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TRADE 4. 5 -4. 7 BOP and F/X TRADE 4. 5 -4. 7 BOP and F/X

Balance of Payments = Current Account Balance vs Capital Account Balance Always sums to Balance of Payments = Current Account Balance vs Capital Account Balance Always sums to 0.

GDP = C + I + G + (X-M) GDP = C + I + G + (X-M)

Current Account Balance • 4 components • 1) Balance of trade in goods • Current Account Balance • 4 components • 1) Balance of trade in goods • Rev from X - Exp on M • Injections and leakages • 2) Invisible Balance • Rev from X Services - Exp on M services • All services • 3 & 4) Net Income Flows A) Grants and foreign aid B) Foreign profits repatriated/savings bonds • ALL Add up to (X- M)

4 Factor Circular Flow 4 Factor Circular Flow

Top Surplus Top Surplus

The Capital Account Balance • Assets – Ownership Assets – Lending Assets – Foreign The Capital Account Balance • Assets – Ownership Assets – Lending Assets – Foreign currency reserves • How many of your assets are owned by a foreign company or country? • Surplus vs deficit

Chrysler Building Chrysler Building

So… • If all components of Curr Acc. Balance add up to a DEFICIT So… • If all components of Curr Acc. Balance add up to a DEFICIT • Then Capital Account Balance should be a • SURPLUS

BOP BOP

Curr Account SURPLUS vs DEFICIT Curr Account SURPLUS vs DEFICIT

III. Possible Consequences • Of a Curr. Account Deficit – – – – Run III. Possible Consequences • Of a Curr. Account Deficit – – – – Run out of F/X reserves Reduced AD Depreciation of exchange rate Unemployment Economic sovereignty issues Interest paid on foreign debt Political pressure for protectionism • Of a Curr. Account Surplus – Can lead to retaliation – Long term harms exporters (F/X rate)

Consequences of a Capital Account Surplus • • Indicator of …. . CAB deficit Consequences of a Capital Account Surplus • • Indicator of …. . CAB deficit Could be sign of inflation BIG ASSUMPTION QUESTION – Surplus based on Ownership or Lending Assets – or ?

Capital Account Deficit • Means CAB surplus – Leads to currency appreciation (more on Capital Account Deficit • Means CAB surplus – Leads to currency appreciation (more on this later)

IV. How to fix a CAB deficit • Not a short term problem • IV. How to fix a CAB deficit • Not a short term problem • But Long TERM… • A) Expenditure Switching – Get them to consume domestic products • B) Expenditure Reducing – Theoretical. – Could harm domestic economy • C) Supply Side – Market or forced intervention

V. Foreign Exchange FOREX • Volume • London, New York, Zurich, Frankfurt, Tokyo • V. Foreign Exchange FOREX • Volume • London, New York, Zurich, Frankfurt, Tokyo • Gov’t, central banks, private banks, MNCs • Exchange rate index vs…

Change for Good Change for Good

CURRENCY EXCHANGE 2005 CURRENCY 5 Euros = $6. 50 100 Baht (Thailand) = $2. CURRENCY EXCHANGE 2005 CURRENCY 5 Euros = $6. 50 100 Baht (Thailand) = $2. 59 5 Canadian = $4. 08 20 Pesos (Mex) = $1. 77 50 Pesos(Mex) = $4. 44 10 Pesos (Nic) =. 61 2000 Colones (CR) = $4. 33 1000 Colones (CR) = $2. 16 500 Colones (CR) = $1. 08 2 Belizian = $1. 00 100, 000 Pesos Bolvianos = OLD 1 Gourde (Haiti) =. 027 5, 000 Riel (Cambodian) = $1. 30 100 Riel =. 026 1000 Won (S. Korea) =. 98 £ 5 (British Pounds) = $9. 30 2009 CURRENCY 5 Euros = 6. 26 100 Baht (Thailand) = 2. 76 5 Canadian = 3. 87 20 Pesos (Mex) = 1. 30 50 Pesos(Mex) = 3. 26 10 Pesos (Nicaragua) = 0. 49 2000 Colones (CR) = 3. 55 1000 Colones (CR) = 1. 77 500 Colones (CR) = 0. 88 2 Belizian = 1. 01 100, 000 Pesos Bolvianos = OLD 1 Gourde (Haiti) =. 025 5, 000 Riel (Cambodian) = 1. 21 100 Riel =. 024 1000 Won (S. Korea) =. 64 £ 5 (British Pounds) = 7. 05 500 (Congo) = 0. 70 10 Lira (Turkey) = 5. 76 20 Francs (Swiss) = 16. 94

 • 2011 CURRENCY • 5 Euros = 6. 94 USD – 100 Baht • 2011 CURRENCY • 5 Euros = 6. 94 USD – 100 Baht (Thailand) = 3. 29 USD 5 Canadian = 3. 87533 USD 20 Pesos (Mex) = 1. 66 USD 10 Pesos (Nicaragua) =. 44 USD – 1000 Colones (CR) = 1. 97 USD – 2 Belizian =. 99 USD – 1 Gourde (Haiti) =. 024 USD 5, 000 Riel (Cambodian) = 1. 23 USD 1000 Won (S. Korea) =. 89 USD 」 5 (British Pounds) = 8. 08 USD 500 (Congo) =. 52 USD 10 Lira (Turkey) = 6. 29 USD 20 Francs (Swiss) = 21. 44 USD 10 Egyptian Pounds = 1. 68 USD 500 Tanzanian Shillings =. 32 USD 10 Saudi Riyals = 2. 66 USD • • •

The Dirham The Dirham

A. Exchange Rate Systems • Fixed – v. One – v. Collection(basket) – v. A. Exchange Rate Systems • Fixed – v. One – v. Collection(basket) – v. Gold • Floating - S & D diagram • Managed (Dirty Float)

Terminology • Fixed – Revaluation – Devaluation • Floating – Appreciation – Depreciation Terminology • Fixed – Revaluation – Devaluation • Floating – Appreciation – Depreciation

Why does it move? • Two components –D –S • Effect of Curr Acc. Why does it move? • Two components –D –S • Effect of Curr Acc. Bal. On FX

Hi’s and Lo’s • ADVANTAGES – Fights Inflation – Imports increase – Efficiencies in Hi’s and Lo’s • ADVANTAGES – Fights Inflation – Imports increase – Efficiencies in the domestic market • DISADVANTAGES – Exports suffer – Hurts domestic industries • ADVANTAGES – Exports gain – Domestics gain • DISADVANTAGES – inflation

B. Gov’t Intervention In • WHY? • HOW? B. Gov’t Intervention In • WHY? • HOW?

C. EFFECTS • Imports vs exports (Current Account Bal) • Change in AD • C. EFFECTS • Imports vs exports (Current Account Bal) • Change in AD • EX: Chinese Yuan

The Big Mac Index • PPP • Over valued vs under valued • Short The Big Mac Index • PPP • Over valued vs under valued • Short run vs long run – Start 1 USD = 1. 20 GBP, then

VI - Terms of Trade • • Has to do with value Value of VI - Terms of Trade • • Has to do with value Value of exports vs value of imports Uses an index (like CPI) aka “basket” Formula:

Divide by Year Avg. Export Price Index Avg. Import Price Index To. T 1 Divide by Year Avg. Export Price Index Avg. Import Price Index To. T 1 100 100 2 100 102 3 106 104 101. 92 4 110 100 5 108 106 101. 89 6 108

Why does To. T change? • • • SHORT RUN Change in S/D in Why does To. T change? • • • SHORT RUN Change in S/D in importing country Inflation rates in home country Exchange rates LONG RUN Income changes – In LEDC leads to more imports – Elasticity*****

How this impacts LEDCs • Most LEDC dependent on one or two commodities for How this impacts LEDCs • Most LEDC dependent on one or two commodities for export. – Primary (aka Commodity) – Secondary – Tertiary • Commodity prices are falling – Why? – So? • IMPORTANT: To. T diff than Bo. P.