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Payments Among Nations. Pugel: Chapter 15 Mankiw: Chapter 5, Section 1. Accounting in Open Economies. Balance of Payments International Investment Position. Questions. Why does the USA have a Trade Deficit? Is this “Bad?”. Answers. Why does the USA have a Trade Deficit?

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Payments among nations l.jpg

Payments Among Nations

Pugel: Chapter 15

Mankiw: Chapter 5, Section 1


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Accounting in Open Economies

  • Balance of Payments

  • International Investment Position


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Questions

  • Why does the USA have a Trade Deficit?

  • Is this “Bad?”


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Answers

  • Why does the USA have a Trade Deficit?

    - Because Savings is Less than Investment

  • Is this “Bad?”

    - Yes, if the Saving Rate is “Too Low”


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Wrong Answers

  • Why does the USA have a Trade Deficit?

    • Foreign Trade Barriers

    • US Goods Aren’t “Competitive”

  • Is this “Bad?”

    - Yes, Trade Deficits Cause Unemployment



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Balance of Payments - 1

  • Record of International Payments

  • Payments to Domestic (firms, individuals, or governments) from Foreigners are a plus (+)

  • Payments from Domestic (firms, individuals, or governments) to Foreigners are a minus (-)


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Balance of Payments – 2

  • Current Account (CA) =

    Exports – Imports

    + Net Factor Income Received

    + Net Transfers Received

  • GNP = C + I + G + CA

  • GDP = C + I + G + NX


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USA Current Account(2004, $ Billions)

IMF, International Financial Statistics, February, 2004


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CHN Current Account(2002, $ Billions)

IMF, International Financial Statistics, February, 2004. Estimate for 12 months to Oct, 06: CA=161 The Economist


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Balance of Payments - 4

  • Capital Account (Financial Account)

  • = Sales of Assets to Foreigners (+) minus Purchases of Assets from Foreigners (-)

  • Sale to = Capital Inflow

  • Purchase from = Capital Outflow


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Balance of Payments - 5

  • Three types of capital flows:

    • Foreign Direct Investment (Ownership > 10%)

    • Portfolio Investment (Financial Assets such as stocks and bonds)

    • Other (Bank loans & deposits, other)


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USA Financial Account(2004, $ Billions)

IMF, International Financial Statistics, February, 2004


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CHN Financial Account(2002, $ Billions)

* Foreigners reduced holdings of Chinese other assets.

IMF, International Financial Statistics, February, 2004


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Official Reserve Transactions - 1

  • Domestic Monetary Authority Holds Reserves of Foreign Currencies

  • Many Countries hold $US, Euros, Yen

  • Often, Short-term Government Debt

  • Note: When People’s Bank buys $US, it enters as a debit (negative) for China


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Official Reserve Transactions - 2

  • Net Purchases (-) or Sales(+) of Official Reserves during 2002

    USA: -$4 billion CHN: -$75 billion

  • Stock of Foreign Currency Reserves (End of 2002)

    USA: $68 billion CHN: $291 billion

  • The Economist estimate (Oct, 06): CHN = $988 billion


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Official Reserve Transactions - 3

  • Why keep foreign currency reserves?

  • Attempt to stabilize exchange rate by filling the gap between supply and demand in the foreign exchange market.

  • More later.


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Official Reserve Transactions - 4

  • Why does the USA have so few reserves?

  • Currency floats.

  • US dollar is the primary reserve currency of other countries.


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Balance of Payments - 6

  • In principle, Current Account + Financial Account + ORT = 0

  • => Current Account = -(Financial Account + ORT)

  • = Net Purchases of Foreign Assets

  • Household: Income – Expenditure = Saving = (“Foreign”) Investment


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Balance of Payments - 7

  • But reported data are estimates, so in the accounts:

    Current Account + Financial Account + ORT + Statistical Discrepancy = 0



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CA + (FA + ORT) = 0

  • CA < 0 if and only if (FA +ORT) > 0

  • Two Equivalent Questions:

    • Why does the USA have a Current Account deficit?

    • Why does the USA have a (Financial Account + ORT) surplus?


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NIPA - 6

  • Closed: GNP = C + I + G =>

    S = I

  • Open: GNP = C + I + G + CA =>

    S = I + CA

  • Domestic Savings can be used either for domestic I or to buy foreign assets.


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S = I + CA

  • A Country has a Current Account Deficit if and only if Domestic Saving < Investment

  • Why does the USA have a CA Deficit?

  • Because S < I


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CA = S - I

  • How Can the USA end the CA deficit?

  • Reduce I

  • Increase S

  • Recall: S = Y – C – T + (T – G)

    • Reduce C

    • Reduce G

    • Increase T (Unless Ricardian Equiv)


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CA = S - I

  • Is a CA Deficit “Bad?”

  • Better to Invest Less?

  • Better to Save More?

  • What is Done with the Capital Inflow?

    • 19th Century USA: I

    • 21st Century USA: G and C


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International Investment Position

  • Balance of Payments records Flows per period (usually a year).

  • International Investment Position (IIP) records Stocks at a point in time.

  • IIP is the Cumulative result of Flows.

  • US: Financial Account Surplus for 20 years => IIP declining.


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“World’s Largest Debtor Country”International Investment Position USA

*Includes $352 of US Currency

http://www.bea.gov/bea/newsrelarchive/2006/intinv05.xls


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Is This “Bad?”

  • When China receives FDI, China’s IIP decreases/becomes negative. Bad?

  • When the USA was developing in the 19th Century, it was also a huge debtor.


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Is this “Bad?”

  • If the US stock market goes up, US IIP goes down (since foreigners own US stocks).

  • If I sell my house in Montana to a Chinese, is the USA worse off? Is China better off?


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IIP is NOT a Balance Sheet

  • Includes USA-owned Assets Abroad

  • Does NOT include USA-owned Assets in USA

  • Includes Foreign-owned Assets located in USA

    • Some are Liabilities for USA (e.g. US Government Bonds)

    • Some are Not Liabilities (Toyota plant in California)


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Net Worth: US Households and Nonprofits; End of 2001

http://www.federalreserve.gov/releases/z1/current/z1r-5.pdf


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US Household Net Worth(Constant $2001)

2006Q2: NW = $48T or $160,000 per person

http://www.federalreserve.gov/releases/z1/current/z1r-5.pdf


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Notes on USA “Net Worth”

  • Does NOT Include:

    • Government Assets (27% of USA Land)

    • Government “Promises” Implied by Social Security, Medicare and Medicaid Laws

  • Present Value (Expend - Revenues) = $50-70T

  • “Something’s got to give.”

  • NOT (Primarily) an International Issue

  • IS Domestic Saving/Expenditure Issue


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For Next Class

  • Read Chapter 15

  • Do Problems 1,2,4,5,7,8,9,10


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