Copyright 2008 The McGraw-Hill Companies 36-1 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show 36 Exchange Rates, the Balance of Payments, and Trade Deficits

Copyright 2008 The McGraw-Hill Companies 36-2 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Chapter Objectives How Currencies of Different Nations are Exchanged When International Transactions Take Place About the Balance Sheet the United States Uses to Account for the International Payments it Makes and Receives How Exchange Rates are Determined in Currency Markets The Difference Between Flexible Exchange Rates and Fixed Exchange Rates The Causes and Consequences of Recent Record-High U.S. Trade Deficits

Copyright 2008 The McGraw-Hill Companies 36-3 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Financing International Trade U.S. Export Transactions –Importer must pay in their currency which is exchanged by the US for dollars –US exports create a foreign demand for dollars & increases the US supply of foreign currency U.S. Import Transactions –US must pay in US dollars which is exchanged by the importer for their currency. –US importing of product creates demand for foreign currency and decreases the supply of foreign currency held in the US.

Copyright 2008 The McGraw-Hill Companies 36-4 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Balance of Payments- sum of all transactions that take place between it’s residents and residents of foreign nations. The Current Account –Record of nations exports and imports of: goods and services (Product, travel, insurance) Net investment income(US earnings on investments abroad minus foreign investment earnings in US) Net transfers (foreign aid, pensions paid to US citizens living abroad)

Copyright 2008 The McGraw-Hill Companies 36-5 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Financing International Trade U.S. Trade Balances in Goods and Services Select Nations, 2008 Goods and Services SurplusGood and Services Deficit Australia Belgium Canada China Germany Mexico Netherlands Source: BEA GLOBAL PERSPECTIVE Japan -75.6

Copyright 2008 The McGraw-Hill Companies 36-6 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Capital/Financial Account –Flows of money from the purchase of a Real or Financial Asset domestically or abroad. –Real Asset: AB sold to Inbev –Financial Asset: Shares of Inbev sold to American investors. Official (Reserve) Account-is the offsetting account the government controls. –Country uses foreign assets or currency to offset a balance of payments deficit (Credit-positive) –Balance of payment surpluses are earned foreign currency (Debit-negative)

Copyright 2008 The McGraw-Hill Companies 36-7 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Balance of Payments Classifying transactions –Loss of foreign currency –Gain of foreign currency If the international transaction uses foreign currency to complete the transaction it is a Debit(negative) If the international transaction earns foreign currency to complete the transaction it is a Credit (positive)

Copyright 2008 The McGraw-Hill Companies 36-8 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Flexible Exchange Rates Flexible or Floating Exchange Rates Fixed Exchange Rate system Depreciation and Appreciation Determinants of Exchange Rates –Changes in Tastes –Relative Income Changes –Relative Price-Level Changes Purchasing-Power-Parity Theory –Relative Interest Rates –Speculation G36.1

Copyright 2008 The McGraw-Hill Companies 36-9 Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Q 0 Dollar Price of 1 Pound Quantity of Pounds P Flexible Exchange Rates The Market for Foreign Currency (Pounds) DlDl SlSl Dollar Depreciates (Pound Appreciates) Dollar Appreciates (Pound Depreciates) Exchange Rate: $2 = £1 $2 $3 $1 QlQl

Copyright 2008 The McGraw-Hill Companies Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Q 0 Dollar Price of 1 Pound Quantity of Pounds P Flexible Exchange Rates The Market for Foreign Currency (Pounds) DlDl SlSl Exchange Rate: $2 = £1 $2 $3 $1 QlQl D2D2 Exchange Rate: $3 = £1 Balance Of Payments Deficit Q2Q2 x a b c

Copyright 2008 The McGraw-Hill Companies Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Flexible Exchange Rates Flexible Rates and the Balance of Payments Disadvantages of Flexible Exchange Rates Uncertainty and Diminished Trade Terms-of-Trade Changes Instability

Copyright 2008 The McGraw-Hill Companies Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Fixed Exchange Rates Use of Reserves –Currency Interventions Trade Policies Exchange Controls and Rationing –Distorted Trade –Favoritism –Restricted Choice –Black Markets Domestic Macroeconomic Adjustments

Copyright 2008 The McGraw-Hill Companies Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show International Exchange-Rate Systems The Gold Standard: Fixed Exchange Rates –Devaluation –Gold Flows –Domestic Macroeconomic Adjustments –Collapse of the Gold Standard

Copyright 2008 The McGraw-Hill Companies Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show International Exchange-Rate Systems The Bretton Woods System –International Monetary Fund (IMF) –IMF and Pegged Exchange Rates Official Reserves Gold Sales IMF Borrowing –Fundamental Imbalances: Adjusting the Peg –Demise of the Bretton Woods System

Copyright 2008 The McGraw-Hill Companies Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show International Exchange-Rate Systems The Current System: The Managed Float –Managed Floating Exchange Rates In Support of the Managed Float Concerns With the Managed Float

Copyright 2008 The McGraw-Hill Companies Financing International Trade Capital and Financial Account Flexible Exchange Rates Fixed Exchange Rates International Exchange- Rates System Recent U.S. Trade Deficits Last Word Key Terms End Show Recent U.S. Trade Deficits Causes of Trade Deficits Implications of U.S. Trade Deficits –Increased Current Consumption –Increased U.S. Indebtedness