FOREX Practice

Graph both currencies.

Label them as either “appreciating” or “depreciating” in value.

Tell what happens to US Exports after the change.

US $ and the Mexican Peso (M$):

Drug wars in Mexico cause US tourists to stay away from Mexico.

US $ and the Euro (€):

US goes into deep recession, Europe does not.

US $ and the Japanese Yen (¥):

Japanese game companies bring out hugely popular new game systems.

US $ and the Chinese Yuan (C¥ or ):

China decides to reduce sales of rare earth minerals to the US.

(Assume that the Yuan trades on S and D markets.)

US $ and the Canadian Dollar (C$)

After the Calgary Winter Olympic Games, Canada becomes a favorite US tourist destination.

US $ and the Chilean Peso (CLP$):

The two countries sign a trade agreement that dramatically increases the food Chile will export to the US during the winter in the northern hemisphere.

US $ and the Euro (€):

Gasoline prices spike to $10.00 a gallon worldwide and German car companies introduce several models of cars that get 75 miles per gallon in efficiency.

US $ and the Australian Dollar (A$):

After massive flooding in Australia, the US decides to send billions in aid money to Australia.

US $ and the Russian Ruble ( R ):

Russians decide that US cars are extremely fashionable to own.

US $ and the Nigerian Naira ( N ):

The US increases investments in newly discovered oil fields in Nigeria.

Protectionism vs. Trade

Arguments for protectionism

Military Self-Sufficiency

• not economic, political and military
• need to preserve industries that are essential for national defense 
• point: when you do this, you will incurs economic costs 
• what counts as "essential?"

Diversification for Stability

• common in economies dependent on one or two products (Saudi Arabia)
• need to diversify at home because changes to the dependent product markets can be devastating
• not relevant to the US

Infant Industry 

• need to shelter young industries temporarily until they compete globally 
• which industries will be capable of competing in the future? 
• protection may not be temporary

Protection Against Dumping 

• dumping: the sale of a product in a foreign country at prices either below cost or below the prices commonly charged at home.
• tactic for driving competitors in other countries out of business. 
• US imposes antidumping duties where it find it
• hard to differentiate between dumping and competition

Increased Domestic Employment

• tariff to "save our jobs"
• common during recessions 
• idea is to protect certain jobs by blocking foreign imports
• jobs are also created, only some gone 
• maintaining status quo by making neighbors poorer 
• trade wars likely 

Cheap Foreign Labor

• domestic workers must be shielded from counties where wages are low 
• ignores the fact that trade benefits both parties
• ignores comparative advantage
• ignores differences in labor productivity

Big Picture: Protectionist actions will benefit some part of the economy at the expense of the rest of the economy, and in some cases, the rest of the world. 

Let's talk about labor in the third world 
 

Trade and Growth

We already know

• people and nations trade to improve their standard of living
• trade is voluntary 
• trade will only occur if both sides expect to gain something
• a nation will import if world price < domestic price
• a nation will export is world price > domestic price  
• allows nations to specialize in what they do best

recall: law of comparative advantage: through specialization and trade, nations are able to go beyond their PPF

short and sweet: free trade makes everyone better off

but....

Barriers to trade

tariff: excise taxes on imported goods

• revenue tariff: taxes on imported goods not produced domestically in order to raise revenue for the federal government.
• protective tariff: tax designed to shield domestic producers from foreign competition

nontariff barrier: licensing requirements imposed on domestic importers of foreign goods.
quotas. By restricting licensing, governments can restrict imports.

voluntary export restriction: voluntary limitations agreed to in the hopes of avoiding more stringent trade barriers.

Quota: legal limit placed on the amount of a good that can be imported in a given year.

Effects: 

• quotas generate revenue for foreign producers by keeping prices high. 
• tariffs generate revenue for the domestic government.
• in both cases, the prices for domestic consumers are higher. 
• limit potential gains from trade
• protect domestic sellers and the expense of domestic buyers

they also

• reduce efficiency in the allocation of scarce resources
• (slows economic growth!)

BoP and FOREX

(Balance of Payments and Foreign Exchange)
 
First, some differentiation

• Balance of Trade: looks only at a nation's exports and imports of goods.
• Balance of Payments: considers all economic transfers.

For the current and capital accounts:

• if foreign currency is used to complete the transaction, it is a debt (negative)
• if foreign currency is earned in a transaction, it is a credit (positive)

Trade requires nations to exchange currencies 

• exchange rate: the price of one currency in terms of another. Generally set by supply and demand.

Appreciation:

• increase in the value of a nation's currency in foreign exchange markets
• tends to reduce exports and increase imports

Depreciation:

• decrease in the value of a nation's currency in foreign exchange markets
• tends to increase exports and decrease imports

Monetary and Fiscal policies can affect exchange rates, and therefore the international balance of trade and balance of payments. 

Recall: Three rules for S/D of currency graphs

• Always change the D line on one currency graph, the S line on the other currency’s graph. 
• Move the lines of the two currency graphs the same direction. (demand moves out, supply moves out, etc.)
• One currency will appreciate, the other will depreciate. 

Recall: Shifters of currency supply and demand 

• taste and preferences  
• demand for products increases
• so will demand for currency  
• cell phones, other electronics, etc.   
• price level (inflation
• consumers will seek cheaper goods if domestic prices rise 
• income 
• imports vary directly with its income level 
• income rises, people buy more domestic good and more foreign goods.  
• real interest rates
• higher real interest rates will attract investment as foreigners seek higher returns 

Balance of Payments

Balance of payments (BoP) accounts: an accounting record of all monetary transactions between a country and the rest of the world

These include: 
Current Accounts
    Goods: Consumer, Capital, Agricultural
    Services:  Receipts versus Payments
        (includes Travel, Royalties, License Fees)

Capital / Financial Accounts
    “Net Capital Account Payments”
    Assets:  Purchases of Securities, Direct Investment Payments

Official Reserve Assets

Why keep track of this?

• To establish the ability to balance accounts and trade in the future
• Fixed vs. floating exchange rates 

Individuals and Businesses record stuff like...

• Job income, interest income, consumption payments, investment payments

So nations are expected to keep track of this responsibly

• Why? helps stabilize currencies and trade expectations for future investments

International BOP can be summarized as a ledger sheet for each trading nation.

• Current Account keeps track of the difference between a country's total exports and total imports. (physical stuff, services, investment income, transfers) 
• trade deficit = importing more than you export (Xn is a negative number) 
• trade surplus = exporting more than you import (Xn is a positive number) 
• Capital Account (sometimes called the Financial Account) keeps track of ownership of assets. (foreigners who own US assets and US citizens who own foreign assets)
• Net Capital Outflow 

Terms:
Current Account (CA): An immediate and final transaction
CA Net Exports                                 Export values minus Import                                                                 values
CA Balance of Trade                        (Goods and Services)
CA Balance on Goods & Services   Tourism Expenditures
CA Trade Balance

• CA Net Investments: Payments on prior stock and bond investments like dividend payments 
• CA Net Transfers: Aid, Transfers and Remittances, Royalty Payments

Capital and Financial Account (KA): Purchases and payments are made that hope to create future revenues and obligations (people buy stuff as an investment)

• KA Real and Financial Assets: Stocks, Bonds, Land, Companies, Franchises, ….

Reserves: Used to balance out accounts if Current Accounts don’t equal Capital and Financial Accounts  

• Official Reserves: Gold and Currency Holdings 
• Official Settlements: Also Gold and Currency Holdings 
• Special Drawing Rights at the IMF: Funds held by the International Monetary Fund

BOP Assets or Credits: A positive number for a nation

• Currency Inflows: Wealth amounts coming into a country as a result of the transaction 
• Currency Demand: Wealth amounts are therefore demand for the currency of the country

BOP Liabilities or Debits: A negative number for a nation

• Currency Outflows: Wealth amounts leaving a country as a result of the transaction 
• Currency Supply: Wealth amounts are therefore supply of the currency moving out of the country

A Final Word on Balances

• There is constant news and discussion about the USA’s massive and increasing Trade Deficit.  
• This is most obvious in the imbalance of imports versus exports, 
• the US imports hundreds of billions more annually that it exports.  

The two major culprits are usually:  

• oil imports 
• trade with China.  

We do export lots of items, 

• mostly heavy equipment and services
• but those amounts do not equal the oil imported and the lack of ability to sell goods to China. (right now) 

what really occurs 

• oil producing nations and China turn around and use lots of the extra dollars they receive and invest in US stocks and bonds (Capital and Financial Account Asset for the US).

People in the US worry when 

• China tries to buy stuff like US car companies
• US ports (blocked by the government)
• China tries to buy the panama canal
• resource rich areas in Africa  

Exchange Rates, Supply and Demand of Currencies

Currencies as part of Supply and Demand

• All major currencies of the world “float” on supply and demand markets. 
• Some minor currencies are “pegged” to other major currencies like the 
• US dollar and the Euro, 
• but rise and fall in value with those major currencies.
• The only major currency that is “fixed” in exchange rates by governmental decree is the People’s Republic of China’s Yuan.  
• The Chinese government does adjust the “fixed” rate occasionally, 
• most recently as a response to US pressure to balance trade issue flaws.
• Currencies either “appreciate” or “depreciate” in EP.

When changes occur between two countries’ economies, the currencies will reflect those changes:

• When other countries want something from us they are demanding dollars.

• When we want something from other countries we are supplying dollars.  

three rules of currency demand graphs 

• Always change the D line on one currency graph, the S line on the other currency’s graph.
• One currency will appreciate, the other will depreciate.
• Move the lines of the two currency graphs the same direction and you will end up with the correct answer.

How do currencies move?

1. Fads, tastes, and political actions like boycotts, occur in a country as it deals with another country.
2. The country with less inflation has the more attractive economy compared to a trading partner.
3. The country with better investment opportunities (higher real interest rates for investments) has the more attractive economy.
4. The country “expected” to improve its economic standing more quickly than trading partners will have the more attractive economy.
5. If the overall real wealth of one country improves, compared to the wealth of a trading partner, the improving country will have the more attractive economy.

Economic Growth

Economic growth
(A percentage rate of growth per quarter)

• increase in real GDP
• (or)
• increase in real GDP per capita
• real GDP / population, compared to previous quarters 

growth lessens the burden on scarcity 

Rule of 70: provides a mathematical grasp of the effect of economic growth rate changes.

• Number of years for variable to double = 70 / Annual Growth Rate of the Variable

Why do we see growth in some areas and not in others?

 

Institutions that promote growth

• strong property rights
• patents and copyrights
• efficient financial institutions
• widespread education
• free trade
• competitive market system 

Non-institutional factors

(supply) increase in:

• quantity and quality of natural resources 
• quantity and quality of human resources 
• stock of capital goods 
• advances in technology     

(demand) increases in:

• total spending

(efficiency) increase in:

• allocative efficiency 
• productive efficiency

Discussion: is growth desirable?