1 ECONOMICS 3150B Fall 2015 Professor Lazar Office: N205J, Schulich

2 Lecture 3: September 17 Ch. 13

3 Balance of Payments Finance Account: transactions involving financial assets –Direct investment –Portfolio investments –Other: loans, deposits –Capital inflow – credit in capital account [CNOOC acquires Nexen] –Capital outflow – debit in capital account [TD acquires US bank] Official reserve transactions by central banks: official settlement balance Unilateral transfers (net secondary income): repatriation of income; foreign aid Sum of all accounts in each country = 0 (equilibrium in foreign exchange markets) –Debits  supply of Canadian $ –Credits  demand for Canadian $

Canada’s Finance Account (C$ M) (C$ B) Canadian direct investment abroad-52,423-49,050 Foreign portfolio bonds-43,7615,888 Foreign portfolio stocks-28,107-26,255 Loans-11,819-14,629 Deposits ,105 Canadian assets, net flow-166, ,485 Foreign direct investment in Canada68,39540,503 Canadian portfolio bonds16,56444,177 Canadian portfolio stocks10,81421,136 Loans19,635-1,175 Deposits20,38922,561 Canadian liabilities, net flow139,998161,510 Finance account, net flows-26,96951,025 4

5 Bank of Canada, International Reserves As of August 8, 2015, the Bank of Canada held a total of $77 billion in international reserves, consisting of the following: –U.S. dollars: $48.1 billion: –Other foreign currencies: $18.3 billion; –Gold: $105 million; –Special drawing rights with the IMF: $7.8 billion; and –Reserves with the IMF: $2.7 billion The Bank’s holdings of international reserves increased $23.5 billion between September 8, 2009 and August 8, 2015

Top 25 Countries with Foreign Exchange Reserves, December 31, 2013 (US$ B) Table 10 6

7 1China3,880 2Japan1,267 3Saudi Arabia738 4Switzerland536 5Russia510 6US448 7Brazil359 8South Korea346 9India298 10Singapore278 11Algeria201 12Germany198

8 13Mexico180 14Thailand167 15Italy146 16France145 17Malaysia135 18Turkey131 19Libya120 20Poland106 21UK104 22Indonesia99 23Denmark89 24Philippines82 25Israel82

9 National Income Accounts Y – (C + I +G) = TB –Y < (C + I + G)  TB < 0 –Domestic demand > domestic production (case of US) –TB =  net foreign wealth = - FA (Finance account balance) –TB 0 –Net foreign debt  –TB > 0,  China lends (invests) to (in) foreigners  FA < 0 –Net foreign debt 

Canada’s International Investment Position (C$ M) (C$ B) Canadian direct investment abroad518,839684,496 Foreign portfolio bonds124,029147,232 Foreign portfolio stocks227,364326,674 TOTAL ASSETS1,181,7031,675,668 Foreign direct investment in Canada437,171607,497 Canadian portfolio bonds410,020620,070 Canadian portfolio stocks96,705197,626 TOTAL LIABILITIES1,272,5871,891,480 NET INTERNATIONAL POSITION-90, ,811 10

11 Changes in Net Foreign Wealth Consider case of US – largest debtor country in history Net international investment position of US, 2011: -$3,731 B –US owned assets abroad: $21,636 B –Foreign owned assets in US: $25,367 B Net international investment position, 2012: -$3,864 B –US owned assets abroad: $21,628 B –Foreign owned assets in US: $25,502 B Changes in 2008: –Financial flows: -$439 B –Price changes : $490 B –Exchange rate changes: $5 –Other: -$189

12 Changes in Net Foreign Wealth Financial flows – mirror image of TB Valuation effects – capital gains/losses, exchange rate revaluations –Importance of expectations

13 Globalization Expanded economic interaction among countries –Anything that makes it easier to buy/sell goods across borders –Anything that makes it easier for an investor to invest in securities originating in another country –Anything that makes it easier for a worker in one country to travel and seek employment in another –Spread of culture and ideas – tourism, Internet

14 Globalization Recycling from countries with current account surpluses to countries with current account deficits –Current account balance + finance account balance - change in official holdings of reserves = 0 –Countries with current account deficits (surpluses) must either generate finance account surpluses (deficits) or central banks must be selling (buying) foreign reserves or both

15 Globalization Recycling can take place smoothly as long as foreign investors have confidence in country with current account deficit –If confidence shaken, foreign investors will expect significant risk premium – loss of confidence will result in capital outflows, depreciation of currency and higher interest rates –Slippery slope: financial outflows worsen confidence, higher interest rates and possible liquidity squeeze reduce economic growth and reduce asset values – threaten viability of banking sector and major companies –IMF intervention may be necessary to restore confidence (IMF mandates economic policies of government in exchange for assistance) –IMF, World Bank and major central banks are lenders of last resort to countries – consider case of Greece

16 Globalization Trade and economic interdependence spills over and affects exchange rates, interest rates, rate of domestic economic growth, financial position of governments, profitability of domestic companies –If China’s economy slows down, decrease in demand for Canadian products (exports of goods and services to the US), so economic slowdown spills over into Canada –Oil prices and economic growth in Canada –World trade declined in 2008 for first time in over 50 years because of global recession resulting from spillover from U.S. –World trade growing less rapidly than global GDP

17 Globalization: China China’s imports as % of world trade: –Oil – 14.4% (Saudi Arabia, Russia) –Iron ore – 57.7% (Chile, Peru) –Cars – 6.3% (Germany, Japan) –Integrated circuits – 31.8% (Taiwan, Hong Kong) –Copper ore – 31% (Australia, Brazil) –Soya beans – 57.7% (US, Brazil)

18 Slowdown in Global Trade After outpacing global GDP growth in the era, growth in global trade slowed and has barely matched the lacklustre pace of overall economic activity since 2010 –As a result, the global propensity to trade (i.e., the ratio of trade to global GDP) has stopped rising Variety of factors beyond slow economic growth that explain the post-crisis slowdown in global trade: diminished incentives to expand trade, the changing composition of global demand and increased protectionism Some of these factors are likely to have only a temporary restraining effect on the global propensity to trade, but others could be more long- lasting

19 Slowdown in Global Trade Starting in the mid-1980s, the world economy entered a phase of rapid globalization. Trade reforms and technological innovations that lowered trade costs during the 1990s had a substantial effect on global trade by encouraging emerging markets to integrate into the global economy and by making global value chains economically viable. As a result, global trade rose relative to GDP. However, since this process is largely complete, the underlying incentives to expand trade are likely weaker now than they were in previous decades At the global level, a change in the composition of GDP away from import- intensive components of demand (such as investment) and toward components that have higher degrees of local or non-traded content (such as consumption or government spending) would decrease the global propensity to trade While tariffs have generally fallen since , additional non-tariff measures have been introduced Michael Francis and Louis Morel, “The slowdown in Global Trade”, Bank of Canada Review, Spring 2015