33.1 Financing International Trade Balance of payments accounts: records of a country’s international trading, borrowing, and lending US Balance of Payments AccountsCurrent Account (billions of dollars)Exports (g/s)Imports (g/s)Net interest Net transfers Current Account Balance +1,827-2,524+119 -128 -706 Capital Account (billions of dollars)Foreign investment in US (what we borrow)US investment abroad (what we loan)Other net foreign investment in US Statistical discrepancy Capital account balance +5340 -29 206 +711Official settlements account (billions of dollars)Official settlements account balance -5 *items in the current account and capital account that provide foreign currency to the US have a plus sign; items that cost the US foreign currency have a minus sign Current Account: Imports > Exports  Deficit of $706 billion Capital Account balance = $711 billion -706 + 711 = 5  subtract 5 from the official settlements account balance to get a total of 0 - 3 Balance of payments accounts: 1. Current account: (no liabilities)a. Exports – Imports + (interest and transfers paid to other countries – interest and transfers received from other countries) = Current Account2. Capital account: (liabilities)a. Foreign investment into a country – a country’s investment in other countries = capital account 3. Official settlements account a. Records the change in a country’s reserves b. Official reserves: government’s holdings of foreign currency i. If US official reserves increase, official settlements account balance is negative (holding foreign money is like investing abroad, which is a negative item in the capital account ii. If US official reserves decrease, official settlements account balance is positive - Current account + capital account + official settlements account = 0 o Deficit  borrow more abroad than we lend abroad or decrease our official reserves to cover the shortfall o Surplus  borrow less abroad than we lend abroad or increase our official reserves to cover the shortfall Borrowers and Lenders, Debtors and Creditors - Net borrower: a country that is borrowing more from the rest of the world than it is lending to the rest of the world o Surplus - Net lender: country that is lending more to the rest of the world than it is borrowing o Deficit - Debtor nation: country that during its entire history has borrowed more from the rest of the world than it has lent to the rest of the world - Creditor nation: country that during its entire history has invested more in the rest of theworld than other countries have invested in it Net Exports, Private Sector Balance, and Government Sector Balance - Net Exports = Exports – Imports o Positive number  surplus o Negative number  deficit - Private Sector Balance = Savings – Investment o Positive number  surplus o Negative number  deficit - Government Sector Balance = Net Taxes – Government spending on g/s o If positive  surplus (government lends money to other sectors)o If negative deficit (government must borrow from other sectors) - Net exports = private sector balance + government sector balance o NX = (S – I) + (NT – G)33.2 The Exchange Rate - When we buy foreign goods or invest in another country, we pay using that country’s currency; when foreigners buy US made goods or invest in the US, they pay in US dollars - Foreign exchange market: market in which the currency of one country is exchanged for the currency of another - Foreign exchange rate (XR): the price at which one currency exchanges for another o Currency appreciation: rise in the value of one currency in terms of another currency o Currency depreciation: the fall in the value of one currency in terms of another currency - XR is a price  like all other prices, demand and supply determine the XR - Quantity demanded in the foreign exchange market: amount that traders plan to buy during a given time period at a given exchange rateo Depends on:  The exchange rate  Interest rates in the US and other countries  The expected future exchange rate - The Law of Demand for Foreign exchange: o People demand US dollars to buy:  US g/s (US exports) US assets (bank accounts, bonds, stocks, businesses, and real estate) o The higher the exchange rate, the smaller the quantity of dollars demanded o 2 reasons XR and QD are inversely related: o Exports effect: XR decreases  goods are cheaper  exports increases  quantity demanded increases o Expected profit effect: XR decreases  expected profit increases  quantity demanded increases Change in the Demand for Dollars - Influences that shift the demand curve: o Interest rates: if your lending interest rate is higher than your borrowing interest rate, you are making a profit  US interest rate differential = US interest rate – foreign interest rate  US interest rate differential increases  Demand for dollars increases o Expected future exchange rate  Expected future XR increases  Demand for dollars increases Supply in the Foreign Exchange Market - Quantity supplied in the foreign exchange market: amount that traders plan to sell during a given time period at a given XR o Quantity supplied depends on many factors:  Exchange rate Interest rates  Expected future exchange rates - Law of supply of foreign exchange: o Traders supply US dollars when:  People and businesses buy other currenciesXR  QD$ They buy foreign currencies so that people and businesses can buy foreignassets such as bank accounts, bonds, stocks, businesses, and real estate o The higher the exchange rate, the greater is the quantity of dollars supplied o 2 reasons XR and QS are directly related:  Imports effect: XR increases  cheaper foreign made g/s to Americans  greater US imports  greater quantity of US dollars supplied  Expected profit effect: XR increases  expected profit from selling dollars increases  increased quantity of dollars