1 The International Trade and Capital Flows Chapter 23

2 Intro Individuals, businesses and governments in a country may interact with individuals, businesses and governments in another country. In this sense, we say residents of different countries interact. As you know, in the US the money we carry around and use in our day to day transactions is called the dollar. But, other countries may call their money something else. For example, there is the British Pound, the Japanese Yen, the Canadian Dollar and the Chinese Yuan. Note that typically one US dollar does not equal 1 unit of the other country’s money (not even the Canadian Dollar).

3 Here I want you to see that when we engage in economic activity with other countries we typically give up something and get something back/ US of A R est O f W orld Give up Get With all trade

4 Balance of Payments A nation’s balance of payments, BOP, is a system to keep track of the international transactions of the residents for a particular period of time. The focus is on the money flows, or financial side of the transactions. Any transaction that causes money to flow into a country is a credit to its BOP account and will have a plus sign attached to it. Any transaction that causes money to flow out of a country is a debit to its BOP account and will have a minus sign attached to it. The BOP is made up of the CURRENT ACCOUNT and the CAPITAL AND FINANCIAL ACCOUNT.

5 US export Say some folks in Nebraska want to sell beef in Columbia. This would be a US export. Ultimately the Nebraska sellers want dollars. If the Columbians do not have dollars they can get them in the foreign exchange market. The Nebraska export of beef will mean money flows into US (either in US dollars Columbians already have, or by giving up their currency in the exchange market to get dollars). This is an example of a good being exported, but a similar result holds if we export a service (like engineering knowledge of building a bridge), or if we make a financial investment in a foreign country and we are going to get paid interest or dividends.

6 US import Say in Nebraska someone wants to roast coffee beans to sell to the public in the form of coffee. The Nebraskan would import the coffee beans from Columbia. Ultimately the Columbian sellers want their own currency. If the Nebraskans do not have the Columbian currency they can get them in the foreign exchange market. The Nebraska import of coffee beans will mean money flows out of US (either in Columbian currency we already have, or by giving up dollars in the exchange market to get their currency). This is an example of a good being imported, but a similar result holds if we import a service (like insurance from a foreign company), or if foreigners make a financial investment in the US and we are going to pay them interest or dividends.

7 The Current Account The current account is one part of the BOP. The types of transactions kept track of in the current account include a) export of goods, b) import of goods, c) export of services, d) import of services, e) net investment income or income payments, and f) net transfers or unilateral transfers.

8 More Current Account Remember a credit is a money inflow and will have a plus sign and a debit is a money outflow and will have a minus sign. For the items in the current account we have a) export of goods+ b) import of goods - c) export of services + d) import of services- e) income payments+ f) unilateral transfers- Recall exports bring money in and imports have money go out. The signs we see here for imports and exports will always be the case. But the signs on net investment income and net transfers will not always be as shown. Let’s explore this and other ideas next.

9 Even more Current Account info Folks talk about balance on goods (or what is called the merchandise trade balance), balance on services, and balance on goods and services. The point here is the combining of exports and imports. Note in a recent year the balance on goods was negative, the balance on services was positive and the balance on goods and services (the trade balance) was negative meaning the goods negative was bigger than the services positive. When the balance on goods and services is negative we talk of a trade deficit, and when positive we talk of a trade surplus. Net investment income or income payments is made up of i) interest and dividends paid by foreigners to us (an inflow, a credit or plus sign) and ii) interest and dividend paid by us to foreigners (an outflow, a debit or minus sign). It just so happens in a recent year this was a net positive.

10 Still more current account info Net or unilateral transfers are made up of i) foreigners making payments to us for things like aid after a disaster (hurricane Katrina, an inflow, a credit or plus sign ), and ii) US making similar payments abroad ( an outflow, a debit or minus sign ). In the US this term has been a net minus for many years. A current account deficit means when looking at the whole set of accounts the debits are larger than the credits. This also means the outflow is larger than the inflow.