foreigners who earn interest from deposits in Canadian banks, then convert it into their respective currencies
9. Exchange Rates An exchange rate is the price at which one currency can be purchased for another The exchange rate of the Canadian dollar is usually expressed in terms of US dollars For example, the statement “the Canadian dollar is worth 0.625 US dollars” means that Can$1.00 will obtain US$0.625 in the exchange market Another way of looking at the exchange rate of our dollar is to price other currencies in terms of Canadian dollars For example, the statement “the US dollar is worth 1.60 Canadian dollars” means that US$1.00 will obtain Can$1.60 in the exchange market
10. How Exchange Rates are Determined The value of a currency is measured by its price in terms of other currencies If that price increases, the currency is said to have appreciated in value Ex: If the Canadian dollar rises from US$0.62 to US$0.64, an appreciation of the Canadian dollar, in terms of the US dollar, is said to have occurred A currency depreciates when its price falls in terms of other currencies
11. How Exchange Rates are Determined If the exchange rate is expressed in terms of the amount of Canadian dollars it takes to buy a foreign currency, the dollar appreciates when that amount falls Ex: If the exchange rate for Canadian dollars and British pounds changes from £1 = Can$2.24 to £1 = Can$2.20, the dollar has appreciated against the pound, and the pound has depreciated against the dollar A dollar depreciation occurs when the value of foreign currency raises in terms of Canadian dollars
12. How Exchange Rates are Determined In order to understand how these rates are determined, we apply a familiar economic tool Demand and supply analysis We’ll assume that the exchange rates are flexible, or floating They are determined entirely in the market by the forces of demand and supply, with no government intervention
13. The Demand for Canadian Dollars A demand for Canadian dollars is created in the foreign exchange market by the foreign importers of our good or service They need to pay for Canadian goods in Canadian dollars Figure 18.3a shows the demand for Canadian dollars by French importers
14. The Demand for Canadian Dollars The vertical axis represents the exchange rate between the euro and the Canadian dollar Note that the dollar appreciates in value as the numbers rise The horizontal axis represents the quantity of Canadian dollars demanded by French importers When the exchange rate falls, or depreciates, French importers demand more dollars because our exports become less expensive to them (i.e. the euro “buys” more dollars) Ex: At an exchange rate of Can$1.00 = €0.75, a tonne of newsprint worth Can$10,000 costs €7500; the same tonne costs €7000 when the Canadian dollar falls to Can$1.00 = €0.70
15. The Demand for Canadian Dollars Dollar depreciation (which causes the euro to appreciate) increases the demand for our exports, thus the quantity of Canadian dollars demanded will rise as well If the dollar appreciates, our exports become more expensive to French importers, so they demand fewer Canadian dollars So the demand curve has the familiar inverse, or negative relationship between the exchange rate (vertical axis) and the number of dollars demanded (horizontal axis) As the dollar appreciates, fewer dollars are demanded As the dollar depreciates, more dollars are demanded
16. The Supply of Canadian Dollars When Canadians import goods and services, we must pay foreign exporters in their own currency We supply Canadian dollars in the exchange market and demand foreign currency in exchange
17. The Supply of Canadian Dollars When the dollar appreciates in terms of the euro (one dollar now buys more euros), Canadians find that French goods and services are less expensive By demanding more euros in order to buy these goods and services, Canadians supply more dollars Imported French perfume prices at €60 costs Can$85.71 when the exchange rate is Can$1.00 = €0.70 When the dollar appreciates to Can$1.00 = €0.75, the price of the perfume falls to $80.00, and imports rise
18. The Supply of Canadian Dollars Alternatively, dollar depreciation makes foreign imports more expensive for Canadians Fewer euros are demanded and fewer Canadian dollars are supplied So the supply curve has the familiar direct, or positive, relationship between the exchange rate and the number of dollars supplied As the dollar appreciates, more dollars are supplied As the dollar depreciates, fewer dollars are supplied
19. The Exchange Rate at Equilibrium The actual exchange rate will be set at the point where the quantity of euros demanded equals the quantity of Canadian dollars supplied i.e. where demand and supply are at equilibrium As shown in Figures 18.4a and 18.4b, demand and supply intersect at Can$1.00, or €0.75
20. The Exchange Rate at Equilibrium Figure 18.4a shows that if the exchange rate were set too high, at Can$1.00 = €0.80… The supply of Canadian dollars would exceed the demand for them The exchange rate would fall to Can$1.00 = €0.75
21. The Exchange Rate at Equilibrium Figure 18.4b shows that if the exchange rate were set too low, at Can$1.00 = €0.65… The demand for Canadian dollars would exceed the supply of them The exchange rate would rise to Can$1.00 = €0.75
22. The Exchange Rate at Equilibrium Assuming no other forces are operating in this market, the exchange rate moves toward equilibrium at Can$1.00 = €0.75 However, we know other forces are always present, and the exchange rate does change
23. Causes of Fluctuations in the Exchange Rate We have learned how changes in the exchange rate of the Canadian dollar affect our exports and imports But what causes the exchange rate itself to change? Although economists don’t agree on the exact causes of specific declines, let’s consider some of the reasons that usually explain fluctuations in the exchange rate
24. A Change in Demand for Canadian Goods Figure 18.5 shows a rise in Canadian exports as the demand curve moves to the right from D1 to D2 Such an increase creates an increased demand for Canadian dollars because Canadian exporters want to be paid in their own currency The exchange rate rises, or appreciate, from $0.75 to $0.80, where the demand for dollars equals the supply of them
25. A Change in Demand for Canadian Goods Conversely, a decrease in exports would move the demand curve left, from D1 to D3 Causes the exchange rate to fall, or depreciate, as a result of the new equilibrium point In order to find out what causes these changes in demand, let’s explore two factors
26. A Change in Demand for Canadian Goods Canadian exports tend to increase when the economies of our trading partners, particularly the US, are growing During the 1990s, the US economy was prospering, which increased the demand for Canadian products However, the demand for our products was partially offset by a slowdown in the economy of another significant trading partner, Asia, during the late 1990s As a result, the demand in the Asian market for Canada’s natural resource products decreased The key point here is that the demand for exports depends, to a large extent , on the economic health of our trading partners
27. A Change in Demand for Canadian Goods Canadian interest rates affect the demand for Canadian dollars If interest rates in Canada rise, Canadian bonds and bank deposits become more attractive to foreign financiers and traders, increasing the demand for Canadian dollars If Canadian rates fall, the inflow of foreign capital seeking interest rate profits declines, and the demand for the dollar falls
28. A Change in the Supply of Canadian Dollars Figure 18.6 shows a rise in Canada’s imports as the supply curve moves to the right from S1 to S2 Creates an increased supply of Canadian dollars Causes the equilibrium point to shift to E2, where the supply of Canadian dollars equals the demand for them The value of the dollar has depreciated from $0.75 to $0.70
29. A Change in the Supply of Canadian Dollars A decrease in imports would move the supply curve to the left Causes the equilibrium rate (E3) to rise to $0.80, or to appreciate to the point where supply equals demand These different equilibrium rates also cause changes in the quantity of dollars (Q1, Q2, Q3) actually transacted Imports tend to increase when the Canadian economy is growing and to decrease when it is in recession, similar to the demand for domestic goods
30. Exchange Rate Systems: Fixed Exchange Rates Until the 1970s, most nations had fixed exchange rates They fixed, or pegged, their exchange rate in terms of the US dollar In order to maintain the pegged rate, governments bought or sold their own currencies in the foreign exchange market and kept foreign currencies in special reserve funds
31. Exchange Rate Systems: Fixed Exchange Rates Suppose the Canadian dollar was pegged at US$0.75 and, because of a fast-growing US economy, demand for Canadian exports was rising The demand for Canadian dollars would move upward, pressuring the Canadian dollar upward To prevent the dollar from appreciating beyond its pegged rate, the Bank of Canada would intervene in the exchange market by purchasing US dollars and supplying Canadian dollars Figure 18.7a shows the result The supply curve moves to the right, which causes the exchange rate to move down to its pegged rate
32. Exchange Rate Systems: Fixed Exchange Rates Conversely, the Canadian dollar could be pressured downward by a fall in exports or by a rise in Canadian import Suppose Canadian imports were rising from S1 to S2, as shown in Figure 18.7b To prevent the Canadian dollar from depreciating, the Bank of Canada would have to use the US dollars in its reserve fund to buy Canadian dollars on the foreign exchange market Would increase demand for Canadian dollars from D1 to D2, restoring the exchange rate to its pegged value However if increases in market demand for dollars were met with equal increases in market supply, the government would not have to intervene in order to support the pegged value
33. Exchange Rate Systems: Fixed Exchange Rates Although central banks tried to prevent the devaluation or depreciation of their nation’s currency by using foreign reserves to purchase it, the actions of corporations and individual speculators often nullified the central banks’ efforts For example, if these groups believed that the Canadian dollar was pegged too high, they would cash in their Canadian investments and invest the money in other countries They were counting on the fact that the amount of money they were moving out would be so large that the Bank of Canada couldn’t buy back the Canadian dollars with the limited foreign exchange reserves on hand
34. Exchange Rate Systems: Fixed Exchange Rates If they were proved correct, the Bank of Canada would be forced to devalue the dollar i.e. reduce its value in relation to other currencies The businesses and speculators would then reconvert their investments into Canadian funds at a profit For this and other reasons, fixed exchange rates were abandoned in 1973
35. Exchange Rate Systems: Fixed Exchange Rates Under the market value system that replaced the fixed rate system, the value of the Canadian dollar continues to be greatly influenced by international confidence in the Canadian economy For example, as Quebec approached each referendum on sovereignty-association (an arrangement that would grant the province political independence), the Canadian dollar took a direct hit on the money markets As the size of Canada’s public debt continued to grow during the 1980s, the dollar lost value in international money markets
36. Exchange Rate Systems: Fixed Exchange Rates At this point, it’s important to clarify our terms If currency loses value in money markets as a result of some government or central bank intervention, this is described as currency devaluation If a currency loses value as a result of the transactions of business and speculators, this is described as currency depreciation Revaluation and appreciation both refer to currency value gains, but they result from different actions
37. Exchange Rate Systems: Flexible Rates A flexible, or floating, exchange rate is set solely by demand and supply, without government intervention Few nations are willing to allow their exchange rate to float without some intervention from time to time Since the 1970s, most nations have used a system called a managed float, a compromise between flexible and fixed rates
38. Exchange Rate Systems: Flexible Rates Under this system, the government allows the international market to set the exchange rate in the long run, as it would under a flexible exchange rate system, but intervenes from time to time to smooth out short-term fluctuations In Canada, the Bank of Canada mainly uses interest rates to control short-term fluctuations in the exchange rate If the dollar is depreciating, the Bank can raise rates to increase the demand for the dollar If the dollar is appreciating, it can lower rates
39. Exchange Rate Systems: Flexible Rates The Bank of Canada can also use foreign exchange reserves to buy and sell Canadian dollars in the international market, in the same way it would under a fixed exchange system In 2002, the Bank had approximately $34 billion in foreign exchange reserves, which could be used to prevent the dollar from falling
40. The Balance of Payments Nations keep track of their international payments and receipts in their balance of payments account This account is divided into two main parts: The current account The capital and financial account
41. The Current Account The current account includes 3 components: Goods (or visibles) Include raw materials and processed or manufactured goods Services (or invisibles) Include tourism; transportation charges for shipping goods by rail, sea, and air; commercial services such as management and consulting; and government assistance to other nations, the UN, and other international organizations Investment income Composed of dividends and interest earned from investments in Canada and abroad
42. The Current Account Figure 18.9 illustrates the structure of Canada’s current account from 1989 to 2000 It indicates whether Canada has a surplus or deficit balance on each of the three components Also indicates whether the three add up to an overall surplus or deficit balance on the entire account
43. The Current Account The goods trade balance shows that between 1989 and 2000 Canada always exported more visible, or merchandise, goods than it imported, producing a surplus balance Services, or invisibles, tended to record a slight deficit balance While not indicated in Figure 18.9, goods and services are often combined to arrive at the balance of trade This balance almost always records a surplus, reflecting Canada's traditional role as an exporting nation
44. The Current Account Investment income shows a deficit balance in Figure 18.9 Means that foreign investors are collecting more interest and dividends from their investments in Canada than Canadian investors are collecting from their investments abroad This investment deficit is large enough that, when combined with the other two balances on goods and services, Canada usually records a current account deficit
45. The Current Account How can a country pay out more than it receives? The answer is found in the capital and financial account, which must record a surplus Alternatively, if the current account records a surplus, then the capital and financial account must record a deficit
46. The Capital and Financial Account The capital and financial account is subdivided into two accounts: Capital account Financial account
47. Capital Account The capital account includes: Migrants’ funds Inheritances Government pension payments to Canadians living abroad These items are further subdivided into inflows and outflows For example, when Canadians receive an inheritance from a relative in another country, it is considered an inflow When immigrants to Canada send money to their home country, it is an outflow A government pension paid to a “snowbird” in Florida is also considered an outflow
48. Financial Account The financial account includes two types of investment The first is direct investment, either by Canadians abroad (CDI), or by foreigners in Canada (FDI) Involves investors who either establish a new plant or business or take over an existing one by purchasing controlling shares When foreigners invest in our country, it’s an inflow, or receipt for Canada When Canadians invest abroad, it is an outflow, or payment
49. Financial Account The second type is portfolio investment Involves investors who receive dividends or interest on stocks or bonds, but who don’t control a company, as is the case with direct investment Purchases of Canadians stocks or bonds by foreigners represent an inflow, or receipt for Canada Similar purchases of foreign stocks or bonds by Canadians represent an outflow, or payment
50. Financial Account In Figure 18.10, we see a pattern of more foreign portfolio investment than Canadian, except for the periods 1996 and 1999-2000
51. Official International Reserves The official international reserves are another important component of the financial account Managed by the Bank of Canada, the official reserves are composed of foreign currencies, mostly US dollars, and gold In 2002, they totaled $34 billion The reserves are similar to a bank account held by an individual When income exceeds expenditures for a period of time, the individual’s bank account increases However, when expenditures exceed income, the individual must use the savings in the account to make up the difference
52. Official International Reserves The official reserves can be used by the Bank of Canada in the same way If Canada’s current account and capital account are in surplus, then the official reserves increase If the current account and the capital account are in deficit, then the official reserves can be drawn down to pay for the shortfall
53. Balancing the Account Figure 18.11: Canada’s balance of international payments (in millions of dollars), 2000. This table shows a simplified balance of payments for Canada in 2000. When the accounts are totaled, the current account and the capital and financial account should balance, as indicated in Figure 18.11
54. Balancing the Account In order to understand this concept, let’s start with the current account Measures exports and imports of goods and services Foreigners need Canadian dollars in order to buy Canadian exports Canada supplies these dollars by importing foreign goods Remember that when we import goods and services, we convert Canadian dollars into foreign currency
55. Balancing the Account If Canada is exporting more goods and services than its importing, the supply of Canadian dollars will be insufficient for foreigners to buy our exports This is where the financial and capital account comes into play It must finance foreign demand for our dollars by recording more outflows of Canadian money than inflows of foreign money It runs a deficit to pay for the surplus on Canada’s current account
56. Balancing the Account The opposite occurs if the current account runs a deficit If Canadians are importing more than they are exporting, they are demanding more foreign money than foreign buyers are supplying The financial and capital account of Canada records more inflows of foreign money than outflows It runs a surplus to pay for the deficit on the current account
57. Balancing the Account Since its impossible to track all transactions, the current account doesn’t balance exactly with the capital and financial account An adjustment called the statistical discrepancy is calculated to being the two main divisions of the account into balance