FIN4604 EXAM 1 Chapters 2 3 4 5 Chapter 2 International Flow of Funds Balance of Payments Balance of payments summary of transactions between domestic and foreign residents for a specific country over a specified period of time country s transactions with other countries o Inflows credits for the country s balance o Outflows debits for the country s balance Current Account Balance of Payments Balance of Trade Factor Income Transfer Payments Direct Foreign Investment Other Capital Investment Capital Account Portfolio Investment o Current account the flow of funds b w one specified country and all other countries due to purchases of goods or services or the provision of income on financial assets Balance of trade how many goods are being brought in relative to goods being sold exports imports in a perfect world we want more exports cash inflow than imports cash outflow but typically imports are higher than exports Balance of PaymentsCurrent AccountBalance of TradeFactor IncomeTransfer PaymentsCapital AccountDirect Foreign InvestmentPortfolio InvestmentOther Capital Investment trade gap trade deficit exceeds the value of its exports the amount by which the cost of a country s imports Factor income comparing money leaving the country to money coming in interest and dividends received by investors on foreign investments Transfer payments aids grants and gifts from one country to another i e when there is a natural disaster in a foreign country and they need help from our country U S Current Account 1 2 3 all credits to U S capital cash inflow 4 total of all credits 1 2 3 5 6 7 all debits U S capital cash outflow 8 total of all debits 5 6 7 9 net of transfer payments typically negative 10 credits debits transfers U S we buy more than we sell o Capital Account summarizes the flow of funds resulting from the sale of assets between one specified country and all other countries Direct foreign investment FDI fixed assets investment of more than 10 Very large investments can t easily back out i e M A Portfolio Investment no transfer of control investment of less than 10 Other capital investment very short term investment i e one share of Honda very liquid investments i e money market 10 is decided by the IMF International Trade Flows Some countries are more dependent on trade than others o Trade volume of a European country 30 40 of its GDP vs trade volume of U S and Japan 10 20 of its GDP If trade is big and GDP is small percentage will be higher GDP growth to see how country s wealth is doing 3 is a good GDP for U S GDP per capita individual wealth o But the volume of trade has grown over time for most countries Distribution of U S Exports and Imports o Geography plays a big part we buy a lot from Mexico and Canada and they buy a lot from us o We purchase more from China than they do from us we are one of their biggest customers U S Balance of Trade over time o U S Balance of Trade is negative deficit o Most of the trade deficit is due to China and Japan but mostly China Lower currency Cheaper products Higher global competitiveness Trade or o Foreign goods more expensive for consumers buy in home country Agreements these agreements can be positive negative Many agreements have been made to reduce trade restrictions U S and Canada free trade pact agreement of no tariffs or quotas between trades 1988 North American Free Trade Agreement added Mexico to this agreement General Agreement on Tariffs and Trade GATT substantial reduction of tariffs and other trade barriers 117 nations signed it Single European Act and the European Union establishing a single market 2003 U S and Chile signed a free trade agreement no tariffs on 90 of tradable products o U S uses tariffs tax on goods so U S companies don t go out of business o U S uses quotas cap on the amount you can purchase of specific product to stabilize the U S price o Positive GDP grows with trade agreements but there s always a negative i e blue collar workers during NAFTA thought Mexican employees would take their jobs Trade Disagreements o But even without tariffs or quotas governments find strategies that can give their local firms an advantage in exporting leaders of our country are going to do their best to benefit our country Different environmental labor laws Bribes government subsidies but most countries have laws against bribery South American countries requiring bribery Tax breaks for specific industries Exchange rate manipulations China o U S China Disagreement Decline of the Yuan unprecedented China s artificially weak Yuan gives the country an unfair trade advantage Targeting overseas currency manipulation China and Japan continuing to rely on easy monetary policy and currency depreciation to protect short term growth China is currently facing slower economic growth o Other trade related issues jobs The use of trade policies for political reasons Disagreements within the EU The outsourcing of services of mostly college educated white collar jobs are losing their Factors Affecting International Trade Flows Lower currencyCheaper productsHigher global competitiveness o Impact of Inflation higher prices our salary cannot afford the same A relative increase in a country s inflation rate will decrease its current account as imports increase and exports decrease due to higher prices o Impact of National Income higher income higher spending A relative increase in a country s income level will decrease its current account as imports increase due to being able to spend more o Impact of Government Restrictions A government may reduce its country s imports by imposing a tariff on imported goods or by enforcing a quota Tariff tax on a foreign good i e textile industry Quota Maximum amount that can be purchased to keep our market from being flooded with a specific product Some trade restrictions are placed for health and safety reasons Examples Kinder Egg being a choking hazard prescription drugs from Canada because can t regulate the quality temporary shut down of imports due to disease o Impact of Exchange Rates if a country s currency begins to rise in value its current account balance will decrease as imports increase and exports decrease because everyone else s products will be cheaper to the appreciating country The opposite is true right now for the U S If our currency is weak our goods are cheap for the rest of the world so our exports increase The factors interact such that their simultaneous influence on the balance of trade is