1. Copyright 2008 The McGraw-Hill Companies 36-1 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show 36 Exchange Rates, the Balance of Payments, and Trade Deficits

2. Copyright 2008 The McGraw-Hill Companies 36-2 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show 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. Copyright 2008 The McGraw-Hill Companies 36-3 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Financing International Trade U.S. Export Transactions U.S. Import Transactions Balance of Payments A yearly summary of all the economic transactions between residents of one country and residents of the rest of the world The Current Account –Balance on Goods –Balance on Services –Trade Deficit –Trade Surplus –Balance on Current Account W36.1

4. Copyright 2008 The McGraw-Hill Companies 36-4 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Current account The current account is an important indicator about an economy's health. It is defined as the sum of the balance of trade (goods and services exports less imports), net income from abroad and net current transfers. the capital account (also known as the financial account) reflects net change in ownership of national assets

5. Copyright 2008 The McGraw-Hill Companies 36-5 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show When CA is the current account, X and M are respectively the export and import of goods and services, NY the net income from abroad, and NCT the net current transfers. Current account = (-)Capital account + Change in official reserves sum of 3 things – balance of trade, net income on capital held abroad including interest and dividends, net transfer payments such as foreign aid Ex: earnings – spending, earning money on a savings bond that your grandmother gave you when you were 10 (interests from abroad); getting money from relatives (foreign aid)

6. Copyright 2008 The McGraw-Hill Companies 36-6 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Financing International Trade U.S. Trade Balances in Goods and Services Select Nations, 2004 Goods and Services SurplusGood and Services Deficit Australia Belgium Canada China Germany Mexico Netherlands +6.8 -66.5 -45.8 +4.4 -162 -45.1 +11.8 Source: BEA GLOBAL PERSPECTIVE -10-20-30-40-50-60-70-160 10 20 Japan -75.6

7. Copyright 2008 The McGraw-Hill Companies 36-7 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Capital and Financial Account Capital Account – measures changes in foreign ownership of domestic assets including financial assets like stocks and bonds as well as physical assets (country its in increases) Capital surplus – when the inflow of foreign capital is greater than he outflow of domestic capital to other nations

8. Copyright 2008 The McGraw-Hill Companies 36-8 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Capital account Financial Account Balance on the Capital and Financial Account –Payments, Deficits, and Surpluses –Balance-of-Payments Deficits and Surpluses –Official Reserves Ex: When Chinese government buys American government bonds or when Japanese investors buy assets like Rockefeller Center in Manhattan, the US capital account increases. More generally, when there is more investment going into a country than out, that country is running a capital account surplus Third category – official reserves account – measures reserves or currency held by the govt – can include foreign currencies, gold, IMF

9. Copyright 2008 The McGraw-Hill Companies 36-9 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show 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 G36.1

10. Copyright 2008 The McGraw-Hill Companies 36-10 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Q 0 Dollar Price of 1 Pound Quantity of Pounds P Flexible Exchange Rates The Market for Foreign Currency (Pounds) DlDl SlSl Dollar Depreciates (Pound Appreciates) Dollar Appreciates (Pound Depreciates) Exchange Rate: $2 = £1 $2 $3 $1 QlQl

11. Copyright 2008 The McGraw-Hill Companies 36-11 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Q 0 Dollar Price of 1 Pound Quantity of Pounds P Flexible Exchange Rates The Market for Foreign Currency (Pounds) DlDl SlSl Exchange Rate: $2 = £1 $2 $3 $1 QlQl D2D2 Exchange Rate: $3 = £1 Balance Of Payments Deficit Q2Q2 x a b c

12. Copyright 2008 The McGraw-Hill Companies 36-12 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Flexible Exchange Rates Flexible Rates and the Balance of Payments Disadvantages of Flexible Exchange Rates Uncertainty and Diminished Trade Terms-of-Trade Changes Instability

13. Copyright 2008 The McGraw-Hill Companies 36-13 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Fixed Exchange Rates Use of Reserves –Currency Interventions Trade Policies Exchange Controls and Rationing –Distorted Trade –Favoritism –Restricted Choice –Black Markets Domestic Macroeconomic Adjustments

14. Copyright 2008 The McGraw-Hill Companies 36-14 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show International Exchange-Rate Systems The Gold Standard: Fixed Exchange Rates –Devaluation –Gold Flows –Domestic Macroeconomic Adjustments –Collapse of the Gold Standard

15. Copyright 2008 The McGraw-Hill Companies 36-15 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show 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

16. Copyright 2008 The McGraw-Hill Companies 36-16 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show 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

17. Copyright 2008 The McGraw-Hill Companies 36-17 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Recent U.S. Trade Deficits Causes of Trade Deficits Implications of U.S. Trade Deficits –Increased Current Consumption –Increased U.S. Indebtedness

18. Copyright 2008 The McGraw-Hill Companies 36-18 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Speculation in Currency Markets 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 Last Word Negative or Positive Influence on Currency Markets and Trade

19. Copyright 2008 The McGraw-Hill Companies 36-19 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Key Terms balance of payments current account balance on goods and servicesbalance on goods and services trade deficit trade surplus balance on current accountbalance on current account capital and financial accountcapital and financial account balance on capital and financialbalance on capital and financial balance-of-payments deficits and surplusesbalance-of-payments deficits and surpluses official reserves flexible- or floating- exchange-rate systemflexible- or floating- exchange-rate system fixed-exchange-rate systemfixed-exchange-rate system purchasing-power- parity theorypurchasing-power- parity theory currency interventionscurrency interventions exchange controls gold standard devaluation Bretton Woods systemBretton Woods system International Monetary Fund (IMF)International Monetary Fund (IMF) managed floating exchange ratesmanaged floating exchange rates

20. Copyright 2008 The McGraw-Hill Companies 36-20 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Course Review… Final Discussions…