Payments Among Nations

1. Payments Among Nations Pugel: Chapter 15 Mankiw: Chapter 5, Section 1

2. Accounting in Open Economies • Balance of Payments • International Investment Position

3. Questions • Why does the USA have a Trade Deficit? • Is this “Bad?”

4. 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”

5. 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

6. Trade Deficit and UnemploymentUSA: 1973 - 2003

7. 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 (-)

8. 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

9. USA Current Account(2004, $ Billions) IMF, International Financial Statistics, February, 2004

10. CHN Current Account(2002, $ Billions) IMF, International Financial Statistics, February, 2004. Estimate for 12 months to Oct, 06: CA=161 The Economist

11. 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

12. 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)

13. USA Financial Account(2004, $ Billions) IMF, International Financial Statistics, February, 2004

14. CHN Financial Account(2002, $ Billions) * Foreigners reduced holdings of Chinese other assets. IMF, International Financial Statistics, February, 2004

15. 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

16. 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

17. 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.

18. Official Reserve Transactions - 4 • Why does the USA have so few reserves? • Currency floats. • US dollar is the primary reserve currency of other countries.

19. 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

20. Balance of Payments - 7 • But reported data are estimates, so in the accounts: Current Account + Financial Account + ORT + Statistical Discrepancy = 0

21. The Balance of Payments

22. 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?

23. 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.

24. 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

25. 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)

26. 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

27. 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.

28. “World’s Largest Debtor Country”International Investment Position USA *Includes $352 of US Currency http://www.bea.gov/bea/newsrelarchive/2006/intinv05.xls

29. 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.

30. 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?

31. 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)

32. Net Worth: US Households and Nonprofits; End of 2001 http://www.federalreserve.gov/releases/z1/current/z1r-5.pdf

33. US Household Net Worth(Constant $2001) 2006Q2: NW = $48T or $160,000 per person http://www.federalreserve.gov/releases/z1/current/z1r-5.pdf

34. 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

35. For Next Class • Read Chapter 15 • Do Problems 1,2,4,5,7,8,9,10