Llad Phillips 1 Introduction to Economics Microeconomics The World Economy

Llad Phillips 2 Outline: Lecture Sixteen  The US in the World Economy  Balance of Payments Accounting  Puchasing Power Parity  Central Bank Reserves & Foreign Exchange Intervention

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4 Growth in World Trade Source: Economic Report of the President,

Llad Phillips 5 Measuring the Balance of Trade  Merchandise Balance of Trade: goods  Balance of Trade ( Net Exports) : add services  Balance on Current Account: –first: add net transfer payments –second: add income from US assets abroad

Llad Phillips 6 Balance of Payments  Merchandise Trade Balance –Exports of Goods  capital goods, except automotive: 41%  industrial supplies and materials: 24%  consumer goods, except automotive: 11%  automotive vehicles, engines & parts: 11%  foods, feeds, beverages: 9%

Llad Phillips 7 Balance of Payments (Cont.) –Imports of Goods  capital goods, except automotive: 29%  industrial supplies and materials: 25%  consumer goods, except automotive: 21%  automotive vehicles, engines & parts: 16%  foods, feeds, beverages: 4%

Llad Phillips 8 Source: CIA

Llad Phillips 9 Source: US Dept. of Commerce, Survey of Current Business

Llad Phillips 10 Source: Economic Report of the President, 1997

Llad Phillips 11 Balance of Payments  Merchandise Trade Balance  Balance of Trade: Net Exports(component of GNP) –Exports of Goods and Services  other private services: 31%  travel: 30%  royalties and license fees: 13% –Imports of Goods and Services  travel: 31%  other private services: 27%  other transportation: 18%

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14 Balance of Payments  Merchandise Trade Balance: Goods  Balance of Trade: Goods & Services  Balance on Current Account –Exports of goods & services plus net transfer payments plus US income on assets abroad –Imports of goods & services plus net transfer payments plus foreign income on assets in US  transfers –US Government grants –US Government pensions & other –private remittances

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17 Balance of Payments  Merchandise Trade Balance: Goods  Balance of Trade: Goods & Services  Balance on Current Account –Exports of goods & services plus net transfer payments plus US income on assets abroad  US income on assets abroad –direct investment receipts –other private receipts –US government receipts –Imports of goods & services plus net transfer payments plus foreign income on assets in US  transfers  payments to foreign assets in the US

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20 DebtorNation Creditor Nation 

Llad Phillips 21 How Do We Pay Balance on Current Account?  We Sell Bonds to Foreign Investors  Capital Account, 1996 –Foreign Assets in the US, net change (Capital Inflow)  foreign official assets in the US, net: $ M  other foreign assets in the US, net: $ M –US Assets Abroad, net change (Capital Outflow)  US official reserves, net $ M  other US Government Assets, net $ -690 M  US private assets, net: $ M

Llad Phillips 22 Capital Inflow: receipts from sale of US bonds & assets Relation Between Capital Account and Current Account + Stock of US Assets Abroad Interest Rate Interest Receipts on US Assets Stock of Foreign Assets in US Interest Rate Interest Payments on Foreign Assets Components of Current Account  Capital Outflow: payments for foreign bonds & assets     Stock of US Assets Abroad capital account component

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24 DebtorNation  CreditorNation

25 Puchasing Power Parity  Exchange Rate Ought to Reflect Puchasing Power –a bundle of goods that costs $1000 dollars in the US should be purchasable for $1000 dollars in Japan  food, clothing, shelter, etc.  Exchange Rate:119.6 yen to the dollar –$1000 =119,600 yen –so 119,600 yen should buy in Japan what $1000 buys in US  Price of the dollar is yen

Llad Phillips 26 Price of $ Quantity of $ Market for Foreign Exchange in Japan Demand for $ Supply of $ yen

Llad Phillips 27 Purchasing Power Parity  real exchange rate equals nominal exchange rate divided by relative prices for a bundle of goods –real x-ch rate = yen per $ ÷(CPI Japan /CPI US )  For Example, if there is inflation in Mexico, then the number of pesos to buy a $ should increase –real x-ch rate = pesos per $ ÷(CPI Mex /CPI US )

Llad Phillips 28 Source:Yardeni

29 Source: International Monetary Fund, International Financial Statistics Yearbook, 1996

Llad Phillips 30 Source: OECD

Llad Phillips 31 Link Between Government Deficits and Trade Deficits

Llad Phillips 32  US Govt. runs a deficit –citizens don’t want higher taxes  US Treasury finances deficit by selling treasuries –US citizens & institutions buy in primary market –foreign citizens & institutions buy in primary market  Why do foreigners invest in US? –politically stable country –may be attracted by:  low US inflation rate  high US interest rate

Llad Phillips 33 US Govt Deficit Treasury Issues Bonds Foreigners Buy Bonds Foreign Concern with US Inflation Foreign Concern with US Interest Rates FederalReserve Central Bank Responsibilities: Domestic and Foreign

Llad Phillips 34 Capital Flight 1. foreigners sell their US securities 2. foreigners exchange their US $ proceeds for Yen 3. Supply of dollars shifts and price of the dollar falls Yen price of US $ quantity of $ demand for $ supply of $ 4. Federal Reserve may use its Yen Reserves to buy $, stabilize x-ch rate

Llad Phillips 35 Mexico in 1995  Salinas Government runs a deficit –spending domestically to “buy” the election  burst of inflation  capital flight from peso –Mexicans sell pesos and demand $ –demand for $ increases, peso price of $ rises  forces devaluation

Llad Phillips 36 Demand for $ Quantity of $ Peso Price of the $ Supply of S Flight of Pesos from Mexico

Llad Phillips 37 Source:Yardeni

38 Source: International Monetary Fund, International Financial Statistics Yearbook, 1996

Llad Phillips 39 Thailand in 1997  Production down –Toyota shuts down 2 large factories in Bangkok  Banks hold bad loans –speculation in golf courses, condos, high rises  West worries: potential Intl. financial crisis  International Monetary Fund: bailout loans –Indonesia: $10 B  US Treasury pledges $3B –Thailand: $22 B –Philippines: $1B –South Korea: $40B source: Business Week

Llad Phillips 40 Changing Scenario in Asia Source: Economic Report of the President, 1997 Four Tigers: Hong Kong, Taiwan, Singapore, South Korea Thailand and Neighbors: China, Malaysia, Indonesia

Llad Phillips 41 source: Federal Reserve Bank of St. Louis

Llad Phillips 42 source: CIA

Llad Phillips 43 Source:

Llad Phillips 44 Source: Yardeni ‘94 Exports: Manufactures: 73% Partners: US 21% Japan 17%

Llad Phillips 45 Source: Yardeni

Llad Phillips 46 Summary-Vocabulary-Concepts  merchandise trade balance  balance of trade  balance on current account  creditor nation  debtor nation  income on US assets abroad  payments on foreign assets in US  capital account  capital inflow  capital outflow  balance of payments  purchasing power parity  real exchange rate  Mexican Peso  Japanese Yen  Thailand Baht  capital flight  devaluation