International Flow Of funds Prelim

Balance of Payments

is a measurement of all transactions between domestic and foreign residents over a specified period of time.

Each transaction is recorded as both a credit and a debit, i.e. double-entry bookkeeping.

The transactions are presented in three groups - a current account, a capital account, and a financial account.

Current Account

Merchandise trade,Services,Income receipts,Unilateral transfers

summarizes the flow of funds between one specified country and all other countries due to the purchases of goods or services, the provision of income on financial assets, or unilateral current transfers (e.g. government grants and pensions, private remittances).

commonly used to assess the balance of trade, which is simply the difference between merchandise exports and merchandise imports.

current account deficit

suggests a greater outflow of funds from the specified country for its current transactions.

Items in the Current Account of the BoP

Capital Account

Capital transfers

Sales and purchases of nonproduced, nonfinancial assets (as defined in the 1993 System of National Accounts and the fifth edition of IMF's Balance of Payments Manual) is adopted by the U.S. in 1999.

It includes unilateral current transfers that are really shifts in assets, not current income. E.g. debt forgiveness, transfers by immigrants, the sale or purchase of rights to natural resources or patents.

Financial Account

Financial assets abroad

Foreign-owned financial assets

(which was called the capital account previously) summarizes the flow of funds resulting from the sale of assets between one specified country and all other countries.

Assets include official reserves, other government assets, direct foreign investments, investments in securities, etc.

International Trade Flows

Different countries rely on trade to different extents.

The trade volume of European countries is typically between 30-40% of their respective GDP, while the trade volume of U.S. and Japan is typically between 10-20% of their respective GDP.

Nevertheless, the volume of trade has grown over time for most countries.

In 1975, the U.S. exported $107.1 billions in goods, and imported $98.2 billions. Since then, international trade has grown, with U.S. exports and imports of goods valued at $773.3 and $1,222.8 billions respectively for the year of 2000.

Since 1976, the value of U.S. imports has exceeded the value of U.S. exports, causing a balance of trade deficit.

Recent Changes in North American Trade

In 1998, a 1989 free trade pact between U.S. and Canada was fully phased in.

Passed in 1993, the North American Free Trade Agreement (NAFTA) removes numerous trade restrictions among Canada, Mexico, and the U.S.

In 2001, trade negotiations were initiated for a free trade area of the Americas. 34 countries are involved.

Recent Changes in European Trade-Single European Act of 1987

The was implemented to remove explicit and implicit trade barriers among European countries.

Consumers in Eastern Europe now have more freedom to purchase imported goods.

The single currency system implemented in 1999 eliminated the need to convert currencies among participating countries.

Trade Agreements Around the World such as tariff

In 1993, a General Agreement on and Trade (GATT) accord calling for lower tariffs was made among 117 countries.

Other trade agreements include:

Association of Southeast Asian Nations

European Community

Central American Common Market

North American Free Trade Agreement

Friction Surrounding Trade Agreements

Trade agreements are sometimes broken when one country is harmed by another country's actions.

Another situation that can break a trade agreement is copyright piracy.

Dumping

refers to the exporting of products by one country to other countries at prices below cost.

Inflation

A relative increase in a country's inflation rate will decrease its current account, as imports increase and exports decrease.

National Income

A relative increase in a country's income level will decrease its current account, as imports increase.

Government Restrictions

A government may reduce its country's imports by imposing tariffs on imported goods, or by enforcing a quota. Note that other countries may retaliate by imposing their own trade restrictions.

Sometimes though, trade restrictions may be imposed on certain products for health and safety reasons.

Exchange Rates

If a country's currency begins to rise in value, its current account balance will decrease as imports increase and exports decrease.

Note that the factors are interactive, such that their simultaneous influence on the balance of trade is a complex one.

Correcting A Balance of Trade Deficit

By reconsidering the factors that affect the balance of trade, some common correction methods can be developed.

For example, a floating exchange rate system may correct a trade imbalance automatically since the trade imbalance will affect the demand and supply of the currencies involved.

However, a weak home currency may not necessarily improve a trade deficit.

Foreign companies may lower their prices to maintain their competitiveness.

Some other currencies may weaken too.

Many trade transactions are prearranged and cannot be adjusted immediately. This is known as the J-curve effect.

The impact of exchange rate movements on intracompany trade is limited.

Capital flows

usually represent portfolio investment or direct foreign investment.

The DFI positions inside and outside the U.S. have risen substantially over time, indicating increasing globalization

In particular, both DFI positions increased during periods of strong economic growth.

Changes in Restrictions

New opportunities may arise from the removal of government barriers.

Privatization

DFI has also been stimulated by the selling of government operations.

Potential Economic Growth

Countries with higher potential economic growth are more likely to attract DFI.

Tax Rates

Countries that impose relatively low tax rates on corporate earnings are more likely to attract DFI.

Exchange Rates

Firms will typically prefer to invest their funds in a country when that country's currency is expected to strengthen.

International Monetary Fund (IMF)

is an organization of 183 member countries. Established in 1946, it aims

to promote international monetary cooperation and exchange stability;

to foster economic growth and high levels of employment; and

to provide temporary financial assistance to help ease imbalances of payments.

Its operations involve surveillance, and financial and technical assistance.

In particular, its compensatory financing facility attempts to reduce the impact of export instability on country economies.

uses a quota system, and its unit of account is the SDR (special drawing right).

World Bank Group

Established in 1944, the Group assists development with the primary focus of helping the poorest people and the poorest countries.

It has 183 member countries, and is composed of five organizations - IBRD, IDA, IFC, MIGA and ICSID.

IBRD: International Bank for Reconstruction and Development

Better known as the World Bank, provides loans and development assistance to middle-income countries and creditworthy poorer countries.

In particular, its structural adjustment loans are intended to enhance a country's long-term economic growth.

is not a profit-maximizing organization. Nevertheless, it has earned a net income every year since 1948.

It may spread its funds by entering into cofinancing agreements with official aid agencies, export credit agencies, as well as commercial banks.

IDA: International Development Association

was set up in 1960 as an agency that lends to the very poor developing nations on highly concessional terms.

lends only to those countries that lack the financial ability to borrow from IBRD.

IBRD and are run on the same lines, sharing the same staff, headquarters and project evaluation standards.

IFC: International Finance Corporation

was set up in 1956 to promote sustainable private sector investment in developing countries, by

financing private sector projects;

helping to mobilize financing in the international financial markets; and

providing advice and technical assistance to businesses and governments.

MIGA: Multilateral Investment Guarantee Agency

was created in 1988 to promote FDI in emerging economies, by

offering political risk insurance to investors and lenders; and

helping developing countries attract and retain private investment.

ICSID: International Centre for Settlement of Investment Disputes

was created in 1966 to facilitate the settlement of investment disputes between governments and foreign investors, thereby helping to promote increased flows of international investment.

World Trade Organization (WTO)

Created in 1995, is the successor to the General Agreement on Tariffs and Trade (GATT).

It deals with the global rules of trade between nations to ensure that trade flows smoothly, predictably and freely.

At the heart of the multilateral trading system are its trade agreements.

Its functions include:

administering WTO trade agreements;

serving as a forum for trade negotiations;

handling trade disputes;

monitoring national trading policies;

providing technical assistance and training for developing countries; and

cooperating with other international groups.

Bank for International Settlements (BIS)

Set up in 1930, is an international organization that fosters cooperation among central banks and other agencies in pursuit of monetary and financial stability.

It is the "central banks' central bank" and "lender of last resort."

The __ functions as:

a forum for international monetary and financial cooperation;

a bank for central banks;

a center for monetary and economic research; and

an agent or trustee in connection with international financial oprations.

Regional Development Agencies

Agencies with more regional objectives relating to economic development include

the Inter-American Development Bank;

the Asian Development Bank;

the African Development Bank; and

the European Bank for Reconstruction and Development.