HSC Economics Topic 2 - Australia's Role in the Global Economy

Terms of Trade

Prices/value of our exports are compared to our imports x 100

Improvement (ToT)

Average prices of imports have decreased compared to price of exports gaining purchasing power

Deteriorated (ToT)

Average prices of exports have decreased compared to the price of imports of that nation

Australia’s Place in the Global Economy

Ranked 12th, advanced, produces 2% of GWP

Trends - Free Trade

Increased substantially over the years (move since 1970’s), attributed to the deregulation in Australian markets, foreign businesses have invested in Australian assets, Australian businesses have increased overseas investments

Key Flows

Inflows = taking in money to economy

Outflows = spending money out of economy

Trade Flows

Sum of export inflows + import outflows (of G&S)

Capital Flows

Sum of financial capital inflows from overseas + investors capital outflows from Australians investing abroad

Income Flows

Sum of returns on financial investments

Value of Trade

E: $673 Billion

I: $547 Billion (2023)

Top 4 Exports

Minerals + fuels, services, and manufacturing

Australia’s Exports

Comparative advantage in commodities, agriculture and services. Vast natural resources, imports large quantities of capital goods and manufactured consumer goods.

Australia’s Imports

PErsonal travel, refined petroleum, cars, telecom equipment and computers. Composition has not changed significantly.

Direction of Trade

Since 2007 China has become Australia’s dominant trading partner.

Foreign Investment

Stock of Australian liabilities owed to non Australians

Australia’s Financial Reform

Occurred with the floating of the Australian dollar in 1983, allowed for greater accessibility to world capital markets, technology changes facilitated movement of finance.

Direct Investment

Longer term investment or establishment of a new company, and investor wants to take on a managerial role of the business or control, own the entire land, or the entire company

Foreign Direct Investment

Where companies purchase controlling interest greater than 10% in a foreign company.

Portfolio Investments

Shorter term and does not involve management of investment, investment in equity securities

Foreign Portfolio Investment

Investment where companies buy equity securities such as shares, speculative investment, or bonds, land of a foreign compnay, less than 10%.

Financial Derivatives

Value of investments is from the performance of specific assets, interest rates, exchange rates or indices.

Reserve Assets

Foreign financial assets controlled bby nation’s monetary authorities (RBA), for financiing or regulating payment imbalances

Other Foreign Investment

Trade credit, loan (including financial leases, currency and deposits)

Debt

money borrowed by an individual bonds, securuties and notes

Net Foreign Debt

Value of foreign borrowing by Australia - value of lending loans to overseas

Equity

The ownership of money such as assets, land and shares

Net Foreign Equity

Value of foreign owned assets in Australia - total assets owned by Australians from oversea

Total Foreign Assets

Money invested and lent by Australians overseas

Total Foreign Liabilities

What foreign investors owe or contribute to an economy (Net foreign equity + net foreign debt)

Trends of Australia

Australia has always borrowed more money internationally than it has saved though investment

Australia’s Investment Sources

US, UK, Japan (TNC’s have established subsidiaries in Australia)

Deregulation of Australian financial system and floating of the exchange rate

Access to foreign capital to fund domestic investment

Other drivers of Australia’s economic integration

Reduced levels of protection and negotiation of FTA, advancements in information of communication technology.

Balance of Payments

Record of transactions between Australia and the rest of the world during a given period - tracks trade, capital and income flows.

Balance of Payments (made up of)

Current account + Capital and financial account

Current Account + capital and financial account + nett errors omission

= 0

Current account = surplus

Capital and financial account = deficit

Current Account includes:

Credits of exports and debits of imports, credits and debits of net primary income, credits and debits of net secondary income

KAFA includes:

Financial derivatives, direct investment, portfolio investment, reserve assets, and other assets.

Current Account

Records unilateral transactions representing income as a return on a factor of production, which is non reversible

Balance of G&S (BOGS: X-M)

Difference between number of goods and services exported and imported. Net G&S.

Net Primary Income

Difference between income flows in and out of Australia, and earnings on international investment as a return. (Dividens, interest, profit, rent, and income)

Net Secondary Income

Small and non-market, government tranfers like unconditional foreign aid.

Capital and Financial Account (KAFA)

Capital account + Direct investment + Portfolio investment + Financial derivatives + Reserve assets + Other investments

Capital Account

Conditional foreign aid grants, purchase of non-purchased, non financial assets (new franchise in new country or copyright)

Financial Account

Records debt and equity transfers, foreign investment in and out of Australia

Cyclical Factors

Vary with the level of economic activity, can cause fluctuations and create unstable short term trends.

Cyclical - Exchange Rate Appreciation

Cost of importing decreases, cost of exporting increases. Lowering the BOGS and meaning an increase CAD

Cyclical - Exchange Rate Depreciation

Cost of importing increases, Cost of exporting decreases, increasing the international competitiveness. Therefore improving BOGS, and as Australia is exporting more than imports meaning a CAS

Cyclical - ToT Improvement

Improvement = economy can purchase more imports for same amount of exports sold. Export prices rise faster than import or import prices fall faster than export. Leading to an improvement in BOGS and decrease in the CAD

Cyclical - ToT Deterioration

Occurs when an economy can't purchase as much imports for the same amount of exports sold. Export prices fall faster than import or Import prices rise faster than export. Leads to a worsening in the BOGS and a increase of the CAD

Cyclical - Domestic Economic Growth

Increase in economic growth, results in high income and consumption, increasing nations demand for imports, increase in import spending decreases BOGS.

Cyclical - World Economic Growth

Strong Economic growth in Australia's foreign trading partners increase demand for Australian exports, improving the BOGS.

Structural Factors

Long term and persistent factors that usually are difficult to change in an economy.

Structural - Narrow Export Base

Concentrated export base, towards a small number of commodities.

Structural - Lack of International Competitiveness

Expensive labour costs, strict governemnt regulations, high transport costs, lower access to quality technolgy - reducing BOG

NPY Cyclical - Exchange Rate Appreciation

Australians will have to pay less A$ overseas to match the level of debt valued in foreign currencies

NPY Cyclical - Exchange Rate Depreciation

Australians will have to pay more A$ overseas to match the level of debt valued in foreign currencies.

NPY Cyclical - Domestic Growth

Causes domestic company profits rise, profits are redistributed to investors both domestically and overseas. Makes investments more attractive, raising investment in AUS

NPY Cyclical - International Growth

When international companies experience strong growth their profits rise. Profits are redistributed back to Australia to those who invested

NPY Cyclical - Decline in Interest Rates

If global interest rates are low then more debt can be borrowed, and lower interest is paid.

NPY Structural - Savings and Investment Gap

Australia has low levels of national savings due to being a smaller economy, but high requirements of capital investment for its economic growth.

NPY Structural - Investment Overseas

Growth in investment overseas means that we have large inflows of NPY

Link Between CA +KAFA

Deficit on CA → surplus on KAFA

Surplus on CA → deficit on KAFA

Reason for Link - NPY

Surplus on KAFA means deficit on NPY

Reason for Link - Foreign Borrowings

AKAFA surplus represents more foreign borrowing from Australia to overseas, and a KAFA deficit represents more lending to overseas from australia. The more we lend, the more foreign equity, more inflows of NPY as foreigners need to pay interest back on our loans

Reason for Link - Foreign Investment

Foreign investment → inflow in KAFA

Paying debt → outflow on the NPY

We invest → outflow in KAFA

Get payed back → contributes to CAS

KAFA credit

Foreigners invest and Australia receives funds from borrowing from overseas

KAFA Debit

Australia invests overseas, Australia lends money to foreigners who borrow

CA Debit

Profits from investments flow back to foreigners, interest repayments to foreigners

CA Credit

Profits from investments back to Australia, interesr repayments of loans flow back into Australia

Australia’s Persistent CAD

Reflects a high rate of international investment and low savings

Risks associated with high CAD

Reluctance from lenders to invest in or lend to Australia, increased servicing costs for foreign liabilities leading to larger outflows on NPY, increased volatility for exchange rates.

High KAFA → Debt Trap

Maintaining a high KAFA can result in a debt trap (an economy has to borrow money to pay off debts)

Reasons for CAS (2019 + pandemic savings)

Strong commodity prices (increase BOGS), low global interest rates (decreased NPY outflows), larger contraction in imports compared to exports during COVID (increasing BOGS)

CAD

Increase of overseas borrowing, increased soze of foreign debt, foreign debt increases in cost compared to the NPY,

CAS

Consumers buy domestic goods as the economy can produce more goods cheaper, higher demand for exports as domestic goods are cheaper, Australia lends more therefore and borrow less

M + Y debits + K outflow =

X + Y credits + K inflows

Exchange Rate

The measure of value of one currency in comparison to another currency

Bilateral Exchange Rate

Value of currency against another. Appreciation: 1 AUD can buy more, Depreciation: 1 AUD buys less

Trade Weighted Index

Movement of AUD in a basket of foreign currencies of major trading partners, these currencies are weighted according to their significance to Australia’s trade flow

Demand for Currency

Those who wish to buy AUD - Export buyers, foreign investors investing in Australia, and speculators

Supply of Currency

Those who wish to sell AUD and buy foreign currency - Australian investing overseas, buyers of imports and speculators

Increase in Demand (Appreciation)

Higher Australian interest rates, more investment opportunitities in Aus, expectations of future appreciation from foreign speculators, increase in export revenue, expansionary period

Decrease in Supply (Appreciation)

Lower overseas interest rates, less investment opportunities overseas, expectation of future depreciation from other countries, fall in import spending decreases

Decrease in Demand (Depreciation)

Lower Australian interest rates, less investment opportunities in Aus, expectation of future depreciation from specualtors, decrease in export revenue, contractionary period

Increase in Supply (Depreciation)

Higher overseas interest rates, more investment opportunities overseas, expectation of future appreciation from other countries, increase in import spending

Fixed Exchange Rate

Exchnage rate system is determined by the central bank (RBA) or government

Fixed Exchange Rate Process

Central bank must buy or sell a sufficient amount of foreign reserves in order to intervene and match the rate as it is either above or below the equilibrium

Floating Exchange Rate

The value of a country’s currency is determined by demand and supply (Aus floated in 1983)

Clean Float

No Government intervention in the exchange rates of a currency = volatile currency

Dirty Float

RBA intervention, to modify and manipulate the short term highs and lows of the AUDm mitigating effects of volatility

Managed Exchange Rate

Any official interevention by governemnt in setting of exchange rates

Direct Intervention - AUD is too high

RBA sells AUD reserves to increase supply and buys foreign currencies to increase demand

Direct Intervention - AUD is too low

RBA buys AUD reserves to increase demadn and sells foreign currencies to increase their supply

Indirect Intervention - Monetary Policy

RBA sets the interest rates to manage the domestic economy therefore changing the interest reate difference between Australia and overseas

Indirect Intervention - Interest Rates increase

Foreign savings in Australia increase → demand for AUD increase → Appreciation

Indirect Intervention - Interest Rates Decrease

Foreign savings in Australia decrease → demand for AUD decreases → Depreciation

Advantages of Appreciation

Cheaper imports, valuation effect on debt, overseas assets will be reduced in price

Disadvantages of Depreciation

Exports are more expensive, valuation effect on assets, higher imports spending and lower export revenue, foreign investors find it more expensive, cheaper imports (U/E)