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Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International ExchangeRates System Recent U.S. Trade Deficits Last Word Key Terms 36 Exchange Rates, the Balance of Payments, and Trade Deficits End Show 36-1 Copyright 2008 The McGraw-Hill Companies Chapter Objectives Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International ExchangeRates System Recent U.S. Trade Deficits Last Word Key Terms End Show 36-2 • How Currencies of Different Nations are Exchanged When International Transactions Take Place • About the Balance Sheet the United States Uses to Account for the International Payments it Makes and Receives • How Exchange Rates are Determined in Currency Markets • The Difference Between Flexible Exchange Rates and Fixed Exchange Rates • The Causes and Consequences of Recent Record-High U.S. Trade Deficits Copyright 2008 The McGraw-Hill Companies Financing International Trade Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International ExchangeRates System Recent U.S. Trade Deficits Last Word Key Terms End Show 36-3 • U.S. Export Transactions – Importer must pay in their currency which is exchanged by the US for dollars – US exports create a foreign demand for dollars & increases the US supply of foreign currency • U.S. Import Transactions – US must pay in US dollars which is exchanged by the importer for their currency. – US importing of product creates demand for foreign currency and decreases the supply of foreign currency held in the US. Copyright 2008 The McGraw-Hill Companies Balance of Payments- sum of Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International ExchangeRates System Recent U.S. Trade Deficits Last Word all transactions that take place between it’s residents and residents of foreign nations. The Current Account – Record of nations exports and imports of: • goods and services (Product, travel, insurance) • Net investment income(US earnings on investments abroad minus foreign investment earnings in US) • Net transfers (foreign aid, pensions paid to US citizens living abroad) Key Terms End Show 36-4 Copyright 2008 The McGraw-Hill Companies Financing International Trade GLOBAL PERSPECTIVE Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International ExchangeRates System Recent U.S. Trade Deficits Last Word U.S. Trade Balances in Goods and Services Select Nations, 2008 Good and Services Deficit Goods and Services Surplus +6.8 Australia Belgium +4.4 Canada -66.5 China Germany -45.8 Key Terms Japan -75.6 Mexico -45.1 Netherlands End Show -162 -160 -70 -60 -50 -40 -30 -20 -10 +11.8 10 20 Source: BEA 36-5 Copyright 2008 The McGraw-Hill Companies • Capital/Financial Account Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International ExchangeRates System Recent U.S. Trade Deficits Last Word Key Terms End Show 36-6 – Flows of money from the purchase of a Real or Financial Asset domestically or abroad. – Real Asset: AB sold to Inbev – Financial Asset: Shares of Inbev sold to American investors. • Official (Reserve) Account-is the offsetting account the government controls. – Country uses foreign assets or currency to offset a balance of payments deficit (Credit-positive) – Balance of payment surpluses are earned foreign currency (Debit-negative) Copyright 2008 The McGraw-Hill Companies Balance of Payments Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International ExchangeRates System Recent U.S. Trade Deficits Last Word Key Terms End Show 36-7 • Classifying transactions – Loss of foreign currency – Gain of foreign currency • If the international transaction uses foreign currency to complete the transaction it is a Debit(negative) • If the international transaction earns foreign currency to complete the transaction it is a Credit (positive) Copyright 2008 The McGraw-Hill Companies Flexible Exchange Rates • Flexible or Floating Exchange Rates • Fixed Exchange Rate system • Depreciation and Appreciation • Determinants of Exchange Rates G36.1 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International ExchangeRates System Recent U.S. Trade Deficits Last Word – Changes in Tastes – Relative Income Changes – Relative Price-Level Changes • Purchasing-Power-Parity Theory – Relative Interest Rates – Speculation Key Terms End Show 36-8 Copyright 2008 The McGraw-Hill Companies Flexible Exchange Rates The Market for Foreign Currency (Pounds) P Sl Dollar Price of 1 Pound Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International ExchangeRates System Recent U.S. Trade Deficits Last Word $3 $2 Dollar Depreciates (Pound Appreciates) Exchange Rate: $2 = £1 Dollar Appreciates (Pound Depreciates) $1 Dl 0 Key Terms Ql Quantity of Pounds End Show 36-9 Copyright 2008 The McGraw-Hill Companies Q Flexible Exchange Rates The Market for Foreign Currency (Pounds) P Sl Dollar Price of 1 Pound Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International ExchangeRates System Recent U.S. Trade Deficits Last Word c $3 $2 $1 a x Exchange Rate: $3 = £1 Balance Of Payments Deficit b D 2 Exchange Rate: $2 = £1 Dl 0 Key Terms Ql Quantity of Pounds End Show 36-10 Copyright 2008 The McGraw-Hill Companies Q2 Q Flexible Exchange Rates Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International ExchangeRates System Recent U.S. Trade Deficits Last Word Key Terms End Show 36-11 • Flexible Rates and the Balance of Payments • Disadvantages of Flexible Exchange Rates • Uncertainty and Diminished Trade • Terms-of-Trade Changes • Instability Copyright 2008 The McGraw-Hill Companies Fixed Exchange Rates • Use of Reserves Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International ExchangeRates System Recent U.S. Trade Deficits Last Word – Currency Interventions • Trade Policies • Exchange Controls and Rationing – Distorted Trade – Favoritism – Restricted Choice – Black Markets • Domestic Macroeconomic Adjustments Key Terms End Show 36-12 Copyright 2008 The McGraw-Hill Companies Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International ExchangeRates System Recent U.S. Trade Deficits Last Word Key Terms International Exchange-Rate Systems • The Gold Standard: Fixed Exchange Rates –Devaluation –Gold Flows –Domestic Macroeconomic Adjustments –Collapse of the Gold Standard End Show 36-13 Copyright 2008 The McGraw-Hill Companies International Exchange-Rate Systems Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International ExchangeRates System Recent U.S. Trade Deficits Last Word Key Terms End Show 36-14 • The Bretton Woods System – International Monetary Fund (IMF) – IMF and Pegged Exchange Rates • Official Reserves • Gold Sales • IMF Borrowing – Fundamental Imbalances: Adjusting the Peg – Demise of the Bretton Woods System Copyright 2008 The McGraw-Hill Companies International Exchange-Rate Systems Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International ExchangeRates System Recent U.S. Trade Deficits Last Word Key Terms End Show 36-15 • The Current System: The Managed Float –Managed Floating Exchange Rates • In Support of the Managed Float • Concerns With the Managed Float Copyright 2008 The McGraw-Hill Companies Recent U.S. Trade Deficits Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International ExchangeRates System Recent U.S. Trade Deficits Last Word Key Terms End Show 36-16 • Causes of Trade Deficits • Implications of U.S. Trade Deficits –Increased Current Consumption –Increased U.S. Indebtedness Copyright 2008 The McGraw-Hill Companies