1. Foreign Exchange and Currencies Economics 71a Spring 2007 Mayo, Chapter 6 (skim) Lecture notes 2.6

2. International Money Flows  Funds flow between countries  Two basic reasons Trade flows Investment (capital) flows  Central banks also intervene in these markets

3. The Demand and Supply of Foreign Currency  Example: U.S. ($) and France (euros)  U.S. consumer buys French wine + demand for euros  U.S. firm sells ipod to French consumer +supply for euros  U.S. investor buys French stock +demand for euros  U.S. firm sells stock to French investor +supply for euros

4. Supply and Demand for Euros P = $/euro Q = euros D S

5. The Demand and Supply of Foreign Currency  Example: U.S. ($) and France (euros)  U.S. consumer buys French wine + demand for euros ($/euro rises)  U.S. firm sells ipod to French consumer +supply for euros ($/euro falls)  U.S. investor buys French stock +demand for euros ($/euro rises)  U.S. firm sells stock to French investor +supply for euros ($/euro falls)

6. $/euro = exchange rate  Amount of $’s required to purchase 1 euro  When this rises $ price of euro goods rises (imports more expensive)  US consumers of imports worse off Euro price of $ goods falls (U.S. exports cheaper)  US firms exporting better off  And investors feel $ price of euro investments (stocks) rises  US investors holding foreign assets better off Euro price of $ investments (stocks) falls  Foreign investors holding US assets worse off

7. More Supply/Demand  In the end it is the aggregate of all of these that matters  One other key player: Central bank  Some central banks actively intervene to move (or fix) the exchange rate

8. Foreign Exchange Markets  Huge markets  Open 24 hours  Moving both trade and investment flows  Important to international investors  As exchange rates move, values of investments change

9. Balance of Payments (Measured over fixed period)  Exports - Imports = Trade account >0 Trade surplus <0 Trade deficit  Net new foreign investments = Capital account <0 net investment flows out of country >0 net investment flows into country  Trade account + net investment income + Capital account = 0  Investment income relatively small

10. U.S. Balance of Payments  Large trade deficit  Relatively small income flows  Large capital inflows Borrowing from rest of world Trading IOU’s for goods