Welcome! Sorry I can’t be here everyone! The baby, my husband, and I have all been sick. Hopefully the medicine kicks in soon. Get the Trade/FOREX packet Ads and Posters- bring those Thursday/Friday Notes: Trade Barriers and Balance of Payments. Activities are due at the end of class

Trade Barriers

What is TRADE? The voluntary exchange of goods and services among people and countries. Trade and voluntary exchange occur when buyers & sellers freely and willingly engage in market transactions. When trade is voluntary and non-fraudulent, both parties benefit and are better off after the trade than they were before the trade.

Free Trade vs. Trade Barriers Nations can trade freely with each other or there are trade barriers. Free Trade: Nothing hinders or gets in the way from two nations trading with each other. Sometimes countries complain about trade. They say that too much trade causes workers to lose jobs. Therefore, countries sometimes try to limit trade by creating trade barriers.

Should countries create trade barriers that limit trade? It is true that some workers in certain industries may be hurt by trade. For example, some US clothing workers have had to change jobs during the past 30 years because many clothes are now imported from other countries. However, this trade allows people in the US to buy quality clothing imports at good prices, which results in a higher standard of living for people in the US and for our trading partners. For this reason, most economists agree that it is good to let countries trade as much as possible.

Economic Trade Barriers The most common types of trade barriers are tariffs and quotas. A tariff is a tax on imports (imports are goods purchased from other countries and exports are goods sold to other countries). A quota is a specific limit placed on the number of imports that may enter a country. Another type of trade barrier is an embargo. a complete trade block for a political purpose

Tariffs A tariff is a tax put on goods imported from abroad. The effect of a tariff is to raise the price of the imported product. It makes imported goods more expensive so that people are more likely to purchase domestic products. EXAMPLE: The European Union removes tariffs between member nations and imposes tariffs on nonmembers.

Quotas A quota is a limit on the amount of goods that can be imported. Putting a quota on a good creates a shortage, which causes the price of the good to rise and makes the imported goods less attractive for buyers. This encourages people to buy domestic products, rather than foreign goods. EXAMPLE: Brazil could put a quota on foreign made shoes to 10,000,000 pairs a year. If Brazilians buy 200,000,000 pairs of shoes each year, this would leave most of the market to Brazilian producers.

Embargos Embargos are government orders which completely prohibit trade with another country. If necessary, the military actually sets up a blockade to prevent movement of merchant ships into and out of shipping ports.

US-Cuban Trade Embargo The embargo is the harshest type of trade barrier and is usually enacted for political purposes to hurt a country economically and thus undermine the political leaders in charge. EXAMPLE: The United States placed an embargo on Cuba after the Cuban Missile Crisis. We currently have limited trade with Cuba with exceptions to the embargo of some agricultural and medical exports. Any trade must go through government channels to ensure US dollars do not take hold in Cuba

Benefits of Trade Barriers Most barriers to trade are designed to prevent imports from entering a country. Trade barriers provide many benefits because they protect homeland industries from competition. protect jobs. help provide extra income for the government. increase the number of goods people can choose from. decrease the costs of these goods through increased competition.

Costs of Trade Barriers Tariffs increase the price of imported goods. Less competition from world markets means there is an increase in the price. The tax on imported goods is passed along to the consumer so the price of imported goods is higher.

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The Balance of Payments

Balance of Payments Measure of money inflows and outflows between the United States and the Rest of the World (ROW) Inflows are referred to as CREDITS Outflows are referred to as DEBITS The Balance of Payments is divided into 3 accounts Current Account Capital/Financial Account Official Reserves Account

Double Entry Bookkeeping Every transaction in the balance of payments is recorded twice in accordance with standard accounting practice. Ex. U.S. manufacturer, John Deere, exports $50 million worth of farm equipment to Ireland. A credit of $50 million to the current account ( - $50 million worth of farm equipment or physical assets) A debit of $50 million to the capital/financial account ( + $50 million worth of Euros or financial assets) Notice that the two transactions offset each other. Theoretically, the balance payments should always equal zero…Theoretically

Double Entry Bookkeeping Lucky for you, in AP Macroeconomics we only worry about the 1 st half of the transaction. We simplify and see the export of farm equipment as a credit (inflow of $) to the current account. Why then, did I mention double entry bookkeeping? To illustrate my innate intelligence? No To help you understand that the current account and capital/financial account are intrinsically linked together and help balance each other? Yes, that’s it!

Current Account Balance of Trade or Net Exports Exports of Goods/Services – Import of Goods/Services Exports create a credit to the balance of payments Imports create a debit to the balance of payments Net Foreign Income Income earned by U.S. owned foreign assets – Income paid to foreign held U.S. assets Ex. Interest payments on U.S. owned Brazilian bonds – Interest payments on German owned U.S. Treasury bonds Net Transfers (tend to be unilateral) Foreign Aid  a debit to the current account Ex. Mexican migrant workers send money to family in Mexico

Capital/Financial Account The balance of capital ownership Includes the purchase of both real and financial assets Direct investment in the United States is a credit to the capital account Ex. The Toyota Factory in San Antonio Direct investment by U.S. firms/individuals in a foreign country are debits to the capital account Ex. The Intel Factory in San Jose, Costa Rica

Capital/Financial Account Purchase of foreign financial assets represents a debit to the capital account. Ex. Warren Buffet buys stock in Petrochina. Purchase of domestic financial assets by foreigners represents a credit to the capital account. The United Arab Emirates sovereign wealth fund purchases a large stake in the NASDAQ.

What causes Capital/Financial Flows? Differences in rates of return on investment Ceteris Paribus, savings will flow toward higher returns r% Q LF China S LF China D LF USA r% Q LF USA S LF USA D LF China S LF 1 Debit to the Chinese Capital Account Credit to the U.S. Capital Account     

Relationship between Current and Capital Account Remember double entry bookkeeping? The Current Account and the Capital Account should zero each other out. That is… If the Current Account has a negative balance (deficit), then the Capital Account should then have a positive balance (surplus). Ex. The constant net inflow of foreign financial capital to the United States (capital account surplus) is what enables us to import more than we export (current account deficit)

Official Reserves The foreign currency holdings of the United States Federal Reserve System When there is a balance of payments surplus the Fed accumulates foreign currency and debits the balance of payments. When there is a balance of payments deficit the Fed depletes its reserves of foreign currency and credits the balance of payments The Official Reserves zero out the balance of payments

Active v. Passive Official Reserves The United States is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate. The People’s Republic of China is active in its use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate with the United States.

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