International Trade and Exchange Rates

Outline

•Balance of payments (BOP) accounting

•How open is the U.S. economy?

•Description of international trade

•Exchange rates—how are they determined?

•Exchange rates and the price of imported and exported goods.

BOP accounting is the recording of transactions between domestic and foreign economic agents.

Any transaction that results in a receipt of money by domestic agents from abroad is recorded as a credit in the BOP accounts.

Any transaction that entails the payment of money by domestic units to foreigners is recorded as a debit in the BOP accounts.

The current account records foreign transactions involving merchandise and services.

The capital account records foreign transactions involving financial assets and land.

Balance of payments accounting

Current Account (in billions)

1. Merchandise exports +671.0

2. Merchandise imports -919.0

3. Trade balance (1 + 2) -248.0

4. Service exports +503.0

5. Service imports -446.6

6. Goods and services balance (3 + 4 + 5) -191.6

7. Net unilateral transfers -41.9

8. Current account balance (6 + 7) -233.5

Source: Department of Commerce

Capital Account (in billions)

9. Outflow of U.S. capital -297.8

10. Inflow of foreign capital +564.6

11. Capital account balance ( 9 + 10) +266.8

12.Net change in U.S. official assets abroad -33.3

TOTAL (8 + 11 + 12) 0.0

Source: Department of Commerce

An index of openness

100

GDP

MX

This is a simple

measure of the relative

importance of the foreign

sector

Let

•O denote the index of openness

•X is exports

•M is imports

•GDP is gross domestic product

Thus, we have:

8

12

16

20

24

28

70 75 80 85 90 95 00

Imports + Exports as a Percent of U.S. GDP, 1969-2000

per

cen

t

Imports and Exports of the U.S., April to July, 1999

billions of current dollars

Source: Dismal Scientist (www.dismal.com)

Month

Jul-99Jun-99May-99Apr-99

110

105

100

95

90

85

80

75

70

Exports

Imports

104103

9997

79797878

70

75

80

85

90

95

Sep-97 Oct-97 Nov-97 Dec-97 Jan-98 Feb-98

ExportsImports

The U.S. trade deficitballooned to $271.31billion in 1999—a $107billion increase from 1998.

-120

-100

-80

-60

-40

-20

0

20

70 75 80 85 90 95 00

U.S. Current Account Balance

In billions of current dollars

U.S. Trade in Goods (Exports), 1996

billions of dollars

Source: Economic Report of the President

94.5 / 15.4%

65.0 / 10.6%

253.1 / 41.4%

137.9 / 22.5%

61.5 / 10.0%

Other

Capital goods

Automotive

Industrial supplies

Agricultural prod.

U.S. Trade in Goods (Imports), 1996

billions of dollars

Source: Economic Report of the President

235.80 / 29.4%

128.90 / 16.0%229.00 / 28.5%

136.80 / 17.0%

72.70 / 9.1%Other

AutomotiveCapital goods

Industrial supplies

Petroleum

CountryCurrent Account(billions of U.S.

dollars)Australia -8.1

Britain -38.9

Canada 16.2

France 23.1

Germany 72.8

Japan 122.9

Netherlands 14.2

Sweden 16.8

U.S. -276.7

Source: The Economist

Current Account balance of selected industrialized nations, August 1998 to August 1999

NationExports as percent of

World Total

United States 12.4

Germany 9.6

Japan 7.5

France 5.3

Britain 4.8

Canada 4.2

Italy 4.1

Netherlands 3.6

Hong Kong 3.5

China 3.3

Source: The Economist

Top Exporters in 1999

An exchange rate is the priceof one national currency

expressed in terms of another national currency. For example, the dollar

price of the British pound is $1.71--meaning it takes $1.71 to buy 1 pound

Exchange ratesare determined by

the supply and demand offoreign exchange

DM per $

$’s0

S

D

D’

1.69

1.82

Why do agents want to swap marks for dollars?

•To buy American-made goods.

•To hold stocks in U.S. companies or other dollar-denominated assets.

•To speculate on future exchange rate movements

In this case, the mark depreciates against the dollar

Dollar

Yen D-Mark Franc Euro

France 7.16 .065 3.35 . . .

6.56

Germany 2.13 .019 . . . .298 1.96

Japan 109.23

. . . 51.15 15.25 100.04

U.S. . . . .009 .46 .14 .92

Euro 1.09 .01 .511 .152 . . .

Currency Cross Rates New York Trading, August1, 2000

Source: Wall Street Journal

0.8

0.9

1.0

1.1

1.2

1/04/99 5/24/99 10/11/99 2/28/00 7/17/00

Dollars per Euro

Euro in free fall

Firms and individuals demand marks to buy German- made

goods, to hold mark-denominatedfinancial assets, or to profit from

what they hope will be an increasein the international value of the mark.

$ per DM

DMs

D

S

S’

.59

.55

Dollar appreciates against the mark

Let the dollar price of the mark = $0.59--i.e., it costs 59 cents to purchase 1 mark in the market for foreign exchange.

Let the mark price of a Krups espresso maker = 100 marks

Question: What is the dollar price of the Krups espresso maker?

$ price = (.59)(100) = $59.00

Effect of an appreciating dollar on the price of imported goods

What if the dollar should appreciate, or gain value, against the mark?

Let the dollar price of the mark decrease to $0.55 .

Question: What is the dollar price of the Krups espresso maker?

$ price = (.55)(100) = $55.00

Let the mark price of the dollar = 1.69 marks--i.e., its cost 1.69 marks to buy a dollar in the foreign exchange market.

Let the dollar price of the Microsoft Windows 98 = $189.00

Question: What is the mark price of Windows 98?

Mark price = (1.69)(189.00) = 319.41 marks

Exchange rates and the prices of exported goods and services

Effect of a depreciating mark on the price of Windows 98

Let the mark price of the dollar increase to 1.82 marks.

Question: What is the mark price of Windows 98?

Mark price = (1.82)(189.00) = 343.98 marks