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Unit 5: International Trade and Foreign Exchange

Unit 5: International Trade and Foreign Exchange. 1. Balance of Trade vs. Balance of Payments. Net Exports (X N ) = Exports – Imports Trade Surplus = Exporting more than is imported Trade Deficit (aka. trade gap) = Exporting less than is imported. Balance of Trade.

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Unit 5: International Trade and Foreign Exchange

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  1. Unit 5:International Trade and Foreign Exchange 1

  2. Balance of Trade vs. Balance of Payments

  3. Net Exports (XN) = Exports – Imports Trade Surplus = Exporting more than is imported Trade Deficit (aka. trade gap) = Exporting less than is imported Balance of Trade

  4. Balance of trade- includes only goods and service Balance of Trade

  5. Balance of Payments (BOP)- a summary of a country’s international trade (includes all international transactions) The BOP summary is within a given year Prepared in the domestic country’s currency Ex. If accounting the BOP of the U.S. it would be in the Dollar. The balance of payments is made up of two accounts. The current account and the financial account. Balance of Payments (BOP)

  6. Current Account The Current Account is made up of three parts: • Trades in Goods and Services (Net Exports)-Difference between a nation’s exports of goods and services and its imports of goods and services Ex: Toys imported from China, US cars exported to Mexico • Investment Income- income from the factors of production including payments made to foreign investors. Ex: Money earned by Japanese car producers in the US • Net Transfers- Money flows from the private or public sectors Ex: donations, aids and grants, official assistance, and remittance

  7. Financial (Capital) Account The Financial Account measures the purchase and sale of financial assets abroad. Purchases of things that continue to earn money Examples: • A Korean company buys a factory in Ohio • An American buys a Japanese government bond • When a foreign company buys business in a different country that is Foreign Direct Investment Net Capital Outflow- The difference between the purchase of foreign assets and domestic assets purchased by foreigners Financial Account Surplus = Inflow > Outflow Financial Account Deficit = Inflow < Outflow

  8. If a country has a deficit in the current account, they must have a surplus in the financial account

  9. Current or Financial Account? Identify if the examples are counted in the current or capital account and determine if it is a credit or debit for the US. • Bill, an American, invests $20 million in a ski resort in Canada • A Korean company sells vests to the US Military • A US company, Boeing, sells twenty 747s to France • A Chinese company buys a shopping mall in San Diego • An illegal immigrant living in the US sends a portion of his earning to his family in Bora Bora • A German investor buys $50,000 US Treasury Bonds • Italian tourists spend 5 million in the US while American tourists spend 8 million in Italy.

  10. Current or Financial Account? Identify if the examples are counted in the current or capital account and determine if it is a credit or debit for the US. • Financial Account (financial asset), Debit • Current Account (trade of goods/services), Debit • Current Account (trade of goods/services), Credit • Financial Account (financial asset), Credit • Current Account (net transfer), Debit • Financial Account (financial asset), Credit • Current Account (net transfer), Debit

  11. Practice 1. U.S. income increase relative to other countries. Does the balance of payments move toward a deficit or a surplus? • U.S. citizens have more disposable income • Americans import more • Net exports (Xn) decrease • The current account balance decreases and moves toward a deficit. 2. If the U.S. dollar depreciates relative to other countries does the balance of payments move toward a deficit or a surplus? • U.S. exports become more desirable • America exports more • Net exports (Xn) increase • The current account balance increases and moves toward a surplus.

  12. Foreign Exchange (aka. FOREX) Exchange Rate = Relative Price of Currencies

  13. What is FOREX? • The market in which currencies are traded • It includes all of the currencies in the world. • There is no central marketplace for currency exchange • currencies are traded worldwide among the major financial centers of London, New York, Tokyo, Zürich, Frankfurt, Hong Kong, Singapore, Paris and Sydney.

  14. Exports and Imports • US sells cars to Mexico • Mexico buys tractors from Canada • Canada sells syrup to the U.S. • Japan buys Fireworks from Mexico For all these transactions, there are different national currencies. Each country must be paid in their own currency The buyer (importer) must exchange their currency for that of the sellers (exporter).

  15. The turnover in FOREX markets is almost $4 trillion (USD) a day

  16. Exchange Rates In the FOREX market we only look at two countries/currencies at a time Ex: US Dollars and Euros We examine the price of one currency in terms of the other currency. Ex:$3 = €2 The Exchange Rate depends on which currency you are converting. The price of one US Dollar in terms of Euros is 1 Dollar = €2/$3 = €.66 The price of one Euro in terms of Dollars is 1 Euro = $3/€2= $1.5

  17. What happens if you need more dollars to buy one euro (the price for a euro increases)? Ex: From $3=€2 to $6=€2 • The U.S. Dollar DEPRECIATES relative to the Euro. Depreciation- The loss of value of a country's currency with respect to a foreign currency • More units of dollars are needed to buy a single unit of the other currency. • The dollar is said to be “Weaker”

  18. What happens if you need less dollar to buy one euro (the price for a euro decreases)? Ex: From $3= €2 to $1= €2 • The U.S. Dollar APPRECIATES relative to the euro. Appreciation- The increase of value of a country's currency with respect to a foreign currency • Less units of dollars are needed to buy a single unit of the other currency. • The dollar is said to be “Stronger”

  19. Investopedia explains: • What determines a currency’s value?

  20. FOREX Supply and Demand Simplified Imagine a huge table with all the different currencies from every country This is the Foreign Exchange Market! Just like at a product market, you can’t take things without paying. If you demand one currency, you must supply your currency. Ex: If Canadians what Russian Rubles. The demand for Rubles in the FOREX market will increase and the supply of Canadian Dollars will increase.

  21. What happens if Europeans prefer vacationing in the United States? € Euros Dollars $ $ € S er1 S S1 ere ere D1 er1 D D Quantity of Euros Quantity of Dollars The Euro DEPRECIATES The Dollar APPRECIATES

  22. FOREX Shifters Let’s use the example of the US Dollar and the British Pound

  23. 1. Changes in Tastes- Ex: British tourists flock to the U.S… Demand for U.S. dollars increases (shifts right) Supply of British pounds increases (shifts right) Pound-depreciates Dollar-appreciates 2. Changes in Relative Incomes (Resulting in more imports)- Ex: US growth increase US incomes…. U.S. buys more imports… U.S. Demand for pounds increases Supply of U.S. dollars increases Pound- appreciates Dollar- depreciates

  24. 3. Changes in Relative Price Level (Resulting in more imports)- Ex: US prices increase relative to Britain…. U.S. demand for cheaper imports increases… U.S. demand for pounds increases Supply of U.S. dollars increases Pound- appreciates Dollar- depreciates 4. Changes in relative Interest Rates- Ex: US has a higher interest rate than Britain. British people want to put money in US banks Capital Flow increase towards the US British demand for U.S. dollars increases… British supply more pounds Pound-depreciates Dollar- appreciates

  25. What will happen to the international value of the Mexican peso if there is high inflation in Mexico? The demand for pesos will decrease since Mexico's trading partners will not want to purchase higher priced Mexican products. The supply will increase as Mexicans look to buy lower priced imports. Pesos The peso DEPRECIATES

  26. Practice

  27. Practice For each of the following examples, identify what will happen to the value of US Dollars and Japanese Yen. • American tourists increase visits to Japan. • The US government significantly decreases personal income tax. • Inflation in the Japan rises significantly faster than in the US. • Japan has a large budget deficit that increases Japanese interest rates. • Japan places high tariffs on all US imports. • The US suffers a larger recession. • The US Federal Reserve sells bonds at high interest rates. How do these scenarios affect exports and imports?

  28. Practice Scenarios 1, 2, and 4 will increase US exports because US products are now relatively “cheaper”

  29. Exchange Rate Regimes Fixed Exchange Rate- The government activity manages the country’s currency Floating Exchange Rate- The market determines the value of the country’s currency Some governments attempt to depreciate their country’s currency in order to promote exports

  30. 5 Key Graphs

  31. Macro Review

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