Chapter 2International Flow of Funds

Chapter 2International Flow of Funds

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Balance of Payments 國際收支帳

a summary of transactions between domestic and foreign residents for a specific country over a specified period of time (usually a quarter or a year).

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inflows of funds generate credits (貸方 ) for the country’s balanceoutflows of funds generate debits (借方 ).

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Current Account 經常帳

The current account summarizes the flow of funds between one specified country and all other countries due to purchases of goods or services, or the provision of income on financial assets.

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Key components of the current account include

balance of trade 貿易收支(exports and imports of merchandise and service) factor income (interest & dividends) transfer payments (aids, gifts, & grants).

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(5) U.S. imports of goods – $1,263+(6) U.S. imports of services – 246+(7) U.S. income payments – 259

=(8) Total U.S. imports & income payments =$1,768

The U.S. Current Account in 2003

(1) U.S. exports of goods + $712+(2) U.S. exports of services + 292+(3) U.S. income receipts + 275

=(4) Total U.S. exports & income receipts =$1,279

Exhibit 2.2 (in billions of $)

(9) Net transfers by the U.S. – $68

(10) Current account balance = (4) – (8) – (9) – $557

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The capital account summarizes the flow of funds resulting from the sale of assets between one specified country and all other countries.

Capital Account

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The key components of the capital account are

direct foreign investment: investment in fixed assets in foreign countries (firm expansion)portfolio investment: transactions of long-term financial assetsother capital investment: transactions of short-term financial assets

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Some countries are more dependent on trade than others.

The trade volume of a European country is typically between 30 ~ 40% of its GDPThe trade volume of U.S. and Japan is typically between 10 ~ 20% of its GDP.

International Trade Flows

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U.S. Balance of Trade

Over Time

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Trade Agreements

Many agreements have been made to reduce trade restrictions:

1988 U.S. and Canada free trade pact North American Free Trade Agreement (NAFTA)General Agreement on Tariffs and Trade (GATT)Single European Act and the European Union

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Trade DisagreementsEven without tariffs and quotas, the strategies that can give local firms an edge in exporting:

environmental restrictionslabor lawsbribes to large customersgovernment subsidies (dumping)tax breaks for specific industries

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Trade DisagreementsOther trade-related issues include:

exchange rate manipulationsthe outsourcing of servicesthe use of trade policies for political reasonsdisagreements within the European Union

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Factors AffectingInternational Trade

FlowsImpact of Inflation

Other things being equal, a relative increase in a country’s inflation rate will decrease its current account, as imports increase and exports decrease.

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Impact of National IncomeA relative increase in a country’s income level will decrease its current account, as imports increase.

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Impact of Government Restrictions

A government may reduce its country’s imports by imposing a tariff on imported goods, or by enforcing a quota.Some trade restrictions may be imposed on certain products for health and safety reasons (口蹄疫、禽流感等 ).

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Impact of Exchange RatesIf a country’s currency begins to rise in value, its current account balance will decrease as imports increase and exports decrease.Example (p44):

A tennis racket = $100 = C$125C$1=$0.8If C$1=0.7Then the tennis racket =C$143

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The factors interact, such that their simultaneous influence on the balance of trade is complex.

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Correcting A Balance of Trade

Deficit

If trade deficit exists severely, we need to increase foreign demand for our goods and services.A floating exchange rate system may correct a trade imbalance automatically since the trade imbalance will affect the demand and supply of the currencies involved.

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Why a Weak Home Currency Is Not a Perfect Solution

Counterpricing by competitorsImpact of other weak currenciesPrearranged international transactions

The lag time between a weaker U.S.$ and increased foreign demand has been estimated to be 18 months or longer.

Stability of intracompany tradeMany firms purchase products that are produced by their subsidiaries. (more than 50% of international trades)

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The J-Curve EffectU

.S.

Tra

de

Bal

ance 0 Time

Deterioration due to dollar depreciation

Change in purchasing power caused by weaker dollar

J Curve

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International Capital Flows

Changes in RestrictionsNew opportunities may arise from the removal of government barriers. (emerging markets)

PrivatizationDFI has also been stimulated by the selling of government operations. (emerging markets)

Factors Affecting DFI

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Potential Economic GrowthCountries that have higher potential for economic growth are more attractive. (emerging markets)

Tax RatesCountries that impose relatively low tax rates on corporate earnings are more likely to attract DFI.

Factors Affecting DFI

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Exchange RatesFirms typically prefer to invest in countries where the local currency is expected to strengthen against their own.

Factors Affecting DFI

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Factors Affecting International Portfolio

InvestmentTax Rates on Interest or Dividends

Investors will normally prefer countries where the tax rates are relatively low.

Interest RatesMoney tends to flow to countries with high interest rates.Borrow from the countries with low interest rates

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Exchange RatesForeign investors may be attracted if the local currency is expected to strengthen.

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International Monetary Fund (IMF)

A result of Bretton Woods conference in 1944.184 member countriesCompensatory financing facility (CFF)Special drawing rights (SDRs)

Agencies that Facilitate International Flows

(self-study)

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World BankThis International Bank for Reconstruction and Development makes loans to countries to enhance their economic development.In particular, its Structural Adjustment Loans (SALs) are intended to enhance a country’s long-term economic growth.Funds are spread through cofinancing agreements with official aid agencies, export credit agencies, and commercial banks.

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Multilateral Investment Guarantee Agency

Established by the World Bank, the MIGA helps develop international trade and investment by offering various forms of political risk insurance.

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World Trade OrganizationThe WTO was established to provide a forum for multilateral trade negotiations and to settle trade disputes related to the GATT accord.

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International Financial Corporation

The IFC promotes private enterprise within countries through loan provisions and stock purchases.

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International Development Association

The IDA extends loans at low interest rates to poor nations that cannot qualify for loans from the World Bank.

Bank for International SettlementsThe BIS is the “central banks’ central bank” and “lender of last resort.”

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Regional development agencies

Inter-American Development BankAsian Development BankAfrican Development BankEuropean Bank for Reconstruction and Development.

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Dilemma

The helps from those organizations aim to promote the global financial stability.However, some nations may rely too much on them, so it may lead to low quality decision production.