COUNTRY ANALYSIS
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Important - world trade grows - greater competition
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Strong prosper and weak (inefficient) must change
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Those who understand the world and various
business cultures have a competitive advantage
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Predict future country behavior and performance marginalist
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Used by CIA, Foreign Offices, State Departments,
International Banks, foreign bond buyers
STRUCTURE - CONDUCT - PERFORMANCE MODEL
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Structure – main supports – don’t often change
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Conduct – goals, strategies, and policies
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Performance –GNP, employment, inflation, Deficits
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CHANGE IN STRUCTURE MAY LEAD TO A
CHANGE IN CONDUCT
AND THUS A CHANGE PERFORMANCE
•
EXAMPLE: Venezuela – Socialist Government Wins
Prediction – more taxes and more inflation
- lower profits and stock prices
INDUSTRY ANALYSIS - MODEL
STRUCTURE - CONDUCT - PERFORMANCE
More difficult to separate structure and conduct for an
industry than a country because industry structures change
faster.
FOUR STRUCTURE-CONDUCT FEATURES
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Intensity of competition (structure diagram)
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Cost and profitability conditions
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Technology & research
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Long term or short term demand
INDUSTRY PERFORMANCE
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profitability -stock vs. accounting
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risk - return volatility
•
debt
•
liquidity
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growth
QUESTION: What determines the intensity of industry
competition?
ANSWER:
industry structure
Industry Structure Determines
the Competitive Intensity
Potential
Entrants
Entry Costs
Bargaining Power
Suppliers
Bargaining Power
Industry
Competition
Exit Costs
Substitutes
Customers
ECONOMY ANALYSIS
IMPORTANT VARIABLES TO FORECAST
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GNP - gives cash flows
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Interest rates - gives discount rate
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Both used to get present value of cash flows
QUESTION: Why try to predict the near future in the
business cycle?
Because different investments are best performers in each
part / few can successfully predict the business cycle.
STOCK PRICES FLUCTUATE MORE THAN GNP
QUESTION: Why?
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firm profits swings are usually amplified in
comparison to GNP swings.
•
profit margin fluctuates - input costs rise faster than
output price heading into a recession.
•
input prices fall or rise slower than output prices
heading into an expansion.
PROFIT MODEL
 = PQ - CQ
where  = Total profit
P = output price per unit
Q = output in units
C = input price per unit of output
Profit margin = P - C
C fluctuates with capacity and labor
utilization rates and technology.
MONETARY MODEL OF GNP - QUANTITY THEORY
GNP = MV = PQ
GNP = GROSS NATIONAL PRODUCT
M = MONEY SUPPLY
V = GNP/M = VELOCITY OR TURNOVER some assume V is constant
P = OUTPUT PRICE
Q = QUANTITY OF OUTPUT
QUESTION: What happens when fed increases M?
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Q rises, P rises, or both
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larger Q increase when capacity is underutilized
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otherwise if at full capacity then only P increases inflation.
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watch Fed numbers for money supply in WSJ Credit Market section.
Example: Exchange candy bars faster and faster. Add more
money and keep candy the same. Then add more candy.
INTEREST RATES
INTEREST RATES HAVE 3 COMPONENTS
Rg
=Rr + I + P
where Rg = gross nominal interest rate
Rr = real interest rate - compensation for saving
I = expected inflation rate - compensation for
expected inflation
P = compensation for business, financial,
liquidity, and exchange rate risks
EXAMPLES
Tbill
Tbond
Junk
Rg
.005 =
.030 =
.100 =
Rr
I
.005 + .000 +
.020 + .010 +
.020 + .010 +
P
.00
.00
.07
DEFICIT EFFECTS ON INTERNATIONAL TRADE
TWO DEFINITIONS
PRODUCT (GNP)
OF
GROSS
NATIONAL
output GNP = C + I + G + EX
income GNP = C + S + T + IM
C = CONSUMPTION
I = INVESTMENT
EX = EXPORTS
G = GOVERNMENT SPENDING
S = SAVINGS
T = TAXES
IM = IMPORTS
1. What is the output definition of GNP?
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The total dollar value of everything produced in
the nation, including services, in one year.
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This is the most commonly understood and used
definition.
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Goods are produced for consumers, for
investment (plant and equipment), for
government, and for export.
2. What is the income definition of GNP?
•
The total dollar value of income
spent in the nation in one year.
•
This definition is seldom used by
the public and less understood.
•
Production generates income for
the factors of production and that
income is spent on consumer
goods, savings, taxes, and
imported good.
IMPLICATIONS OF GNP DEFINITIONS
SET THE TWO DEFINITIONS EQUAL
GNP = C + I + G + EX = C + S + T + IM
I + G + EX = S + T + IM
or
(EX - IM)
= (T - G) + (S - I)
trade (def / surplus) = gov (def / surplus) +
household (def / sur)
This shows that the trade, government, and household
budgets are connected.
(EX - IM)
Simple Example:
-$600
= (T - G) + (S - I)
=
-$400 +
?
More Complex Example: Consider the following
information. Recently, the U.S. Treasury announced that
it expects tax revenues to be $300 billion smaller this year
than last year. Also, the recession is causing people to
save more this year, by about $100 billion. Furthermore,
government spending is expected to increase by $300
billion and companies are expected to invest $100 billion
less than last year. What change can we expect for the
trade deficit? What might happen to interest rates and
the dollar’s value given this scenario?
Adding the Capital Budget
– International Financial Flows
(EX - IM)
=
(T - G) + (S - I)
= (capital out - capital in)
= capital(surplus/deficit)
Example: Suppose that our President throws up on the
Chinese President and the next day the Chinese President
decides to sell $100 billion U.S. Treasury bonds. What
will happen to the U.S. trade deficit assuming that U.S.
investors hold their foreign investment constant? What
might happen to U.S. interest rates and the dollar?
This shows that the trade, government, and household
budgets are also connected to capital flows into deficit
countries and out of surplus countries.
Note: Capital flows move quicker than goods flows so
trade and capital accounts may not match exactly on a
quarterly basis but should be close on an annual basis.
Note: There could be a difference between the trade
account balance and the capital account balance due to
unrecorded transactions or mis-measured transactions.
This could involve illegal or black market transactions.
Like MV = PQ, financial side = goods side of transaction.
But otherwise, the models are not related even though they
both start with GNP.
Ordinarily, when a country has a trade surplus (deficit) its
currency appreciates (depreciates).
What is going on at the micro level?
Illustration 1: Assume that Japan’s Toyota exports $50
billion in cars to the U.S. They could take the cash and buy
$50 billion in parts from U.S. manufactures. If they don’t
do this, they need to spend the $50 billion somehow, say by
buying U.S. real estate, stocks or bonds. Hence, a deficit in
goods trade implies a surplus in financial flows.
Illustration 2: The U.S. government has recently made it
clear that it wants to reduce the value of the dollar. How
might Toyota’s decision change if Toyota believes this?
Question: U.S. investors are buying more foreign stocks
because they have high returns. What could be the effects?
Trivia Question: Why are there so many old sunken ships
with gold in them, which salvagers try to recover?
Steps in the 1997-1998
Asian Financial Crisis
1. Thailand experiences major financial collapse
2. Russia defaults on government debt
3. World-wide rush to buy U.S. Treasury bonds (caused
ITCM collapse – Fed - banks - bail out).
4. Dollar appreciates – intermediate mechanism
5. Real U.S. export (import) prices increase (decrease)
6. U.S. exports (imports) fall (rise)
7. U.S. interest rates fall – intermediate mechanism
8. U.S. consumption (savings) rises (falls), investment
rises
Graphing the relevant data for Asian Financial Crisis
1. Go to economagic.com, click on Federal Reserve, St.
Louis
2. Click U.S. Balance of Payments Data
3. Click Balance on Current Account (this is quarterly)
4. Click Gif Chart or PDF Chart (see recent – and to 1960)
5. Click Foreign Assets in the United States, Net Capital
Inflows (US Assets Abroad, Net Outflows)
6. Click U.S. Interest Rate Data. Then click on 30-Year
Treasury Constant Maturity – or another maturity
7. Click Exchange Rate Data. Then click Trade-Weighted
Exchange Index: Broad
8. For Export and Import Prices – go to www.bls.gov
9. Click Databases & Tables tab
10. Go to Prices – International and click on Top Picks
11. Select Imports – All Comodities
12. Select Exports – All Comodities
13. Click Retrieve Data.
14. Click Include Graphs and then click Go.
15. Click More Formatting Options.
16. Select 12-Month Percent Change and Retrieve Data.
17. You can see that import prices fell faster than export prices
around 1997-1998