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sg34 - Chapter 18 INTERNATIONAL FINANCE Key Concepts...

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267 18 INTERNATIONAL FINANCE* K e y C o n c e p t s Financing International Trade The balance of payments accounts measure interna- tional transactions. Current account — records exports, imports, net interest, and net transfers. The current account bal- ance equals exports minus imports, net interest, and net transfers. Capital account — records foreign investment in the United States and U.S. investment abroad. Official settlements account — shows changes in U.S. official reserves, the government holdings of foreign currency. The current account balance plus capital account bal- ance plus official settlements account must sum to zero. In 2003 the United States had a current account deficit that was nearly equal to its capital account surplus. A nation that is borrowing more from abroad than it is loaning abroad is a net borrower; a country that is loaning more abroad than it is borrowing is a net lender. The United States is a net borrower. A debtor nation owes more to foreigners than foreigners owe to it; a creditor nation has invested more in foreigners than foreigners have invested in it. The United States is a debtor nation. National income accounting provides a framework for analyzing the current account. Combining the national * This is Chapter 34 in Economics . income accounts result that GDP = C + I + G + X – M and that GDP = C + S + T gives: X M = ( T G ) + ( S I ) , where X M is net exports, T G is the government surplus or deficit, and S I is the private sector sur- plus or deficit. In 2003, the government sector had a deficit of $548 billion and the private sector had a sur- plus of $42 billion, so net exports had a deficit of $506 billion. In the United States, there is not a strong relationship between net exports and the other two sector balances separately. Instead, net exports respond to the sum of the other two sector balances. Much U.S. borrowing from abroad is to finance investment. The Exchange Rate The foreign exchange market is the market in which the currency of one nation is traded for the currency of another. The price at which the currency exchanges for another is the foreign exchange rate. Currency depreciation — when one currency falls in value in terms of another currency. Currency appreciation — when one currency rises in value in terms of another currency. As illustrated in Figure 18.1 (on the next page) the demand for U.S. dollars is negatively related to the U.S. exchange rate. There are two reasons for this relation- ship: Exports effect — when the exchange rate falls, the quantity of U.S. exports increases and so the quan- tity of dollars demanded increases. C h a p t e r
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2 6 8 C H A P T E R 1 8 ( 3 4 ) Expected profit effect — for a given expected value of the U.S. exchange rate in the future, the higher the current exchange rate, the smaller the profit from holding U.S. dollars, so the quantity of dol- lars demanded decreases.
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