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CH33 Miller18 InstPPT [Compatibility Mode]

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Chapter 33
Exchange
Rates
and the
Balance
of Payments
Introduction
Between the 1940s and 2012, Japan experienced a
merchandise trade surplus—that is, an excess of
exports of goods over imports of goods in most years.
In the years since 2012, Japan has experienced
merchandise trade deficits; that is, imports of goods
have exceeded exports of goods.
In this chapter, you will learn about the implications that
this shift in trade flows has for Japan’s net cross-border
financial flows.
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33-2
Did You Know That ...
• The Hong Kong dollar’s value has stayed around
$0.128 since 1983?
• The Hong Kong government decided to keep the
value of its dollar at $0.128, meaning that the
exchange rate—the price of its own currency in
terms of the U.S. dollar—is relatively fixed.
• In this chapter, you will learn about both varying
exchange rates and fixed exchange rates.
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33-6
33.1 The Balance of Payments and
International Capital Movements
• Balance of trade
– The difference between exports and imports of
goods
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33.1 The Balance of Payments and
International Capital Movements (cont’d)
• Balance of payments
– A system of accounts that measures
transactions of goods, services, income, and
financial assets between domestic households,
businesses, and governments and residents of
the rest of the world during a specific time
period
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Table 33-1 Surplus (+) and Deficit (–)
Items on the International Accounts
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33.1 The Balance of Payments and
International Capital Movements (cont’d)
• Accounting identities
– Accounting identities are values that are
equivalent by definition.
– Ultimately, net lending by households must
equal net borrowing by businesses and
governments.
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33.1 The Balance of Payments and
International Capital Movements (cont’d)
• When family expenditures exceed income,
the family must be doing one of the
following:
– Reducing its money holdings or selling stocks,
bonds, or other assets
– Borrowing
– Receiving gifts from friends or relatives
– Receiving public transfers from a government
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33-11
33.1 The Balance of Payments and
International Capital Movements (cont’d)
• Disequilibrium:
– If expenditures exceed income, the situation
cannot continue indefinitely.
• Equilibrium:
– Households, businesses, and governments must
eventually reach equilibrium.
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33.1 The Balance of Payments and
International Capital Movements (cont’d)
• An accounting identity among nations:
– When people from different nations trade or
interact, certain identities or constraints must
also hold.
– Let’s look at the three categories of the balance
of payments transactions.
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33.1 The Balance of Payments and
International Capital Movements (cont’d)
• Three categories of balance of payments
transactions:
– Current account transactions
– Capital account transactions
– Official reserve account transactions
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33.1 The Balance of Payments and
International Capital Movements (cont’d)
• Current account
– A category of balance of payments transactions
that measures the exchange of merchandise,
the exchange of services, and unilateral
transfers
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33.1 The Balance of Payments and
International Capital Movements (cont’d)
• Current account transactions:
– Merchandise trade exports and imports:
• Tangible items—things you can feel, touch, and see
– Service exports and imports:
• Intangible items that are bought and sold
– Unilateral transfers:
• Gifts from citizens and from governments
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Table 33-2 U.S. Balance of Payments Account,
Estimated for 2015 (in billions of dollars)
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33.1 The Balance of Payments and
International Capital Movements (cont’d)
• Balancing the current account:
– Current account surplus
• Net exports plus unilateral transfers plus net
investment income exceeds zero
– Current account deficit
• Net exports plus unilateral transfers plus net
investment income is negative
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33.1 The Balance of Payments and
International Capital Movements (cont’d)
• A current account deficit means that we are
importing more goods and services than we
are exporting.
• A current account deficit must be paid by
the export of money or money equivalent.
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What If ... all governments tried to prevent other
nations’ residents from making financial
investments within their own countries’ borders?
• Those governments effectively would
require their nations to have capital account
deficits.
• Some countries can have capital account
deficits only if other nations have capital
account surpluses.
• So, it would not be possible for all countries
to require their nations to have capital
account deficits.
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33-20
33.1 The Balance of Payments and
International Capital Movements (cont’d)
• Capital account
– A category of balance of payments transactions
that measures flows of real and financial assets
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33.1 The Balance of Payments and
International Capital Movements (cont’d)
• The current account and capital account
must sum to zero.
– In the absence of interventions by finance
ministries or central banks:
Capital account
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Current account
0
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Figure 33-1 The Relationship between the
Current Account and the Capital Account
Sources: International Monetary Fund; Economic Indicators.
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33.1 The Balance of Payments and
International Capital Movements (cont’d)
• Official reserve account transactions:
– Foreign currencies
– Gold
– Special drawing rights (SDRs)
– Reserve position in the IMF
– Financial assets held by an official agency (such
as the U.S. Treasury)
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33.1 The Balance of Payments and
International Capital Movements (cont’d)
• Special drawing rights
– Reserve assets created by the International
Monetary Fund for countries to use in settling
international payment obligations
• International Monetary Fund (IMF)
– An agency founded to administer an
international foreign exchange system and to
lend to member countries that had balance of
payments problems
– Functions as a lender of last resort
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33-25
33.1 The Balance of Payments and
International Capital Movements (cont’d)
• Question:
– What affects the balance of payments?
• Answers:
– Relative rate of inflation
– Political stability:
• Capital flight
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33.2 Determining Foreign Exchange
Rates
• When you buy foreign products, you have
dollars.
• But the foreign country can’t pay workers in
dollars.
• So there must be a way of exchanging
these dollars.
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33-27
33.2 Determining Foreign Exchange
Rates (cont’d)
• Foreign exchange market
– A market in which households, firms, and
governments buy and sell national currencies
• Exchange rate
– The price of one nation’s currency in terms of
another
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33-28
33.2 Determining Foreign Exchange
Rates (cont’d)
• Flexible exchange rates
– Exchange rates that are allowed to fluctuate in
the open market in response to changes in
supply and demand
– Sometimes called floating exchange rates
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33-30
33.2 Determining Foreign Exchange
Rates (cont’d)
• The equilibrium foreign exchange rate:
– Appreciation
• An increase in the exchange value of one nation’s
currency in terms of the currency of another nation
– Depreciation
• A decrease in the exchange value of one nation’s
currency in terms of the currency of another nation
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33-31
International Example: China’s Currency
Moves Up in Global Foreign Exchange Trading
• As a result of China’s share in international
transactions, its currency—the yuan—now
accounts for more than $125 billion per year in
foreign exchange trading.
• However, the U.S. dollar—the most-traded
currency in the world—is almost 40 times
greater than the yuan in terms of global
exchange.
• The euro and the Japanese yuan are also
exchanged at levels more than 10 times greater
than the yuan.
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33.2 Determining Foreign Exchange
Rates (cont’d)
• Appreciation and depreciation of euros:
– We say your demand for euros is derived from
your demand for European pharmaceuticals.
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33-33
33.2 Determining Foreign Exchange
Rates (cont’d)
• An example of derived demand:
– Assume that the pharmaceuticals cost €100 per
package.
– If €1 costs $1.20, then a package of
pharmaceuticals would cost $120.
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Figure 33-2 Deriving the Demand for
British Pounds, Panel (a)
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Figure 33-2 Deriving the Demand for
British Pounds, Panel (b)
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Figure 33-2 Deriving the Demand for
British Pounds, Panel (c)
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33.2 Determining Foreign Exchange
Rates (cont’d)
• An example of derived demand:
– In Panel (d) of Figure 33-2 on the next slide, we
see the derived demand for pounds in the
United States in order to purchase the various
quantities given in Panel (a).
– In Panel (e), we draw the resultant demand
curve. This is the U.S. derived demand for
pounds.
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Figure 33-2 Deriving the Demand for
British Pounds, Panel (d)
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Figure 33-2 Deriving the Demand for
British Pounds, Panel (e)
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33.2 Determining Foreign Exchange
Rates (cont’d)
• Let us now look at the total demand for and
supply of euros, as shown in the next
figures.
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Figure 33-3 The Supply of Pounds
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Figure 33-4 Total Demand for and
Supply of Pounds
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Figure 33-5 A Shift in the Demand
Schedule
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Figure 33-6 A Shift in the Supply of
Pounds
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33.2 Determining Foreign Exchange
Rates (cont’d)
• Market determinants of exchange rates:
– Changes in real interest rates
– Changes in productivity
– Changes in product preferences
– Perceptions of economic stability
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33-48
International Example: Plummeting
Perceptions Precipitate a Peso Plunge
• In response to substantial economic
instability in Argentina since 2011, its
residents sought to exchange pesos for
U.S. dollars.
• As a result, the value of the peso in relation
to the dollar fell by half between 2013 and
2015.
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33-49
33.3 Fixed versus Floating Exchange
Rates
• The gold standard:
– The gold standard is an international monetary
system in which nations fix their exchange rates
in terms of gold.
– All currencies are fixed in terms of all others,
and any balance of payments deficits or
surpluses can be made up by shipments of gold.
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33-50
33.3 Fixed versus Floating Exchange
Rates (cont’d)
• The gold standard:
– A balance of payments deficit:
• More gold flowed out than flowed in
• Equivalent to a restrictive monetary policy
– A balance of payments surplus:
• More gold flowed in than out
• Equivalent to an expansionary monetary policy
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33-51
33.3 Fixed versus Floating Exchange
Rates (cont’d)
• Problems with the gold standard:
– A nation gives up control of its monetary policy.
– New gold discoveries often cause inflation.
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33-52
33.3 Fixed versus Floating Exchange
Rates (cont’d)
• Bretton Woods and the International
Monetary Fund:
– In 1944, representatives of capitalist countries
met in Bretton Woods, New Hampshire.
• They created a new international payment system to
replace the gold standard.
– Members agreed to maintain the value of their
currencies within 1 percent of declared par value.
• Members are allowed a one-time adjustment.
• Members can alter exchange rates only with IMF
approval thereafter.
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33.3 Fixed versus Floating Exchange
Rates (cont’d)
• Par value
– The officially determined value of a currency
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33-54
33.3 Fixed versus Floating Exchange
Rates (cont’d)
• Bretton Woods and the IMF:
– 1971: President Richard Nixon suspended the
convertibility of the dollar into gold.
• The United States devalued the dollar (lowered its
official value) relative to the currencies of 14 major
industrial nations.
– 1973: Members of the EEC, now the EU, allowed
their currencies to float against the dollar.
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33-55
33.3 Fixed versus Floating Exchange
Rates (cont’d)
• The United States went off the Bretton
Woods system of fixed exchange rates in
1973.
• Many other nations of the world have been
less willing to permit the values of their
currencies to vary.
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33-56
Figure 33-7 Current Foreign Exchange
Rate Arrangements
Source: International Monetary Fund.
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33-57
33.3 Fixed versus Floating Exchange
Rates (cont’d)
• Central banks can keep exchange rates
fixed as long as they have enough foreign
exchange reserves to deal with potentially
long-lasting changes in the demand for or
supply of their nation’s currency.
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33-58
Figure 33-8 A Fixed Exchange Rate
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33.3 Fixed versus Floating Exchange
Rates (cont’d)
• Foreign exchange risk
– This risk is the possibility that changes in the
value of a nation’s currency will result in
variations in market value of assets.
– Limiting foreign exchange risk is a classic
rationale for adopting a fixed exchange rate.
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33-60
33.3 Fixed versus Floating Exchange
Rates (cont’d)
• Hedge
– A financial strategy that reduces the chance of
suffering losses arising from foreign exchange
risk
– Currency swaps
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33.3 Fixed versus Floating Exchange
Rates (cont’d)
• The exchange rate as a shock absorber:
– Exchange rate variations can perform a valuable
service for a nation’s economy:
• Outside demand for the nation’s products falls.
• A trade deficit leads to a drop in demand for the
nation’s currency; it depreciates.
• The nation’s goods are now less expensive to other
countries; exports increase.
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33-62
You Are There: Turning to the Black
Market to Obtain Egyptian Pounds
• Egyptian banks refuse to exchange Egyptian
pounds with dollars at the official exchange rate as
they know the Bank of Egypt would not provide
them with dollars at this exchange rate.
• So, there is a surplus of Egyptian pounds at the
official exchange rate, which is above the marketing
clearing exchange rate.
• In response, Egyptian residents engage in an
exchange of pounds for dollars in the black market.
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33-63
Issues & Applications: Japan’s Merchandise
Trade Balance Shifts to Deficits
• Japan has operated with a merchandise
trade deficit in each year since 2012.
• One reason for this is that other nations,
such as China and South Korea, have
developed comparative advantages in
producing many physical goods that Japan
had in years past.
• As Japan’s current account balance has also
swung into a deficit, its capital account
balance has become positive.
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33-64
Figure 33-9 Japan’s Merchandise Trade
Balance since 1998
Source: Japanese Ministry of Finance.
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33-65
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