Exchange Rates, the Balance of Payments, & Trade Deficits Chapter 21 10/5/2015 1
21.1 Learning Target I can explain how the U.S. Balance of payments is calculated. 10/5/2015 2
Financing International Trade U.S. export transaction U.S. exports create a foreign demand for dollars Fulfilling that demand increases the supply of foreign currencies owned by U.S. banks & available to U.S. buyers U.S. import transaction Creates a domestic demand for foreign currencies Fulfilling that demand reduces the supplies of foreign currencies held by U.S. banks & available to U.S. consumers 10/5/2015 3
The balance of payments Sum of all the transactions that take place between its residents & the residents of foreign nations Includes: imports & exports of goods, services, tourist expenditures, interest & dividends received or paid abroad, & purchases and sales of financial or real assets abroad. The U.S. Commerce Department’s Bureau of Economic Analysis compiles the balance-of- payments statement annually Shows flow of payments into & out of the country 10/5/2015 4
Current account The section in a nation’s international balance of payments that records: Exports & imports of goods & services, its net investment income & net transfers Exports have a (+) symbol (credit)…imports have a (-) symbol (debit) Balance of trade – difference between its exports & imports of goods Trade deficit – import more than export Trade surplus- export more than import Balance on current account – sum of all transactions in the current account 10/5/2015 5
Capital & financial account Capital Measures debt forgiveness Financial Summarizes the purchase or sale of real or financial assets and the corresponding flows of monetary payments that accompany them 10/5/2015 6
Payments, deficits, & surpluses Balance-of-payments deficit Occurs when a nation must draw down its official reserves to balance the capital & financial account with the current account Balance-of-payments surplus Occurs when a nation adds to its official reserves in order to balance the two accounts 10/5/2015 7
21.2 Learning Targets I can explain how exchange rates are determined in currency markets. I can discuss the difference between flexible exchange rates and fixed exchange rates. 10/5/2015 8
Flexible (Floating) Exchange Rates Demand & supply determine exchange rates & in which no government intervention occurs Depreciation & appreciation Depreciation – more of its currency is needed to buy a single unit of some other currency Appreciation – fewer units of the currency is needed to buy some other currency 10/5/2015 9
Determinants of exchange rates The following factors cause a nation’s currency to appreciate or depreciate in the foreign exchange market 1. Changes in tastes 2. Relative income changes 3. Relative price-level changes 4. Relative interest rates 5. Speculation 6. Changes in Relative Expected Returns on Stocks, Real Estate, & Production Facilities 10/5/
Flexible rates & the balance of payments Proponents of flexible exchange rates say they have an important feature: They automatically adjust & eventually eliminate balance-of-payments deficits or surpluses. Disadvantages of flexible exchange rates Uncertainty & diminished trade Instability Wide fluctuations stimulate & then depress industries producing exported goods 10/5/
Fixed (Pegged) exchange rates Governments determine exchange rates & make necessary adjustments in their economies to maintain those rates How a fixed exchange rate is maintained: 1. Use of reserves Currency interventions 2. Trade policies 3. Exchange controls & rationing Objections Distorted trade, favoritism, restricted choice (controls would limit freedom of consumer choice), & black markets 4. Domestic macroeconomic adjustments 10/5/
21.3 Learning Targets I can explain the causes & consequences of U.S. trade deficits. 10/5/
The Current System: The Managed Float Managed floating exchange rates Exchange rates among major currencies are free to float In support of the Managed Float Concerns with the Managed Float 10/5/
Recent U.S. trade deficits Causes of the trade deficits Economic growth China (fixed exchange rate) Rapid rise in price of oil Decline in U.S. savings rate Implications of U.S. trade deficits Increase U.S. indebtedness Trade deficits must be financed by borrowing from the rest of the world 10/5/