Financing International Trade

  • International trade --> involvement of different national currencies.
  • Foreign exchange market
    • dollars can purchase pesos, European euros
U.S. Export Transaction
  • Say the U.S. sells $300,000 worth of computers to a British firm and the exchange rate is $2 for £1 (real rate is $1.50 for £1).
    • British importers must pay the equivalent £150,000 to the U.S. exporters.
  • U.S. exports create a foreign demand for dollars, which increases supply of foreign currencies in the U.S. as the fulfillment of the demand for U.S dollars is met (McConnell and Brue 712).
The Balance of Payments
  • A nation's balanceof payments is the sum of all the transactions that take place between its residents and the residents of all foreign nations.
    • includes exports and imports of goods, and exports and imports of services, tourist expenditures, interest and dividends paid abroad, and purchases and sales of financial or real assets abroad
    • compiled by the U.S. Commerce Department's of Bureau of Economic Analysis each year
    • The statement shows all the payments a nation receives from foreign countries and all the payments it makes to them.

Current Account:
  • Current Account: summarizes U.S. trade in currently produced goods and services.
  • U.S. exports have a (+) sign because they are a credit; they earn and make available foreign exchanges in the United states.
  • Any export-type transaction that obligates foreigners to make “inpayments” to the United States generates upplies of foreign currencies in the U.S. banks.
  • U.S. imports have a (-) sign as they are a debit; they reduce the stock of foreign currencies in the United States.

Balance on Goods:
  • A country’s balance of trade on goods is the difference between its exports and its importsof goods.
  • If exports > imports the result is a surplus on the balance of goods.
  • If exports < imports, the result is a deficit in the balance of goods.
Balance on Services:
  • insurance, consulting, travel, and brokerage services, to residents of foreign nations
  • The balance of goods and services is the different between U.S. exports of goods and services and U.S. imports of goods and services.
  • Trade deficit: U.S. imports of goods and services exceeded U.S. exports of goods and services.
  • Trade surplus: occurs when exports of goods and services exceed imports of goods and services.
.Balance on Current Acount:
  • By Adding all the transactions in the current account to get the balance on current account.
  • The 504 billion deficit of 2002 indicates that outpayments exceeded inpayments of foreign currencies in 2002
  • net investment income represents difference between interest/dividend payments for exported US capital and interest/dividend payments for foreign capital invested in US
  • Net transfers include foreign aid, pensions paid to US citizens abroad, and remittances by relatives to foreign relatives
Capital Account:
  • Is the the purchase or sale of real or finicial assets and the corresponing flows of monetarty payments that accomopany them. ( McConnel and Brue 714)
  • The "exports" of ownership assests are made to designate foriegn pruchase assests in the united states. ( McConnel and Brue 714)
  • Balance on capital amount: the foreign purchases of assets in the U.S. less American purchases of assets abroad in a year (McConnell and Brue 714).

Official Reserves Account
  • Official reserves- central banks of nations that hold quantities of foreign currencies
  • Reserves can be drawn on to make up a net deficit in the current and capital accounts (McConnell 714)

Payments Deficits and Surpluses
  • balance of payments deficits and surpluses are not necesarily good or bad however a nation's reserves are limited. Problems are only caused when a nation is consistently making payments to a deficit. (McConnell 715)
    • If the Government pays it debt down, that will mean that it is borrowing less, reducing the interest rates, causing the dollar to depreciate.
    • If the Government borrows more it can cause higher interest rates, then the dollar will probably appreciate
  • Refers to the imbalance between current and capital accounts increasing in foreign currencies (McConnell 715)

Flexible Exchange Rates
  • The imbalance in the national balance of payments deficits and surpluses depend on the system of exchange.
  • There are two types of exchange rate systems
    • A flexible or floating exchange rate system is one that through demand and supply exchange rates are determined without government intervention
    • A fixed exchange rate system is one that through government exchange rates are determined, and adjustments will be made to maintain those rates
    • The difference between the two is that on requires government involvment and one does not

Depriciatin and Appriciation
  • when dollar price falls , relative to the pound, then it has appriciated
  • when dollar price rises, relative to the pound, it has depriciated
  • depreciation of the dollar is generally bad and appreciation is generally good for a country

Determinants of Exchange Rates

  • If the demand for a nations curency increases then the nation's curency will appreciate and will depreciate if the demand goes down

  • If the supply of a nation's currency increases then the currency will depreciate and will increase if the nation's currency decreases
  • If the nation's currency appreciates, then some foreign currency will depreciate relative to it (McConnell and Brue 717).
Exchange Controls and Rationing
  • Exchange controls: The U.S. government could handle the problem of a pound shortage by requiring that all pounds obtained by U.S. exporters be sold to the Federal government (McConnell and Brue).
  • There are objections to exchange controls though:
    • Distorted trade: Distorting trade would shift international trade away from comparative advantage model.
    • Favoritism: Scarce foreign exchange rationing can lead to governments favoritism toward certain importers.
    • Restricted choice: Limit the options and impair the consumers.
    • Black markets: Black-market dealings may occur because the consumer wants foreign products so bad.
International Exchange-Rate Systems
  • Gold Standard: Fixed exchange rates (McConnell and Brue 722)
    • required each nation to define its currency using gold
    • required nations to keep constant ratio or relationship between gold stock and currency
    • required nations to allow for exports and imports of gold freely
    • fixed exchange rate came from the fact that once countries established gold to currency ratios, they never changed, and so for instance $2 always got somebody 1 British pound
    • The gold standard was ended owing to the aftermath of the Great Depression during the 1930s.
      • Many countries began to devalue their currency, in order to lower the value of the countries currency in comparison to the currency of other countries.
      • The rationale behind this was to increase exports, since exports would cost less money in the other countries.
  • The current exchange system that deals with the exchange of currencies amongst countries is referred to as the managed floating exchange rate system.
    • The rates generally adjust to the equilibrium price and quantity levels, but a country still has some ability to manage the rates through currency interventions.
      • Currency interventions involve the the use of foreign currency reserves that one country may hold of the currency of another country.
      • For example, suppose a balance of payments deficit occurs in the U.S. with Canada. The U.S. government may use reserves of Canadian dollars present from a balance of payments surplus in the past to maintain a fixed exchange rate. This could be done by the U.S. government selling a portion of the Canadian dollars held in its reserves for U.S. dollars, in order to increase the supply of those Canadian dollars for use by the U.S. importers.
      • A country can increase its supply of official reserves of another foreign country by purchasing it through the use of gold. The U.S. government, therefore, could purchase Canadian dollars through the use of gold and then increase the supply of Canadian dollars by selling those Canadian dollars, so that no fluctuation occurs in the exchange rate.
      • If a balance of payments deficit consistently occurs for the U.S. in relation to Canada, the U.S. will no longer be able to use currency interventions because the supply of Canadian dollars in the official reserves will eventually be depleted. [1]
The Bretton Woods System
  • In 1944 major nations held an international conference in Bretton Woods, New Hampshire to assess the damage to the world monetary system as a result of The Great Depression and World War II (McConnell, Brue 723).
  • It was the first example of an attempt to govern monetary relations with other independent nations.
  • The conference led to a commitment to a changed fixed-exchange-rate system called the Bretton Woods System (McConnell, Brue 723).
  • The conference also established the International Monetary Fund (IMF) to make the new exchange-rate-system applicable and able to be worked with (McConnell, Brue 723).

IMF and Pegged Exchange Rates
  • Official reserves: The US might have pounds, British currency, within its official reserves. This might be due to previous actions against a payment surplus (McConnell and Brue, 724).
  • Gold sales: In order for the US to get pounds, they might sell gold to Britain to do so. As a result, it would be relocated to the exchange market to expand the amount of pounds they have in their reserves (McConnell and Brue, 724).
  • IMF borrowing: Nations that are in the Breton Woods System would have to contribute by donating to the IMF. The donations would depend on the nation’s income, population, and volume of trade (McConnell and Brue, 724).

Fundamental Imbalances
  • The Bretton Woods system recognized that a nation be challenged with balance of payments problems that cannot be corrected.
    • nation would run out of official reserves and be unable to maintain a fixed exchange system
    • correction by devaluation: "orderly" reduction of the nation's pegged exchange rate
  • IMF allowed each member nation to alter the value of its currency by 10% to correct a fundamental balance of payment deficit
  • Large exchange rate changes required the permission of the Fund's board of directors

Demise of the Bretton Woods System
  • Before the 1950s, the world generally regarded the dollar as "good as gold" since the United States had accumulated large quantities of gold, and the dollar was convertible to gold on demand due to the U.S. policy of buying gold from and selling gold to foreign governments at 35 dollars per ounce.
  • Throughout the 1950s and 1960s, the United States had persistent payment deficits, which were financed in part by U.S. gold reserves but mostly by payment of U.S. dollars.
  • This caused other nations to begin to question whether or not the US dollar could really be accepted as international money, especially since the US ability to buy and sell gold at 35 dollars and ounce was growing questionable.

  1. ^ McConnell, Campbell R., and Stanley L. Brue. Economics: Principles, Problems, and Policies. Sixteenth ed. New York: McGraw-Hill, 2005. Print.