The International Flows of Goods and Capital

1
The International Flows of Goods and Capital

• International trade in goods and capital increase
  consumption possibilities beyond production
  possibilities

2
Factors Influencing the International Flow of
Goods

• Domestic Income and Foreign Income
• Relative Price Level--The Ratio of the Domestic
  Price Level to the Foreign Price Level
• The Exchange Rate and
• Other Non-Economic Factors such as Tastes,
  Preferences, etc.

3
Exchange Rates

• Nominal Exchange Rate (e)
• Price of a foreign currency in the units of home
  currency
• US0.8180 C1 or C1.2225 US1.00
• US/C 0.8180 or C/US 1.2225
• Nominal Exchange Rates
• Spot Exchange Rate (e)
• Forward Exchange Rate (ef)

4
Functions of the Foreign Exchange Market

• Clearing
• the act of helping international traders to end
  up with the kind of currency they prefer
• Hedging
• the act of reducing or eliminating a net asset or
  a net liability position in a foreign currency
  and
• Speculating
• the act of taking a net asset position (long) or
  a net liability (short) position in a foreign
  currency

5
If Trade is Balanced

• Goods, services and assets move internationally
  from exporters to importers
• Payments move domestically from importers to
  exporters and
• Foreign exchange markets holdings of each
  currency are unchanged.

6
If Trade is not Balanced

• Goods, services and assets move internationally
  from exporters to importers
• Payments move domestically from importers to
  exporters and
• Foreign exchange markets holdings of each
  currency change, i.e.,
• currency of the surplus country becomes scarce
• currency of the deficit country becomes abundant.

7
If Trade Imbalance Persists

• Currency of the deficit country depreciates
• this results in improvement in the competitive
  position of the deficit countrys goods in world
  markets (i.e., exports will increase and imports
  will decrease) and
• Currency of the surplus country appreciates
• this results in deterioration in the competitive
  position of the surplus countrys goods in world
  markets (i.e., exports will decrease and imports
  will increase).

8
Exchange Rate Management Systems (Regimes)

• Flexible (Floating) Exchange Rate System
• Markets determine and manage exchange rates
• Fixed Exchange Rate System
• Governments manage exchange rates
• Managed Float Exchange Rate System
• Combination of Flexible and Fixed Systems
• Exchange Controls
• Governments monopolize currency markets

9
The Flexible (Floating) Exchange Rate Regime

• Under a flexible (floating) exchange rate
  regime, demand and supply determine the exchange
  rate without intervention by governments or
  central banks. The major countries have been on
  something close to this system since 1973.

10
Sources of Demand for the U.S.

• American exports of goods and services
• American capital inflows
• U.S. being used as a medium of exchange by other
  countries
• U.S. being used as an official reserve by other
  countries and
• Foreign speculators dealing in U.S.

11
Sources of Supply of U.S.

• American imports of goods and services
• American capital outflows
• American speculators dealing in foreign
  currencies and
• The Federal Reserve System