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International Trade in Goods and Services (Measures U.S. Exports and Imports of Goods and Sevices) Web: http://www.bea.gov/newsreleases/international/trade/tradnewsrelease.htm Monthly revisions going back several months. Annual revisions in June that go back several years. As the U.S. economy has moved from a relatively closed economy (1950s–1960s) to one with more international commerce, foreign economic events (1997 Asian financial crisis, 1998 Russian foreign loan default) are having are larger impact on the U.S. economy. World trade is an important force shaping the U.S. economy, but unfortunately the trade data is not a good leading indicator. Trade patterns change slowly because of the long lag time between signing a trade contract and shipping the goods. However, import and export flows can give clues about domestic demand, industry earnings, pricing power, foreign demand and potential changes in currency values. U.S. firms have responded to the rise in imports by increasing their efficiency, lowering prices, and pushing to open overseas markets. Three key forces shaping the U.S. trade balance: 1. Relative economic growth rates between the U.S. and the rest of the world (ROW). Imports are a function of where the U.S. economy stands in the business cycle. Exports are a function of where the ROW stands in their business cycle. If (DY/Y)U.S. > (DY/Y)ROW , then DM/M > DX/X => trade deficit 2. The U.S. dollar exchange rate (E = euros-to-dollar) E => Price exports, Price imports => quantity demand of exports, quantity demand of imports => exports, imports => worsening trade balance. Research has shown that a 1% rise in the dollar leads to a $10-15 billion fall in the trade balance over 2 years. 3. Relative inflation rates between the U.S. and the rest of the world. (DP/P)U.S.=> quantity demand of exports and an quantity demand of imports => declining net exports Three factors could decrease the U.S. trade deficit: 1. (DY/Y)ROW => exports => net exports 2. Depreciating dollar => PX & PM => X, M => net exports. (But we could also see rising inflation rates and interest rates with a falling dollar. Recall Purchasing Power Parity;…. $/e = PLU.S./PL E.U. Recall real exchange rate;…… r = (e/$) x (PLU.S. / PL E.U.) 3. U.S. households must increase savings and decrease consumption. The inflation-adjusted numbers track the actual volume (quantity) of goods traded which impacts real GDP. Traded goods have much more volatility than traded services. Separate tables are broken out for 2 volatile commodities: energy and motor vehicles. Falling oil prices => decrease imports => increase net exports => increase discretionary spending => faster economic growth. Data is published on 6 principal end-use categories: food & beverage, industrial supplies, capital goods, automotive vehicles, consumer goods, and other goods. To analyze changes in trade patterns it is useful to study changes in the six components. For example, an increase in capital goods => firm productivity and efficiency => jobs => inflation. But an increase in consumer goods => falling net exports and reduced long-term health of economy. ------------------------------------------------------------------------------------------------------------------------------------------------ Market Analysis: Bonds: trade deficit => appreciating dollar => (DP/P)ET+1 => DBonds => iBonds Stocks: exports => net exports => domestic manufacturing => future profits => PStocks Dollar: trade deficit => Demand for dollars & de Supply of dollars => appreciating dollar Exports Goods and Services 150 150 Recession 140 140 Services 130 130 120 110 110 100 100 90 90 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 $ Billions $ Billions Goods 120 Recession Services Goods $ Billions 200 190 180 170 160 150 140 130 120 110 100 90 80 70 60 50 40 30 20 10 0 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 200 190 180 170 160 150 140 130 120 110 100 90 80 70 60 50 40 30 20 10 0 $ Billions Imports Goods and Services Trade Balance Goods Exports minus Goods Imports Service Exports minus Service Imports 20 20 10 10 0 0 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 -10 -10 -20 -20 -30 -30 -40 -40 -50 -50 -60 Recession -60 Services -70 -80 Goods -70 -80 $ Billions $ Billions 92 THE GREAT DEBATE: Stimulus Vs Austerity J.M. Keynes F.A. Hayek 1883-1946 Father of Modern Macroeconomics “The General Theory of Employment, Interest and Money” 1899-1992 1974 Nobel Prize “The Road to Serfdom” Advocated the use of fiscal and monetary measures to offset recessions. Changing prices communicate signals to enable individuals to coordinate their plans. This leads to an efficient exchange and use of resources. AD determines the overall level of economic activity. The modern capitalist economy does not automatically work at top efficiency, but can be raised to that level by government intervention. Leading critic of collectivism/socialism because it required a central planner that would eventually become totalitarianism. The free price system is a spontaneous order – the result of human action, but not of human design. Central banks do not possess the relevant info to govern the money supply, nor the ability to use it correctly. “Fear the Boom and Bust” Lyrics Keynes’s Viewpoint 1. We’ve been going back and forth for a century 2. [Keynes] I want to steer markets, 3. [Hayek] I want them set free 4. There’s a boom and bust cycle and good reason to fear it 5. [Hayek] Blame low interest rates. 6. [Keynes] No… it’s the animal spirits 7. [Keynes Sings:] 8. John Maynard Keynes, wrote the book on modern macro 9. The man you need when the economy’s off track, [whoa] 10. Depression, recession now your question’s in session 11. Have a seat and I’ll school you in one simple lesson 12. BOOM, 1929 the big crash 13. We didn’t bounce back—economy’s in the trash 14. Persistent unemployment, the result of sticky wages 15. Waiting for recovery? Seriously? That’s outrageous! 16. I had a real plan any fool can understand 17. The advice, real simple—boost aggregate demand! 18. C, I, G, all together gets to Y 19. Make sure the total’s growing, watch the economy fly 20. We’ve been going back and forth for a century 21. [Keynes] I want to steer markets, 22. [Hayek] I want them set free 23. There’s a boom and bust cycle and good reason to fear it 24. [Hayek] Blame low interest rates. 25. [Keynes] No… it’s the animal spirits 26. You see it’s all about spending, hear the register cha-ching 27. Circular flow, the dough is everything 28. So if that flow is getting low, doesn’t matter the reason 29. We need more government spending, now it’s stimulus season 30. So forget about saving, get it straight out of your head 31. Like I said, in the long run—we’re all dead 32. Savings is destruction, that’s the paradox of thrift 33. Don’t keep money in your pocket, or that growth will never lift… because… 34. Business is driven by the animal spirits 35. The bull and the bear, and there’s reason to fear its 36. Effects on capital investment, income and growth 37. That’s why the state should fill the gap with stimulus both… 38. The monetary and the fiscal, they’re equally correct 39. Public works, digging ditches, war has the same effect 40. Even a broken window helps the glass man have some wealth 41. The multiplier driving higher the economy’s health 42. And if the Central Bank’s interest rate policy tanks 43. A liquidity trap, that new money’s stuck in the banks! 44. Deficits could be the cure, you been looking for 45. Let the spending soar, now that you know the score 46. My General Theory’s made quite an impression 47. [a revolution] I transformed the econ profession 48. You know me, modesty, still I’m taking a bow 49. Say it loud, say it proud, we’re all Keynesians now 50. We’ve been goin’ back n forth for a century 51. [Keynes] I want to steer markets, 52. [Hayek] I want them set free 53. There’s a boom and bust cycle and good reason to fear it 54. [Keynes] I made my case, Freddie H 55. Listen up , Can you hear it? Hayek sings: “Fear the Boom and Bust” Lyrics Hayek’s Viewpoint 56. I’ll begin in broad strokes, just like my friend Keynes 57. His theory conceals the mechanics of change, 58. That simple equation, too much aggregation 59. Ignores human action and motivation 60. And yet it continues as a justification 61. For bailouts and payoffs by pols with machinations 62. You provide them with cover to sell us a free lunch 63. Then all that we’re left with is debt, and a bunch 64. If you’re living high on that cheap credit hog 65. Don’t look for cure from the hair of the dog 66. Real savings come first if you want to invest 67. The market coordinates time with interest 68. Your focus on spending is pushing on thread 69. In the long run, my friend, it’s your theory that’s dead 70. So sorry there, buddy, if that sounds like invective 71. Prepared to get schooled in my Austrian perspective 72. We’ve been going back and forth for a century 73. [Keynes] I want to steer markets, 74. [Hayek] I want them set free 75. There’s a boom and bust cycle and good reason to fear it 76. [Hayek] Blame low interest rates. 77. [Keynes] No… it’s the animal spirits 78. The place you should study isn’t the bust 79. It’s the boom that should make you feel leery, that’s the thrust 80. Of my theory, the capital structure is key. 81. Malinvestments wreck the economy 82. The boom gets started with an expansion of credit 83. The Fed sets rates low, are you starting to get it? 84. That new money is confused for real loanable funds 85. But it’s just inflation that’s driving the ones 86. Who invest in new projects like housing construction 87. The boom plants the seeds for its future destruction 88. The savings aren’t real, consumption’s up too 89. And the grasping for resources reveals there’s too few 90. So the boom turns to bust as the interest rates rise 91. With the costs of production, price signals were lies 92. The boom was a binge that’s a matter of fact 93. Now its devalued capital that makes up the slack. 94. Whether it’s the late twenties or two thousand and five 95. Booming bad investments, seems like they’d thrive 96. You must save to invest, don’t use the printing press 97. Or a bust will surely follow, an economy depressed 98. Your so-called “stimulus” will make things even worse 99. It’s just more of the same, more incentives perversed 100. And that credit crunch ain’t a liquidity trap 101. Just a broke banking system, I’m done, that’s a wrap. 102. We’ve been goin’ back n forth for a century 103. [Keynes] I want to steer markets, 104. [Hayek] I want them set free 105. There’s a boom and bust cycle and good reason to fear it 106. [Hayek] Blame low interest rates. 107. [Keynes] No it’s the animal spirits “Fight of the Century” Lyrics Written by John Papola and Russ Roberts KEYNES Here we are… peace out! great recession thanks to me, as you see, we’re not in a depression Recovery, destiny if you follow my lesson Lord Keynes, here I come, line up for the procession HAYEK We brought out the shovels and we’re still in a ditch… And still digging. don’t you think that it’s time for a switch… From that hair of the dog. Friend, the party is over. The long run is here. It’s time to get sober! KEYNES Are you kidding? my cure works perfectly fine… have a look, the great recession ended back in ’09. I deserve credit. Things would have been worse All the estimates prove it—I’ll quote chapter and verse HAYEK Econometricians, they’re ever so pious Are they doing real science or confirming their bias? Their “Keynesian” models are tidy and neat But that top down approach is a fatal conceit REFRAIN Which way should we choose? more bottom up or more top down …the fight continues… Keynes and Hayek’s second round it’s time to weigh in… more from the top or from the ground …lets listen to the greats Keynes and Hayek throwing down KEYNES We could have done better, had we only spent more Too bad that only happens when there’s a World War You can carp all you want about stats and regression Do you deny World War II cut short the Depression? HAYEK Wow. One data point and you’re jumping for joy the Last time I checked, wars only destroy There was no multiplier, consumption just shrank As we used scarce resources for every new tank Pretty perverse to call that prosperity Rationed meat, Rationed butter… a life of austerity When that war spending ended your friends cried disaster yet the economy thrived and grew faster KEYNES You too only see what you want to see The spending on war clearly goosed GDP Unemployment was over, almost down to zero That’s why I’m the master, that’s why I’m the hero HAYEK Creating employment’s a straightforward craft When the nation’s at war, and there’s a draft If every worker was staffed in the army and fleet We’d have full employment and nothing to eat REFRAIN REPEATS “Fight of the Century” Lyrics HAYEK jobs are a means, not the ends in themselves people work to live better, to put food on the shelves real growth means production of what people demand That’s entrepreneurship not your central plan KEYNES My solution is simple and easy to handle.. its spending that matters, why’s that such a scandal? The money sloshes through the pipes and the sluices revitalizing the economy’s juices it’s just like an engine that’s stalled and gone dark To bring it to life, we need a quick spark Spending’s the life blood that gets the flow going Where it goes doesn’t matter, just get spending flowing HAYEK You see slack in some sectors as a “general glut” But some sectors are healthy, only some in a rut So spending’s not free – that’s the heart of the matter too much is wasted as cronies get fatter. The economy’s not a car, there’s no engine to stall no expert can fix it, there’s no “it” at all. The economy’s us, we don’t need a mechanic Put away the wrenches, the economy’s organic REFRAIN REPEATS KEYNES so what would you do to help those unemployed? this is the question you seem to avoid when we’re in a mess, would you just have us wait? Doing nothing until markets equilibrate? HAYEK I don’t want to do nothing, there’s plenty to do The question I ponder is who plans for whom? Do I plan for myself or leave it to you? I want plans by the many, not by the few. Let’s not repeat what created our troubles I want real growth not a series of bubbles Stop bailing out loser, let prices work If we don’t try to steer them they won’t go berserk KEYNES Come on, Are you kidding? Don’t Wall Street’s gyrations Challenge your world view of self-regulation? Even you must admit that the lesson we’ve learned Is more oversight’s needed or else we’ll get burned HAYEK Oversight? The government’s long been in bed With those Wall Street execs and the firms that they’ve bled Capitalism’s about profit and loss you bail out the losers there’s no end to the cost the lesson I’ve learned? It’s how little we know, the world is complex, not some circular flow the economy’s not a class you can master in college to think otherwise is the pretense of knowledge REFRAIN REPEATS “Fight of the Century” Lyrics Continued KEYNES You get on your high horse and you’re off to the races I look at the world on a case by case basis When people are suffering I roll up my sleeves And do what I can to cure our disease The future’s uncertain, our outlooks are frail Thats why free markets are so prone to fail In a volatile world we need more discretion So state intervention can counter depression HAYEK People aren’t chessmen you move on a board at your whim–their dreams and desires ignored With political incentives, discretion’s a joke Those dials you’re twisting… just mirrors and smoke We need stable rules and real market prices so prosperity emerges and cuts short the crisis give us a chance so we can discover the most valuable ways to serve one another FINAL REFRAIN Which way should we choose? more bottom up or more top down the fight continues… Keynes and Hayek’s second round it’s time to weigh in… more from the top or from the ground …lets listen to the greats Keynes and Hayek throwing down Chapter 17: Macroeconomics in an Open Economy Trade between countries involves the mutual exchange of different currencies (bank deposits denominated in different currencies) When American firms buy foreign goods, services and assets => U.S. $ exchanged for foreign currency Bank deposits denominated in U.S. $ bank deposits denominated in foreign currency This trade takes place in foreign exchange markets Definitions: Exchange Rate - price of one currency in terms of another Spot exchange rate – exchange rate for the immediate (2-day) exchange of bank deposits Forward exchange rate – exchange rate for the exchange of bank deposits at some specified future date Appreciation – currency increases in value Depreciation – currency decreases in value The Circular Flow Diagram U.S. Dollar Versus Euro Exchange Rate $/Euro Euro/$ $1.70 1.70 $1.60 1.60 $1.50 1.50 $/Euro $1.40 1.40 $1.30 1.30 $1.20 1.20 $1.10 1.10 $1.00 1.00 $0.90 0.90 $0.80 0.80 $0.70 0.70 Euro/$ $0.60 0.60 $0.50 0.50 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 Exchange rates are important because they affect the relative price of domestic and foreign goods. Example: The $ price of a German BMW to an American is a function of the interaction of 2 factors: 1.The price of BMWs in Euros (50,000 euros) 2.The exchange rate E = $/euro, If E = $1/1euro => 50,000 euro x ($1/1euro) = $50,000 If euro appreciates to ($1.20/1euro) => $ depreciates => 50,000euro x ($1.20/1euro) = $60,000 Currency appreciates => country’s goods prices abroad and foreign goods prices in that country 1. Makes domestic businesses less competitive 2. Benefits domestic consumers U.S. International Transactions Balance of Payments (Comprehensive Measure of U.S.’s Trade and Investment with the Rest of the World) Web: http://www.bea.gov/international/index.htm#bop Moderate quarterly revisions. Annual benchmark changes make in June. International commerce now makes up more than a quarter of all U.S. business activity. The International Transactions Report tracks cross-border movements in trade in goods and services, imports and exports of investment capital (stocks, bonds, physical assets) and investment income (interest/dividends). Data is seasonally adjusted but not annualized or adjusted for inflation. Data measures quarterly changed in trade and investment flows. The International Transaction Release contains 3 sections. 1. Current Account: Merchandise Trade Account – goods or visible trade. Trade balance = $X -$M Service Trade Account – Invisible trade (investment banking, insurance, engineering, public relations, accounting, advertising, patent/copyright/movie fees). Investment Income Account – interest and dividends. Subcategory of service account. Income receipts are classified as export income because earnings are from overseas investments. Income payments to foreignors are classified as import payments because they are based on capital shipped to the U.S. Unilateral Transfers – One way transfers (foreign aid, government grants, pension payments, worker remittances) 2. Financial Account: Movement of investment capital and loans into and out of U.S. Measures changes in U.S. ownership of foreign stocks, bonds and other assets. Measures changes in foreign ownership of U.S. securities and private assets. Measures changes in central bank’s holdings of foreign currencies and securities. 3. Capital Account: uncommon flows of money. Example includes U.S. residents who emigrate and take assets with them. Balance of Payments = Current account + Financial Account + Capital Account = 0 - represents all economic transactions between U.S. and R.O.W. Since the 1980s, the U.S. current account balance has been negative, indicating Americans have consumed more than they produced (lived beyond their means) They accomplished this feat by borrowing money from the rest of the world (ROW) to finance their spending. Americans borrow $2 billion per day to finance their spending. The U.S. in now the largest debtor nation. The debt buildup cannot go on forever and could destabilize the U.S. and global economy. Current account data is found on lines 71-76 of the report. A negative figure reflects how much the U.S. has to borrow from the ROW to finance spending by American consumers, businesses and government. What is the possibility of a reversal of foreign investor sentiment against the dollar? An in external debt => concentration risk of U.S. assets on foreign balance sheets => foreign investor’s appetite for U.S. stock and bonds => dollar exchange rate => import prices => domestic prices => inflation => interest rates. To compensate for the concentration risk, foreign investors will have to be compensated with higher interest rates. Does the trade deficits and capital surplus reflect the strength of the U.S. economy? The U.S. has a stable and attractive investment environment (liquid markets, creditworthy borrowers, strong productivity growth) ------------------------------------------------------------------------------------------------------------------------------------------------ Market Analysis: Bonds: current account deficit => appreciating dollar => (DP/P)ET+1 => DBonds => iBonds Stocks: exports => net exports => domestic manufacturing => future profits => PStocks Dollar: current account deficit => Demand for dollars & Supply of dollars => appreciating dollar Current Account Balance $100 1% $18 $4 $0 $2 $5 $3 $0 0% 75 -$100 -$200 77-$1579 -$14 81 -$6 83 -$39 85 87 89 91 -$79 -$99 -$121 -$94 -$118 -$147 -$161 93 95 97 99 01 03 05 07 09 11 -$52 -$85 -1% -$114 -$122 -$125 -$141 -2% -$300 -3% $ Billions -$302 -$400 -$377 -$397 -$416 -$457 -$500 -$471 -4% -5% -$519 -$600 -6% -$629 -$700 -$677 -$710 -7% -$746 -$800 -8% -$801 Dollar Amount -$900 % of GDP -9% Percent of GDP -$215 U.S. Dollar Exchange Rate Major Currency Index Nominal & Real (1973 = 100) 150 150 140 140 130 130 120 120 110 110 100 100 90 90 80 80 70 70 60 60 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 Source: FRB: Exchange Rates G.5 (405) Nominal Real How Movements in the Exchange Rate Affect Exports U.S Exports 115 14 110 9 105 4 100 -1 95 -6 90 -11 85 -16 80 (Percent) 19 1999 2000 2001 Source: Bureau of Census 2002 2003 2004 Export Growth 2005 Exchange Rate (Year-Over-Year % Change) 2006 Exchange Rate Balance of payments The record of a country’s trade with other countries in goods, services, and assets. Current account The part of the balance of payments that records a country’s net exports, net investment income, and net transfers. Balance of trade The difference between the value of the goods a country exports and the value of the goods a country imports. Financial account The part of the balance of payments that records purchases of assets a country has made abroad and foreign purchases of assets in the country. Net foreign investment The difference between capital outflows from a country and capital inflows, also equal to net foreign direct investment plus net foreign portfolio investment. Capital Account The part of the balance of payments that records relatively minor transactions, such as migrants’ transfers, and sales and purchases of nonproduced, nonfinancial assets. 2008 International Trade Current Account Balance = - Financial Account Balance Current Account ($ bil) Goods Services Exports $1,291 $544 Imports -$2,112 -$404 Balance on Goods/Services -$821 $140 Income receipts $755 Income payments -$628 Net unilateral transfers -$119 Current Account Balance -$673 ($ outflow) (4.72% of GDP) Financial Account ($ bil) Increase in U.S. owned assets abroad Increase in foreign owned assets in U.S Statistical discrepancy Financial Account Balance $-52 (outflow) $599 $129 $676 ($ inflow) Capital Account ($ -3 bil) Balance of Payments = Current Account Deficit + Financial Account Surplus + Capital Acct = 0 Net Exports = Net Foreign Investment = (-Net Capital Inflow) Current Account Balance (mil $, SA) $25,000 $0 -$25,000 -$50,000 -$75,000 -$100,000 -$125,000 -$150,000 -$175,000 -$200,000 -$225,000 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 Domestic Saving, Domestic Investment, and Net Foreign Investment Saving and investment equation An equation showing that national saving is equal to domestic investment plus net foreign investment. National Saving = Private Saving + Public Saving S = Sprivate + Spublic where Sprivate = Y – C – T Spublic = T – G S = (Y – C – T) + (T – G) S=Y–C–G Substitute for Y S = (C + I + G + NX) – C - G S = I + NX Recall Net Exports = Net Foreign Investment S = I + NFI