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Agenda:1. International Flow of Funds2. International Financial Market3. Exchange rate determination

Agenda:1. International Flow of Funds2. International Financial Market3. Exchange rate determination


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US Dollar Versus Euro: Impact of news

Expectedincrease

in FedRate

Unexpectedly

bademployment

news


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From the news

The dollar plunged across the boardearly in New York after the LaborDepartment reported employers added112,000 jobs in June, far below marketforecasts for a 250,000 increase.

The Fed on Wednesday increased theFed rate by 25 basis points consistentwith the market expectations.

From the news

The dollar plunged across the boardearly in New York after the LaborDepartment reported employers added112,000 jobs in June, far below marketforecasts for a 250,000 increase.

The Fed on Wednesday increased theFed rate by 25 basis points consistentwith the market expectations.


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International Flow of FundsLearning Objectives

To explain the key components of thebalance of payments; and

To explain how the international flow offunds is influenced by economic factorsand other factors.


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Balance of Payments

The balance of paymentsis a measurement ofall transactions between domestic and foreignresidents over a specified period of time.

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

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


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The current accountsummarizes the flow of funds betweenone specified country and all other countries due to:

the purchases or sales of goods;

purchases or sales of services; income payments or receipts on assets; or

unilateral current transfers (e.g. government grants andpensions, private remittances).

A current account deficitsuggests a greater outflow of fundsfrom the specified country for its currenttransactions.

Balance of Payments


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Summary of U.S. InternationalTransactions

Exports of goods and services and income receipts1418568

Goods, balance of payments basis 772210

Services 293492Income receipts 352866

Imports of goods and services and income receipts -1809099

Goods, balance of payments basis -1224417

Services -217024

Income payments -367658

Unilateral current transfers, net -54136

Balance on current account -444667

(For the Year of 2000 in Millions of Dollars)

Current Account

Source: U.S. Bureau of Economic Analysis


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The current account is commonly used toassess the balance of trade, which is

simply the difference betweenmerchandise exports and merchandiseimports.

Balance of Payments


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The new capital account(as defined in the1993 System of National Accounts and thefifth edition of IMFs Balance of Payments

Manual) is adopted by the U.S. in 1999.

It includes unilateral current transfers thatare really shifts in assets, not current

income. E.g. debt forgiveness, transfers byimmigrants, the sale or purchase of rightsto natural resources or patents.

Balance of Payments


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Capital account transactions, net 705


Capital Account



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The financial account(which was called thecapital account previously) summarizes theflow of funds resulting from the sale of

assets between one specified country andall other countries.

Assets include official reserves, other

government assets, direct foreigninvestments, investments in securities, etc.

Balance of Payments


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U.S.-owned assets abroad, net (increase/financial outflow) -580952

U.S. official reserve assets, net -290

Other U.S. Govt assets, net -944U.S. private assets, net -579718

Foreign-owned assets in the U.S., net (increase/financial inflow)1024218

Foreign official assets in the U.S., net 37619

Other foreign assets in the U.S., net 986599

Net financial flows 443266

Statistical discrepancy (sum of items in all accounts with signreversed) 696


Financial Account



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The U.S. balance of payments andrelated data are disseminated by the

Bureau of Economic Analysis.

Visit the Bureau at http://

www.bea.doc.gov.

Online Application
http://www.wto.org/http://www.wto.org/http://www.wto.org/http://www.wto.org/


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For a snapshot of the latestinternational trade conditions, visit the

White Houses Economic StatisticsBriefing Room atwww.whitehouse.gov/fsbr/international.h

.

Online Application
http://www.bea.doc.gov/http://www.bea.doc.gov/


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Different countries rely on trade to differentextents.

The trade volume of European countries istypically between 30 40% of theirrespective GDP, while the trade volume ofU.S. and Japan is typically between 10

20% of their respective GDP. Nevertheless, the volume of trade has

grown over time for most countries.

International Trade Flows


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0%

10 %

20 %

30 %

40 %

50 %

60 %

70 %

80 %

90 %

100%

US

Japan

India*

Brazil

Australia

China

Italy

France

Mexico

Argentina U

K

Poland

Nigeria

SouthAfrica

Chile

Russia

Germany

EuroArea

SouthKorea

SaudiArabia

Canada

Indonesia**

Switzerland

Netherlands

Thailand

Belgium

Ireland

Exports,

Imports

(asapercentofGDP) Export

Import

Prof. Jeff Rosensweig, Emory Univers ity . Data sour ce: IMF, International Financia l Stat is t ics, January 2004

The US Rel ies Less on International Trade as a Share o

Econom y than M ost Nat ionsExpo rts and Im ports as a Percen t of GDP in 2002

** 2001 data * 2000 d


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Distribution ofU.S. Exports

and ImportsFor the Year of 2000(exports, imports)

in Billions of $

Source: U.S. Census Bureau

Canada(179,231)

Mexico(111,136)

Colombia (4,7)Ecuador(1,2)

Peru(2,2)

Chile(3,3)

Venezuela (6,19)

Brazil (15,14)

Argentina (5,3)

Bahamas (1,0)

Costa Rica (2,4)

Dominican Republic (4,4)El Salvador (2,2)Jamaica (1,1)

Panama (2,0)

Guatemala

(2,3)

Honduras (3,3)

Trinidad and Tobago (1,2)


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s r u on o . . xpor s anImports(exports, imports) in Billions of $ for the Year of 2000

Austria (3,3)

Belgium(14,10)

Czech Republic(1,1)

Denmark (2,3)

Germany (29,59)

Italy(11,25)

Ireland (8,16)

United Kingdom(42,43)

Russia (2,8)

Finland (2,3)Sweden(5,10)Norway (2,6)

Netherlands

(22,10)

Poland(1,1)

Portugal(1,2) Spain

(6,6)

Hungary(1,3)

France

(20,30) Switzerland(10,10)

Turkey (4,3)

Greece (1,1)Source: U.S. Census Bureau


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For the Year of 2000(exports, imports)

in Billions of $

Algeria (1,3)

Angola(0,4)

Egypt (3,1)

South Africa (3,4)

Nigeria (1,11)

Gabon (0,2)


Distribution of

U.S. Exportsand Imports


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For the Year of 2000(exports, imports)

in Billions of $

Australia(12,6)

Bangladesh (0,2)

China(16,100)

United Arab

Emirates(2,1)

New Zealand(2,2)

Japan(65,146)

South Korea(28,40)

Taiwan (24,41)

Philippines(9,14)

Indonesia

(2,10)

Hong Kong(15,11)

India(4,11)

Iraq (0,6)

Israel (8,13)

Kuwait

(1,3)

Macao (0,1)

Malaysia(11,26)

Pakistan(0,2)

Saudi Arabia(6,14)

Singapore(18,19)

Sri Lanka(0,2)

Thailand(7,16)


Distribution of

U.S. Exportsand Imports

Di t ib ti f U S E t d


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Distribution of U.S. Exports andImportsFor the Year of 2000 in Billions of $

Source: U.S. Office of Trade and Economic Analysis

Australasia14.8 1.9%

Canada

178.822.8%

Mexico111.7

14.3%

OtherAmerica

59.37.6%

Eastern Europe6.1 0.8%

WesternEurope

181.323.2%

11.0

1.4%Africa27.62.3%

148.519.0%

East Asia340.328.0%

SouthEastAsia

47.46.1%

Other Asia23.6 3.0%

Canada229.2

18.8%

Mexico135.911.2%

OtherAmerica73.36.0%

Eastern Europe16.2 1.3%

241.019.8%

88.07.2%

Other Asia56.5 4.6%

Australasia8.8 0.7%

Exports Imports


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In 1975, the U.S. exported $107.1 billions ingoods, and imported $98.2 billions. Since then,international trade has grown, with U.S.

exports and imports of goods valued at $773.3and $1,222.8 billions respectively for the yearof 2000.

Since 1976, the value of U.S. imports has

exceeded the value of U.S. exports, causing abalance of trade deficit.


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U.S. Balance of Trade Trend

-500

-300

-100

100

300

500

700

900

1100

1300

1960 1965 1970 1975 1980 1985 1990 1995 2000B

illionsof U

S$

U.S. Imports

U.S. Exports

U.S. Balance of Trade



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-5%

0%

5%

10%

15%

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

-5%

-4%-3%-2%-1%0%1%2%3%

4%5%6%7%8%9%10%11%

12%13%14%15%

Imports of goods and servicesExports of goods and services

Trade Balance

Globalization: Trade Rises as a Share of U.S. GDP

Prof: Jeff Rosensw eig, Emory University Data Source: US Dept. of Commerce, January 2004 2003 = estimate. Data repor ted 12 March 2004.


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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 TradeAgreement (NAFTA) removes numerous traderestrictions among Canada, Mexico, and theU.S.

In 2001, trade negotiations were initiated for afree trade area of the Americas. 34 countriesare involved.



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Recent Changes in European Trade The Single European Act of 1987 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 in1999 eliminated the need to convertcurrencies among participating countries.



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Trade Agreements Around the World In 1993, a General Agreement on Tariffs 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



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Friction Surrounding Trade Agreements Trade agreements are sometimes broken when one

country is harmed by another countrys actions.

Dumpingrefers to the exporting of products by onecountry to other countries at prices below cost.

There might be barriers other than tariff:environmental standards, labor standards, politics(mainly non-tariff).

Another situation that can break a trade agreement iscopyright piracy (Intellectual property).



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Factors AffectingInternational Trade Flows

Inflation A relative increase in a countrys inflation rate

will decrease its current account, as imports

increase and exports decrease.

National Income

A relative increase in a countrys income level

will decrease its current account, as importsincrease.


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Government Restrictions A government may reduce its countrys

imports by imposing tariffs on imported goods,

or by enforcing a quota. Note that othercountries may retaliate by imposing their owntrade restrictions.

Sometimes though, trade restrictions may beimposed on certain products for health andsafety reasons.



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Exchange Rates If a countrys 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.



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CorrectingA Balance of Trade Deficit

By reconsidering the factors that affect thebalance of trade, some commoncorrection methods can be developed.

For example, a floating exchange ratesystem may correct a trade imbalanceautomatically since the trade imbalance

will affect the demand and supply of thecurrencies involved.


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However, a weak home currency may notnecessarily 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 cannotbe adjusted immediately.

The impact of exchange rate movements onintracompany trade, which makes up more than 50%of all international trade, is limited.

CorrectingA Balance of Trade Deficit

urve ec


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- urve ecIn fact, initially trade deficit may worsen andthen bounce back. This phenomenon is

known as J-curve effect.

U.S.Trade

Ba

lance

0 Time

J Curve


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Capital flows usually represent portfolioinvestment or direct foreign investment.

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

In particular, both DFI positions increased

during periods of strong economic growth.

International Capital Flows


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Direct Foreign Investment Positions


B

illio

nsof U

S$

0

200

400

600

800

1000

1200

1400

1980 1985 1990 1995 2000

DFI by U.S. Firms

DFI in the U.S.

of the United States on a Historical Cost basis


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Distribution of DFI for the U.S.For the Year of 2000


DFI by U.S. Firms DFI in the U.S.

Canada10.2%

Other WesternHemisphere19.2% 3.4%

Canada8.1%

France

3.1%

Germany4.3%

United Kingdom18.8%

Other

Europe16.6%

Africa1.3%

Middle

East1.0%

Japan4.5%

Other Asia& Pacific

11.6%

OtherAsia &Pacific2.5%

France9.6%

Germany9.9%

Netherlands9.3% 12.3%

United Kingdom18.5%

Other

Europe21.5%

MiddleEast0.7%

Japan13.2%


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Factors Affecting DFI

Changes in Restrictions

New opportunities may arise from the removalof 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.


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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 countrys currency isexpected to strengthen.

Factors Affecting DFI

Factors Affecting


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Factors AffectingInternational Portfolio

Investment Tax Rates on Interest or Dividends

Investors will normally prefer countries wherethe tax rates are relatively low.

Interest Rates Money tends to flow to countries with high

interest rates.

Exchange Rates Foreign investors may be attracted if the local

currency is expected to strengthen.


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International Monetary Fund (IMF)

The IMF is an organization of 183 membercountries. Established in 1946, it aims

to promote international monetary cooperation andexchange stability;

to foster economic growth and high levels ofemployment; and

to provide temporary financial assistance to helpease imbalances of payments.

Agencies that FacilitateInternational Flows

A i h F ili


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In particular, its compensatory financing facilityattempts to reduce the impact of export instabilityon country economies.

The IMF uses a quota system, and its unit ofaccount is the SDR (special drawing right).



Its operations involve surveillance, and

financial and technical assistance.

A i th t F ilit t


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The weights assigned to the currencies in

the SDR basket are as follows:Currency 2001 Revision 1996 Revision

U.S. dollar 45 39Euro 29

Deutsche mark 21French franc 11

Japanese yen 15 18Pound sterling 11 11




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You may learn more about the IMF athttp://www.imf.org.

Online Application

A i th t F ilit t
http://www.whitehouse.gov/fsbr/international.htmlhttp://www.whitehouse.gov/fsbr/international.htmlhttp://www.whitehouse.gov/fsbr/international.html


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World Bank Group

Established in 1944, the Group assistsdevelopment with the primary focus ofhelping the poorest people and thepoorest countries.

It has 183 member countries, and is

composed of five organizations - IBRD,IDA, IFC, MIGA and ICSID.


A i th t F ilit t


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IBRD:International Bank for Reconstruction

and Development

Better known as the World Bank, the IBRD

provides loans and development assistanceto middle-income countries and creditworthypoorer countries.

In particular, its structural adjustment loansare intended to enhance a countrys long-term economic growth.


A i th t F ilit t


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It may spread its funds by entering intocofinancing agreements with official aid agencies,export credit agencies, as well as commercialbanks.


IBRD:International Bank for

Reconstruction and Development

The IBRD is not a profit-maximizingorganization. Nevertheless, it hasearned a net income every year since

1948.

A i th t F ilit t


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IDA: International Development Association

IDA was set up in 1960 as an agency thatlends to the very poor developing nations on

highly concessional terms. IDA lends only to those countries that lack

the financial ability to borrow from IBRD.

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


A i th t F ilit t


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IFC: International Finance Corporation

The IFC was set up in 1956 to promotesustainable 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.


A i th t F ilit t


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MIGA: Multilateral Investment Guarantee

Agency

The MIGA was created in 1988 to promoteFDI in emerging economies, by offering political risk insurance to investors

and lenders; and

helping developing countries attract and retainprivate investment.


A i th t F ilit t


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ICSID:International Centre for Settlement of

Investment Disputes

The ICSID was created in 1966 tofacilitate the settlement of investmentdisputes between governments andforeign investors, thereby helping to

promote increased flows of internationalinvestment.



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To learn more about the World BankGroup and its organizations, visit:

http://www.worldbank.org

http://www.worldbank.org/ibrd

http://www.worldbank.org/ida

http://www.ifc.org

http://www.miga.org http://www.worldbank.org/icsid

Online Application

A i th t F ilit t
http://www.ebrd.com/http://www.worldbank.org/http://www.worldbank.org/ibrdhttp://www.imf.org/http://www.ifc.org/http://www.miga.org/http://www.miga.org/http://www.miga.org/http://www.ifc.org/http://www.ifc.org/http://www.imf.org/http://www.imf.org/http://www.worldbank.org/ibrdhttp://www.worldbank.org/ibrdhttp://www.worldbank.org/http://www.worldbank.org/http://www.ebrd.com/http://www.ebrd.com/


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World Trade Organization (WTO)

Created in 1995, the WTO is the successorto 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 WTO's multilateral trading

system are its trade agreements.


Agencies that Facilitate


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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 fordeveloping countries; and

cooperating with other international groups.


World Trade Organization (WTO)



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Bank for International Settlements (BIS)

Set up in 1930, the BIS is an internationalorganization that fosters cooperation

among central banks and other agenciesin pursuit of monetary and financialstability.

It is the central banks central bank andlender of last resort.




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The BIS functions as:

a forum for international monetary and financialcooperation;

a bank for central banks;

a center for monetary and economic research;

and an agent or trustee in connection with

international financial operations.


Bank for International Settlements (BIS)


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To learn more about the WTO and theBIS, visit:

http://www.wto.org

http://www.bis.org

Online Application

http://www.worldbank.org/idahttp://www.wto.org/http://www.wto.org/http://www.wto.org/http://www.worldbank.org/idahttp://www.worldbank.org/ida


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Regional Development Agencies

Agencies with more regional objectivesrelating to economic development include

the Inter-American Development Bank;

the Asian Development Bank;

the African Development Bank; and

the European Bank for Reconstruction andDevelopment.



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Check out the following regional agencies: Inter-American Development Bank: http://

www.iadb.org

Asian Development Bank: http://www.adb.org African Development Bank: http://

www.afdb.org

European Bank for Reconstruction andDevelopment: http://www.ebrd.com

Online Application

Impact of International Trade on an MNCs
http://www.worldbank.org/icsidhttp://www.worldbank.org/icsidhttp://www.iadb.org/http://www.adb.org/http://www.adb.org/http://www.afdb.org/http://www.afdb.org/http://www.afdb.org/http://www.adb.org/http://www.adb.org/http://www.iadb.org/http://www.iadb.org/http://www.worldbank.org/icsidhttp://www.worldbank.org/icsid


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Impact of International Trade on an MNC sValue

( ) ( )[ ]( )

+

=

n

tt

m

j

tjtj

k1=

1

,,

1

ERECFE=Value

E (CFj,t ) = expected cash flows in

currencyjto be received by the U.S. parent atthe end of period tE (ERj,t ) = expected exchange rate at

which currencyjcan be converted to dollars at

Exchange Rate Movements

Inflation in Foreign CountriesNational Income in Foreign Countries

Trade Agreements


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Balance of Payments Current, Capital, and Financial Accounts


Distribution of U.S. Exports and Imports

U.S. Balance of Trade Trend

Recent Changes in North American and

European Trade Trade Agreements Around the World

Chapter Review


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Chapter Review

Factors Affecting International TradeFlows

Inflation

National Income

Government Restrictions

Exchange Rates

Interaction of Factors


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Chapter Review

Correcting a Balance of Trade Deficit

Why a Weak Home Currency is Not A PerfectSolution

International Capital Flows Distribution of DFI by U.S. Firms

Distribution of DFI in the U.S.

Factors Affecting DFI Factors Affecting International Portfolio

Investment


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Chapter Review

Agencies that Facilitate International Flows


World Bank Group

World Trade Organization (WTO) Bank for International Settlements (BIS)

Regional Development Agencies

How International Trade Affects an MNCsValue

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