International Finance

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International Finance

• Balance of payments
• Trade deficits and surpluses
• Foreign exchange markets

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Balance of payments

• BOP accounting is the recording of transactions
  between domestic and foreign economic agents.
• Any transaction that results in a receipt of
  money by domestic agents from abroad is recorded
  as a credit in the BOP accounts.
• Any transaction that entails the payment of money
  by domestic units to foreigners is recorded as a
  debit in the BOP accounts.
• The current account records foreign transactions
  involving merchandise and services.
• The financial account records foreign
  transactions involving financial assets and land.

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Definitions

• Net investment income abroad Investment earnings
  by U.S. residents minus investment earnings by
  foreign residents from their assets in the United
  States
• Net unilateral transfers abroad The unilateral
  transfers (gifts and grants) received abroad by
  U.S. residents minus the unilateral transfers
  U.S. residents send abroad

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• U.S. balance of payments for 2006 (billions
  of dollars)

Current Account Current Account
Merchandise exports Merchandise imports Merchandise trade balance (12) Service exports Service imports Goods and services balance (345) Net Investment Income from abroad Net unilateral transfers Current account balance (678) 1,023.1 - 1,861.4 - 838.3 422.6 342.8 - 758.5 36.6 - 89.6 - 811.5
Financial Account Financial Account
10. Change in U.S. owned assets abroad 11. Change in foreign-owned assets in U.S. 12. Financial account balance (1011) 13. Statistical discrepancy - 1,059.1 1,888.4 829.3 - 17.8
TOTAL (91213) 0.0
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As you can see, the United States had a large
current account deficit in 2006
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• U.S. imports have exceeded U.S. exports since
  1976, and the trade deficit has widened

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• U.S. trade deficit in 2006 by country or region

U.S. imports more goods from each of the worlds
major economies than it exports to them. The
largest U.S. trade deficit is with China, which
exported five times more to the United States in
2006 than it imported from the United States.
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If Wal-Mart was a country, it would be Chinas
seventh largest trading partner
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Exchange rates
An exchange rate is the price of one national
currency expressed in terms of another national
currency. For example, the dollar price of the
British pound is 1.49 -- meaning it takes 1.49
to buy 1 pound
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If the dollar price of the British pound (/)
is 1.49 1 Then the pound price of the
dollar (/) is given by the reciprocal of the
dollar-pound exchange rate. That is
/
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Exchange Rates are Determined by the Supply
Demand for Foreign Exchange
Supply of euros
Dollars per Euro
1.26
Demand for euros
0
E
Euros
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Why do agents want to exchange dollars for euros ?

• To purchase European-made goods and services.
• To purchase stocks in European companies
  companies or other euro-denominated assets.
• To speculate on future exchange rate movements.

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• The foreign exchange market

The fewer dollars needed to purchase 1 unit of
foreign exchange, the lower the price of foreign
goods, the greater the quantity of foreign goods
demanded, and the greater the quantity of foreign
exchange demanded. The D curve slopes downward.
An increase in in the exchange rate makes US
products cheaper for foreigners. The increases
demand for US goods implies an increase in the
quantity of foreign exchange supplied. The S
curve slopes upward.
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• Effect on the foreign exchange market of an
  increased demand for euros

The intersection of the demand curve for foreign
exchange, D, and the supply curve for foreign
exchange, S, determines the exchange rate. At an
exchange rate of 1.25 per euro, the quantity
demanded of euros equals the quantity supplied.
An increase in the demand for euros from D to D
increases the exchange rate from 1.25 to 1.27
per euro.
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The dollar has strengthened against the euro
recently
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Exchange Rates and the Prices of Imported Goods
Question Suppose the dollar price of a new
Harley Davidson is 22,000. How much would a
German buyer have to pay in euros?
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Euro price of the Harley
Euro price dollar price of the Harley euro
price of the dollar
Thus, at the current exchange rate ( 0.79 1)
we have
Euro price 22,000 0.79 17,380
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An appreciating dollar makes U.S.-made goods and
services less price-competitive
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Example Let the dollar appreciate against the
euro
The new exchange rate is 1 1
Thus we have
Euro price 22,000 1.00 22,000
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Exchange rates and the Affordability of Imported
Goods
The euro price of a Krups coffee maker is
45.00 Question What is the price of the coffee
maker expressed in dollars?
If the dollar price of one euro is 1.26, then
Price (1.26)(45) 56.70
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Effect of an appreciating dollar on the price of
imported goods
What if the dollar should appreciate, or gain
value, against the euro? Let the dollar price of
the euro to decrease to 1.00 . Question What
is the dollar price of the Krups coffee
maker?
price (1.00)(45) 45.00
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• In late June 2007, a Big Mac cost more in the US
  than in most other countries