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Student Name
Allied American University
Author Note
This paper was prepared for [INSERT COURSE NAME], [INSERT COURSE
ASSIGNMENT] taught by [INSERT INSTRUCTOR’S NAME].
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PART I:
Directions: Please answer each of the following questions in a paragraph for each. Explain your
thoughts with theory and at least three scholarly citations throughout your work.
1.
List the factors that might influence a country's exports, imports, and trade balance.
Some notable factor that might influence a country’s imports, exports and trade balance are
listed as under:
 The demand of the economy’s consumers for the local or imported items
 The prices (or price difference) of local items or products and those of imported
from other countries
 The exchange rate of the country’s currency, it determines the price with which
consumers can buy items from other countries using their own currency
 The import expense, higher the cost of importing goods lesser will be the consumer
trend of buying foreign items
 International trade policies and laws of the local government
2.
Suppose that Bill, a resident of the U.S., buys software from a company in Japan.
Explain why and in what direction this changes U.S. net exports and U.S. net capital
outflow.
 As Bill purchased a foreign country’s product so it will fall under import. As
Net Exports = Exports – Imports
Thus, Net Exports decreases.
o Bill paid for the software in US$. So Japanese now have more US assets. Since
Net Capital Outflow = Amount of foreign assets acquired by local residents – Domestic assets acquired by foreign residents
So, the increase in US $ assets of Japanese, decreases US net capital outflow.
3.
What is the logic behind the theory of purchasing-power parity?
The logic behind “purchasing power parity” is the law of one-price. This law states that
Any particular good must sell at the same price in all locations
If the price of an item is higher in one area’s market then somebody might make profit by
buying the item from the area where it is selling comparatively cheaper and selling
that item in the other area’s market where it is selling at a higher price. This arbitrage
leads to an equalization of prices in all the areas. If the law of purchasing-power
parity is functional, the exact amount of US$ it takes to buy a particular product
should be enough foreign currency to buy the same product in that foreign country.
3.
Suppose that money supply growth continues to be higher in Turkey than it is in the
United States. What does purchasing-power parity imply will happen to the real and
to the nominal exchange rate?
Higher money growth leads to higher prices. This means that prices will increase more in
Turkey than in the U.S. According to the purchasing-power parity, it will not affect the real
exchange rate. However, in order for a US$ to buy equal amount of products in Turkey as it
can buy in US, as prices are getting higher faster in Turkey compared to US, the nominal
exchange rate must also be increasing so that US$ can buy more of Turkish Lira.
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5.
State what, if anything, each of the following does to the supply or demand of loanable
funds.
a. Net capital outflow increases at each interest rate
 With the increase of net capital outflow at each interest rate the demand of
loanable funds increases
b. Domestic investment increases at each interest rate
 The demand of loanable funds increases with the increase in domestic
investment at each interest rate
c. The government deficit increases
 If the government deficit increases, this will decrease the supply of loanable
funds
d. Private saving increases.
 With the increase in private savings the supply of loanable funds increases
6.
Suppose that U.S. investors decide that investment opportunities in African countries
have improved. What happens to U.S. net capital outflow? What happens to the U.S.
real interest rate?
o US net capital outflow will increase. The increase in net capital outflow increases the
US demand of loanable funds, which eventually increases US interest rate.
7.
Suppose that U.S. citizens start saving more. What does this imply about the supply
of loanable funds and the equilibrium real interest rate? What happens to the real
exchange rate?
o When citizens start saving more, the supply of loanable funds increases and the
equilibrium real interest rate falls. Due to lower interest rate US net capital flow rises.
This increase makes the supply of US$ to shift towards right while the real exchange
rate of US$ depreciates.
8.
Suppose the U.S. government institutes a "Buy American" campaign, in order to
encourage spending on domestic goods. What effect will this have on the U.S. trade
balance?
o “Buy American” campaign will increase the demand and consumption of locally
manufactured items and thus the demand of foreign imported items will decrease.
This will, in turn, increase the demand of US$ in the foreign currency market. The
real exchange rate of US$ will appreciate while there will be no affect/change in the
trade balance. The net exports ultimately depends upon domestic savings &
investments, neither of which are affected by the said campaign
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PART II: Reflection Paper
After you have had time to review the material in this module about valuing currency and
currency fixing, share your thoughts about our trade partner, China. Are some economists
overstating the damage that currency fixing is doing to our economy? Is it a political issue
or a real economic one? Be sure to back up your thoughts in a two page paper in APA
format with at least two cited scholarly reference. Please utilize LIRN to help you get
started with your search. You may visit the Academic Resource Center for a guide on how
to utilize LIRN successfully.
Some analysts have raised concerns that China’s large holdings of U.S. debt securities could give
China leverage over U.S. foreign policy, including trade policy. They argue, for example, China
might attempt to sell (or threaten to sell) a large share of its U.S. debt securities as punishment
over a policy dispute, which could damage the U.S. economy. Others counter that China’s
holdings of U.S. debt give it very little practical leverage over the United States. They argue that,
given China’s economic dependency on a stable and growing U.S. economy, and its substantial
holdings of U.S. securities, any attempt to try to sell a large share of those holdings would likely
damage both the U.S. and Chinese economies. Such a move could also cause the U.S. dollar to
sharply depreciate against global currencies, which could reduce the value of China’s remaining
holdings of U.S. dollar assets. Analysts also note that, while China is the largest foreign owner of
U.S. Treasury Securities, those holdings are equal to only 10.4% of total U.S. public debt (as of
China-U.S. Trade Issues Congressional Research Service 15 December 2012). Finally, it is
argued that, as long as China continues to largely peg the RMB to the U.S. dollar, it has little
choice but to purchase U.S. dollar assets in order to maintain that peg.
In the 112th Congress, the conference report accompanying the National Defense Authorization
Act of FY2012 (H.R. 1540, P.L. 112-81) included a provision requiring the Secretary of Defense
to conduct a national security risk assessment of U.S. federal debt held by China. The Secretary
of Defense issued a report in July 2012, stating that “attempting to use U.S. Treasury securities
as a coercive tool would have limited effect and likely would do more harm to China than to the
United States.” As the threat is not credible and the effect would be limited even if carried out, it
does not offer China deterrence options, whether in the diplomatic, military, or economic realms,
and this would remain true both in peacetime and in scenarios of crisis or war.30 Currency fixing
is political as well as economical issue. The changes in currency values poses huge effects on the
country’s economy and all related aspects while the decision related to currency fixing and
valuation is controlled by the political powers, so it may well be said that it’s a political as well
as economic issue.
Source:
o
o
Office of the Secretary of Defense, Report to Congress, Assessment of the National Security Risks Posed to the
United States as a Result of the U.S. Federal Debt Owed to China as a Creditor of the U.S. Government, July
2012.
US Department of the Treasury