Notes on International Finance and Trade

International Financial Transactions
  • Types of Transactions:
    • International Trade:
    • Buy/sell current goods or services (imports and exports).
    • International Asset Transactions:
    • Buy/sell real or financial assets, including stocks.
    • E.g., selling a business to foreign investors, buying a foreign business, or transferring real estate across borders.
Balance of Payments
  • Definition: Sum of all international financial transactions.
  • Components:
    • Current Account:
    • Balance on goods and services (trade deficit or surplus).
    • Net investment income and net transfers.
    • Balance on Current Account calculation involves:
      • Goods Exports: $1,762 billion
      • Goods Imports: −$2,853 billion
      • Balance on Goods: −$1,091 billion
      • Exports of Services: $771 billion
      • Imports of Services: −$541 billion
      • Balance on Services: $230 billion
      • Total Balance on Goods and Services: −$861 billion
      • Net Investment Income: $174 billion
      • Net Transfers: −$135 billion
      • Final Balance on Current Account: −$822 billion
    • Capital and Financial Account:
    • Balance on Capital Account: −$2 billion
    • Financial Account:
      • Foreign Purchases of U.S. Assets: $1,948 billion
      • U.S. Purchases of Foreign Assets: −$1,124 billion
      • Balance on Financial Account: $824 billion
      • Total Balance on Capital and Financial Account: $822 billion
  • Conclusion: Balance of payments always balances, with deficits generating asset transfers to foreigners and surpluses generating transfers from foreigners.
Exchange Rate Systems
  • Types of Exchange Rates:
    • Flexible/Floating Exchange Rate: Rates determined by market forces.
    • Fixed Exchange Rate: Rates pegged to a specific value.
    • Managed Float: A hybrid system where the government intervenes occasionally to stabilize currency value.
  • Terminology:
    • Depreciation: When one currency's price rises relative to another.
    • Appreciation: When one currency's price falls relative to another.
Factors Influencing Exchange Rates
  • Demand and Supply Shifters:
    • Changes in tastes.
    • Changes in relative incomes.
    • Changes in relative inflation rates (purchasing-power-parity theory).
    • Changes in relative interest rates.
    • Changes in expected returns on assets.
    • Speculation among currency traders.
  • Examples of Influence:
    • If Japanese electronics decline in popularity, the Japanese yen depreciates, and the U.S. dollar appreciates.
    • Relative inflation affects currency values; for instance, a country with lower inflation will see its currency appreciate.
Trade Deficits
  • Causes:
    • High growth rates in the U.S. relative to other countries.
    • Trade imbalances with China.
    • Low U.S. savings rate leading to increased consumption.
  • Implications:
    • Increased current consumption.
    • Higher levels of indebtedness.
Summary of Exchange Rate Policies
  • Countries can choose between three goals in economic policy:
    • Exchange-Rate Stability.
    • Free Financial and Trade Flows.
    • Independent Monetary Policy.
  • Note: Only two of the three goals can be achieved simultaneously.