GEB 3373 Exam 2
Why is the jones act and anti-cabotage laws still in effect?
"All politics is local": Members of Congress listen to those who lobby them, and studies confirm this is the case
The Lincoln Fallacy
"When we buy goods manufactured abroad, we get the goods and the foreigner gets the money. When we buy goods manufactured at home, we get both the goods and the money." -If we produce goods at which we are relatively less productive at producing, we waste resources
IMF and other rich nations (US, UK, France, Germany) spent over _______to mitigate crisis
$100b
What is the estimated volume of foreign-exchange trading?
$6.6 trillion/day
PPP example. Exchange rate U.S./Canada exchange rate is US$0.80= Can$1 -Jeans sell for US$48 in U.S. and Can$60 in Canada Does PPP exist?
(US$.80/CAN$1)*CAN$60 = US$48. Yes PPP exists
Arbitrageurs
(William Wong) -attempt to exploit extremely small differences in forex prices between markets (discussed more later) -Simultaneously buy currency in lower-price market and sell in higher-priced market -Harder to do in today's instantaneous, 24/7 markets
Spot Market
(current, today, now Market) forex transactions to be completed "immediately" (two days after the trade date) -Lag due to time needed for payments to clear international banking system -Accounts for 33% of all forex transactions
What are some of the island and non-island offshore island states?
(islands: Bahamas, Bahrain, Cayman Islands, Bermuda, Netherlands Antilles, Singapore) -Luxembourg, Liechtenstein, Switzerland also "offshore"
How to calculate fixed exchange rate between currency A and B?
(par value)B / (par value)A example: Par value ₤ = 4.247 -Par value $ = 20.67 20.67/4.247 🡪 ₤1 = $4.867
PPP theory
(purchasing power parody) Prices of tradable goods, when expressed in common currency, will tend to equalize across countries due to exchange rate changes
Types of Foreign-Exchange (Forex) Clients
- Commercial Customers - Speculators -Arbitrageurs -Central banks/treasury depts
According to Bureau of Economic Analysis
- US exports and imports improve, but remain below pre-pandemic levels - exports are below imports - we see a drop off in trade from covid and 2008 recession
Global Equity Markets
- used by Established firms to find money for expanding abroad ex. -Disney initially sold 51% of Disneyland Paris to French investors -MNEs may also cross-list stocks on multiple exchanges -Toyota stock listed on NYSE, London, Tokyo -Empirical evidence: Cross-listed MNEs tend to have higher values -Today, co.'s can raise new equity in global, not just domestic, markets -Swiss pharma co.'s are major equity source for new U.S. biotech firms -country fund
Ex. Numerical export Control: China restricts exports of rare earth minerals—very controversial
-2014: WTO rules against China -2010: China stops exporting metals; do again as retaliatory move against tariffs? -2017: Trump issues EO to ↑ search for metals in U.S. -2019: U.S. looking to coop w/Canada on metal supplies -2020: Trump declares national emergency in industry
Example of Swap
-Apple assembles laptops in U.S., but screens are made in Japan; Apple also sells finished laptops in Japan -Apple both buys from and sells to Japan Suppose: -Apple needs to convert $1 million into ¥ to pay its Japanese supplier of laptop screens today -Apple knows it will be paid ¥120 million in 90 days by its Japanese importer, which buys its finished laptops -Apple wants to convert those ¥ into $ for use in the U.S. Suppose: -Spot rate is $1 = ¥120 -3-month forward rate is $1 = ¥110 Then: -Apple sells $1 million to its bank in return for ¥120 million -Apple pays its Japanese supplier in ¥ -At same time, Apple enters into 90-day forward deal with bank to convert ¥120 million it will receive from its importer into $ So, in 90 days, Apple receives $1.09 million -(¥120 million / ¥110 = $1.09 million) Since ¥ is trading at a premium vis-à-vis $, Apple ends up with more $ than it started with, although the opposite could occur -Whether premium or discount, Apple can use swap to max. profits or min. losses from forex fluctuations
What was happening in the US during the large trade deficits in the 1950s-1960s?
-Booming economy 🡪 imported lots of stuff -Bought stuff w/ $ 🡪 $'s sent abroad
Govt. also uses right to sell within quota as instrument of foreign policy/aid
-Canada allocates ~2/3 of its butter quota to New Zealand -U.S. TRQs on sugar: Exporter to U.S. with rights can easily, legally engage in arbitrage 🡪 buy low on intl. market and sell high in U.S. Let's examine these TRQs and their effects
Currency option
-Contract allowing (but not requiring) firm to buy/sell specified amount of foreign currency at specified price at anytime up to specified date -Call option: Right to buy -Put option: Right to sell -Get contract for a fee -Are publicly traded on organized exchanges worldwide -Account for 5% of forex market
Commercial Services
-Currency exchanges used by exporters and tourists -Financing and facilitating everyday commercial transactions for firms large and small
Whats the main difference between a currency future and a swap?
-Currency future: Price determined when contract signed; currency pair exchanged on delivery date, sometime in future -Swap: Price also determined when contract signed, but currency pair exchanged immediately or within a short time
Important Aspects of the BOP Accounting System. Transactions are recorded
-During certain time period (year, quarter) -Only if they have monetary value -Between Residents of countries (individuals, businesses, govt. agencies, nonprofits) -Using double-entry credit/debit sys. debit = funds used (buying); credit = funds' source (selling)
Foreign Exchange Market
-Facilitates currency conversion, allowing firms to conduct trade more efficiently across national boundaries -Facilitates international investment and capital flows
Infant Industries
-First articulated by U.S. Treasury Secretary Alexander Hamilton in 1791 -New ("infant") industries can become globally competitive if govt. protects them via subsidies, tariffs to give them time to develop
How can BOP provide signals about nation's economy?
-Identifies emerging markets for goods/services -Warns of policies that may change business climate (e.g.: sharp ↑ in imports may signal overheated economy 🡪 tightening of money supply 🡪 ↑ r, currency appreciation) -Shows ↓ in foreign-exchange reserves; may indicate currency depreciation in near future (e.g., Thailand 1997) -Indicates ↑ lending risks
Results of Other Countries' Tariffs: Russia
-Imposed on ag goods post-U.S./EU sanctions due to Crimea annexation Effects: -Food prices ↑ 5% -GDP ↓ 0.2 percentage points 2014-2018
Retail Market
-Individual customers who want to buy/sell currencies -As in other retail markets, retail price = wholesale price + premium
What were the effects of OPEC oil embargo
-Inflation in oil-importing nations 🡪 exchange rates Δ -Oil exporters' currencies appreciate (↑ value); oil importers currencies depreciate (↓ value) -Oil-rich nations used US$ earned from oil exports ("petrodollars") to invest in infrastructure -Unspent petrodollars deposited in intl. banks
Exchange rates are closely related to
-Interest rates -Inflation - Capital gains from domestic securities
What are the challenges and benefits with adopting another currency instead of your own
-It' easier to trade with the countries of the same currency and it's more stable -downside is you give up some sovereignty bc another country now controls the strength of your currency
The World Bank
-Lends only for "productive purposes," i.e., infrastructure, not deficit financing -Hard loans—only makes loans if there is a reasonable expectation it will be repaid
Two ways govt. can affect economy
-Monetary policy (controlling size of money supply) -Fiscal policy (changing taxing/spending)
4 Ways to Obtain a Competitive Advantage
-Own intellectual property rights -Invest in R&D -Use economies of scope to ↓ costs by ↑ variety -Exploit experience curve to ↓ costs (the more you do something, the better you get, the cheaper it becomes)
Corporate clients hire investment bankers to
-Package, locate long-term debt/equity funding -Arrange mergers and acquisitions of domestic and foreign firms
international Finance Corporation (IFC)
-Promotes development of countries' private sectors -Similar to an investment banker, IFC provides debt, equity capital for promising commercial ventures
Determining whether dumping has occurred difficult
-Retail prices irrelevant -Prices different for other reasons -Needed: P charged at factory; hard to get o Defining predatory pricing also difficult, especially when dealing with large, multidivisional MNE -Include R&D costs? Incl. corp. overhead costs? -Costs would exist w/o U.S. market Ex: Current solar, steel tariffs against China
What caused the Asian Currency Crisis
-Significant capital inflows 🡪 banks had lots of $ to lend 🡪 made risky loans 🡪 defaults 🡪 bank and business debt -Increasing trade deficits (led to ↑ Supply baht on global market) -Financial panic*
National trade policies affect
-Size of foreign markets / investments -Profitability of foreign markets / investments -How foreign imports affect domestic markets -Consumers worldwide, influencing products available, price, and quality
International Development Association (IDA)
-Soft loans—those with higher risk of non-payment; cheaper loans with generous terms -Focus on LDCs
Two types of speculation
-Stabilizing: Sell when currency price high 🡪 supply ↑ 🡪 prices ↓ OR Buy when low 🡪 demand ↑ 🡪 prices ↑ -Destabilizing: As currency price ↑, buy more to push it up further, then sell at high rate OR Sell to push price lower then buy back cheap
Key Components of flexible exchange rate system
-Supply & demand mainly determine currency values -Govts. can intervene by buying/selling currencies to affect exchange rates
Three-Point Arbitrage
-The buying and selling of three different currencies to make a riskless profit -When cost of buying currency directly differs from cross rate 🡪 profit opportunity -Market in equilibrium (no profit opportunities) when cross rate = direct exchange rate -Links together individual forex markets b/c of cross rates -Changes in ₤/$ market affect both ¥/₤ and $/¥ markets
objectives included in the IMF's Articles of Agreement
-To promote international monetary cooperation -To assist in the establishment of a multilateral system of payments -To facilitate the expansion and balanced growth of international trade
Forward Market
-forex transactions to be completed sometime in the future -Often-published prices include those for 1, 3, and 6 months in future
Currency controls
-govt. regulations on how foreigners can and can't access currency -Exporters can exchange foreign currency at favorable rates; importers forced to buy local currency from central bank at unfavorable rates -Tourists also sometimes given higher rates -Venezuela, Ethiopia have used dual exchange rates
Speculators
-hope to profit by attempting to predict changes in currency's market value -High risk, high reward
Central banks/treasury depts.
-intervene in forex markets
Green Bonds
-issued in order to raise finance and drive down the overall costs for climate change solutions and assets." -Issuers include commercial banks and other private-sector entities, as well as governments and development banks
Other Nontariff Barriers
-product and testing standards Foreign goods must meet nation's product/testing standards (e.g., safety, efficacy) -U.S.: Drugs need FDA approval -Brazil: New drugs must be tested there, FDA test no good -Long, complicated approval process 🡪 ↑ costs, ↓ imports -Legitimate or not? -restricted access to distribution network -public sector procurement policies -local purchase requirements -regulatory controls -currency controls -investment controls
Public-sector procurement policies
-restricts how govt. agencies can spend their money -Governments require agencies to buy domestic goods/services only -U.S. govt. requires intl. air travel for employees to occur on U.S. airlines; China on Chinese airlines -Important in countries where state ownership is widespread, e.g., China, Egypt, Argentina, Turkey, Peru
In a retail market, the size of the premium (or markup) depends on
-size of transaction and customer's importance to bank -Individual people pay higher premium for cashing in traveler's check than large company that needs foreign currency to pay foreign investors
Commercial Customers
-use forex for their business -Export/import -Pay/receive foreign dividends/interest -Buy/sell foreign assets/investments -Hedge against unfavorable changes in forex rate for monies to be paid/rec'd in future
If ₤ depreciates, firms may want to
-↓ their holdings of assets in ₤ -↑ their liabilities in ₤
Current Account + Capital Account + Official Reserves Account=
0; because double entry
How many goods can a country have comparative advantage in?
1
Global avg for winning cases in WTO? US avg?
1. 84.4% 2. 85.7 (same for Japan) 3. EU -> 90.2% 4. China -> 66.7%
Which country has attracted the most FDI in Latin America?
1. Brazil; $72bil
Which of the least developed countries (LDC) has attracted the most FDI? (top 3)
1. Cambodia $3.7bil 2. Myanmar (Burma) $2.8bil 3. Ethiopia $2.5bil
Which country has attracted the most FDI in Developing Asia? Which other country was a big attractor?
1. China; $141.2bil 2. Singapore; $92.1 bil
4 components of BOP
1. Current account and 2. capital account: Record purchases of goods, services, and assets by private and public sectors 3.Official reserves: Level of assets held by national government; can be used to intervene in foreign-exchange market 4.Errors and Omissions: Mistakes made in calculating BOP transactions
4 demand factors
1. Customer Access 2.Marketing Advantage 3. Competitive Advantage 4. Customer Mobility
PPP theory Occurs b/c process of buying in cheap market and reselling in expensive market affects...
1. Demand for and therefore price of foreign currency 2. Market price of good itself in home market 3. Market price of good itself in foreign market
6 factors that influence exchange rates and what they mean
1. Differentials in inflation 2. Differentials in interest rates 3. Current Account Deficits 4. Public Debt 5. Terms of Trade 6. Political stability and economic performance
Which country has attracted the most FDI in Africa? Which other two countries were big attractors?
1. Egypt; $9bil 2. Nigeria and South Africa
What are the two types of international investment?
1. FDI 2. FPI
two types of dumping
1. Firm sells goods in foreign market at lower price than it charges at home -Form of international price discrimination* 2. Firms sells goods in foreign market below production cost -Form of predatory pricing -Concern: Foreign co. may try to drive out domestic firms and then ↑ prices
Impact of Import Tariff on Foreign SUVs on Demand for U.S.-Made SUVs
1. Foreign producers pass tariff on to U.S. customers and raise prices 🡪 2. U.S. sales of foreign SUVs ↓ 3. Foreign/U.S. SUVs are substitutes (recall ECO 2023) 4. Consumers switch to buy more U.S. SUVs 🡪 5. Demand for U.S. SUVs ↑ 🡪 6. Shift from D to D1 7. Price of U.S. SUVs ↑ from P to P1 -Gainers: U.S. producers, suppliers, labor, dealers, & communities associated with U.S. SUVs -Losers: Domestic consumers, workers, producers, & dealers associated with Foreign SUVs; -Foreign producers, workers, suppliers, and affected communities USUALLY losses outweigh gains
4 Main parts of the Official Reserves Account
1. Gold 2. Convertible Currencies: Those freely exchangeable in world currency markets Most common: $, €, ¥, and the pound 3. SDRs - special drawing rights (paper gold) 4. IMF Reserve Positions: quota - IMF borrowings
What are the 3 functions of money (IMS)?
1. Governs how nations value/exchange currency 2. Provides mechanism to correct payment/ receipt imbalances 3. Can ensure smooth conversion of foreign money into home currency
Why did Barclays lie about LIBOR from 2005 to 2009?
1. Hide Weakness 2. Profit
Effects of the current trade policy under the republican administration
1. Instead of importing from China, the U.S. looked to Vietnam, Mexico, etc. for goods 2. After COVID, the US trade deficit with China decreased and the trade deficit with the rest of the world increased 3. Trumps trade advisors say tariffs forced China to agree to a phase one trade deal in January and will force China to end unfair practices and help rebuild the US manufacturing base over time 4. Since 2018, Manufacturing jobs were on the decline until Covid where they took a steep drop and is no recovering but no where near where we were. 5. Automation is just as responsible if not more for the decline of manufacturing jobs 6. Tariffs have increased prices for American importers and in some cases American consumers
4 Country Based Theories
1. Mercantilism 2. absolute advantage 3. comparative advantage 4. relative factor endowments (hecksher-ohlin)
What are the 4 parts of the current account? Which 2 are the most important parts of the current account?
1. Merchandise Trade: Exports / imports of goods (most important) 2. Services Trade: Exports / imports of services (most important) 3. Primary Income 4. Unilateral Transfers (aka secondary income)
Four arguments for intervention:
1. National Defense 2. Maintenance of Jobs 3. Infant Industries 4. Strategic Trade Theories
3 Stages in the Product Life Cycle Theory
1. New Product 2. Maturing Product 3. Standardized Product
4 supply factors
1. Production costs 2. Logistics 3. Natural resources 4. Key Technology
Balance of Payments (BOP) Accounting System
1. Records intl. transactions 2. Supplies info about economy's health 3. Foreshadows likely changes in fiscal/ monetary policies 4. Can detect trade restrictions, higher r, inflation, ↓ D, general cost of doing business in nation
Which country has attracted the most FDI in Transition Economies (former soviet union)?
1. Russia; $31.7 bil
Who has the most offshore wealth? Where does the U.S. stand?
1. Saudi Arabia (almost 60%) 2. Argentina (almost 40%) 3. European countries slightly above avg US is just below avg (8%)
Two questions for Rationale for Trade Intervention
1. Should governments intervene to protect country's domestic firms by taxing foreign imports or erecting other import barriers? 2. Should governments help domestic firms increase their foreign sales through export subsidies, government-to-government negotiations, and guaranteed loan programs?
In what ways do banks profit from the forex market?
1. Spread between bid/ask prices for currencies -Buy/sell large amounts of currency at different prices 2. Speculation -Banks bet on which direction exchange rates are headed (risky) 3. Arbitrage -Banks act as arbitrageurs (discussed later)
Opportunities of mercantilism
1. Stimulated export sales by lowering taxes and providing subsidies 2. Can keep competitors out of your country
4 Sectors of World Bank Group
1. The World Bank 2. International Development Association 3. International Finance Corporation 4. Multilateral Investment Guarantee Agency
6 Objectives of IMF (International Monetary Fund)
1. To promote international monetary cooperation 2. To facilitate expansion and balanced growth of intl. trade 3. To promote exchange stability, maintain orderly exchange arrangements among members, and avoid competitive exchange depreciation 4. To assist in the establishment of a multilateral system of payments 5. To give confidence to members by making the general resources of the IMF temporarily available to them and to correct maladjustments in their balance of payments 6. To shorten the duration and lessen the degree of disequilibrium in the international balance of payments of members
Three observations of Heckscher-Ohlin Theory
1. Two types of factor resources (endowments): labor and capital 2. Endowments vary among country 3. Goods differ according to types of resources used to produce them
Which country has attracted the most FDI in Developed Economies?
1. U.S. $250 bil
In practice, Current Account + Capital Account + Official Reserves Account = 0 never occurs due to
1. Underreporting of legal capital account transactions -Difficult to keep up with 24/7 currency trading, complicated monetary swaps/hedges 2. Illegal flight capital -Deliberately hidden to cover drug smuggling, money laundering, evasion of governmental currency/ investment controls 3. Inaccurate current account stats -Merchandise exports not often assessed for taxes, so customs info less accurate -Service trade measurements often done via survey
2 questions we always want to ask ourselves with international trade policy
1. What's the net benefit? 2. How can we redistribute the net benefit to those that may have ben hurt by those policies?
4 firm based theories
1. country similarity theory 2. product life cycle 3. new trade theory 4. national competitive advantage
3 reasons trade theories are important
1. if your competitor engages in international trade, you want to be able to get in their head and use predictions against them 2. governments can use them to create policies 3. can be used to identify and justify going into profitable markets or using strategies
How do high/low transaction costs affect internalization?
1.High transaction costs 🡪 FDI more likely to occur; international production is internalized in firm 2.Low transaction costs 🡪 FDI less likely; exporting, licensing instead
Jan. - July 1971: U.S. sold how much gold? why?
1/3 of gold reserves to support $
The EB-5 program must create at least how many jobs?
10
The United States trades with more than 200 countries around the world. With how many of those countries does the United States have a trade surplus?
130
When was the Gold Standard first adopted in by the U.K.?
1821
How members does the IMF have?
189
In 2019 what percent of trade with China was exports? imports?
19%;; 81%
Example of govt adopting policies that negatively impact the country
1920 Jones Act: Restricts foreign co.'s from providing transportation services between U.S. ports -Increases profits of U.S. ocean vessels by $630 million/year 🡪 big incentive for industry to keep law -Costs consumers $10.5 billion/year ($35/person, small) -Temp. lifted after Harvey, Irma, Maria -Full repeal could add $22-74 billion to GDP (0.12%-0.39%)
When did the U.K. get rid of the gold standard? What did they do instead?
1931; allowed their currency to float
Why was International Banking Facilities created?
1970s: U.S. banks complain that reserve requirements and other regulations prevent them from competing with European and Asian banks issuing $-denominated loans not subject to same rules 1981: U.S. Federal Reserve authorizes creation of international banking facility
Where and when did the Asian Currency Crisis begin?
1997 Thailand
Assumptions of Absolute Advantage
2 countries, 2 goods, 1 factor of production (i.e., input), labor
Assumptions of Comparative Advantage
2 countries, 2 goods, 1 factor of production (i.e., input), labor
July 1997: Thailand unpegs currency which devalued baht by
20%
Exim Bank Debate
2016: U.S. Exim $200m in med.-term financing Other sovereign exim banks fund much more -China: $34 billion -BRICS: $51 billion 2017: U.S. Exim $3.4b in short-term export credit -Supported 40k jobs -In 2014, spent $20b and supported 165K jobs Reauthorized In December 2015 after fierce debate:
How many countries seek relief from IMF from debt they can't pay?
40 countries in Asia, Africa, and Latin America seek relief for external debts
What percentage of U.S. trade is a U.S. export?
40%. for every dollar of U.S. trade last year, 40 cents was a U.S. export
How many workers in the U.S. are employed by foreign companies?
5.6 million ( 5% of total private employment)
What percent of countries does the US have surpluses with? deficits?
56%; 44%
Foreign firms in the U.S. pay _______ than domestic firms after controlling for skill level
7% more
What percent of foreign exchange transactions involve the USD?
87%. Followed by euro, yen, and pound
What is the world avg of GDP is held in offshore wealth?
9.8%
Is the Gold standard realistic?
93% of top economists say no
Foreign exchange
A commodity consisting of currencies issued by countries other than one's own
Voluntary export restraint (VER)
A country self-limits its exports to another country. -Why limit your own international trade? -To keep good relations with ally/partner -Ex: Canada currently limits lumber exports lumber to U.S. -Ex.: 1980s, Japan limited auto exports to U.S. -Show good will, may be less than restrictions ally could impose
Heckscher-Ohlin Theory
A country will have a comparative advantage in producing products that intensively use resources it has in abundance. Can estimate exports based on resources
Mercantilism
A country's wealth is measured by its holdings of gold and silver
BOP accounting system
A double-entry bookkeeping system to measure/record all economic transactions between residents of two countries during a certain time period
Ownership Advantage Theory
A firm owns a valuable asset creates a competitive advantage domestically, which it can use to penetrate markets via FDI (superior tech, brand name, economies of scale) ex. Chanel, Pfizer, Tiffany, Intel
Economies of Scale
A firm's average cost of producing good ↓ as firm's output of that good ↑. Shows advantages of mass production
Gold Standard
A fixed exchange rate system because each country pegged (tied) value of its currency to gold
If U.S. and EU can agree on standards....
A lot of $$ can be saved
What happened with French currency in 1969?
A similar situation to that of the UK in the 60s where the value of the Franc decreased so the government had to use other currencies to buy Francs off the global market but investors would get scared and put their Francs back into the market
spot price = $1.5212 and 3month forward price = $1.5203 forward discount
AFP/D=((Pf-Ps)/Ps)n pf = forward price ps = spot price n = # of periods in year = 4 (4 three-month periods in a yr) AFD = ((1.5203-1.5212)/1.5212)4 = -.0024=-.24%
Embargo
Absolute ban on all trade with a country as punishment -Ex.: U.N. 1990 embargo on Iraq -Ex.: U.S. embargo on Cuba
FDI
Acquisition of foreign assets for purpose of controlling them (e.g., buying existing or new assets, plants, and equipment)
Countervailing Duty (CVD)
Ad valorem tariff imposed on imported good to counteract foreign subsidies -Calculated to just offset advantage exporter gets from subsidy -Trade can be driven by competitive advantage, not distorted by subsidies
Who created the theory of absolute advantage?
Adam Smith
Asian Contagion
Aftershocks eventually spread to Lat. Am. and Russia, which defaulted on its foreign debts
Fair Trade
Aka "managed trade"; governments should actively intervene to ensure .... -Domestic firms receive equitable share of market -Imports are controlled to minimize domestic losses in jobs/market share in specific industries -Governments should "level the playing field" so domestic/foreign firms can compete on equal terms (As we'll see, argument often used to justify policies that restrict foreign competition -What looks like "level the playing field" fairness to one nation is protectionism to another)
U.S. Trade Act of 1974, WTO rules
Allow temporary trade barriers to be enacted if ITC determines U.S. firms have been seriously harmed by sudden ↑ in imports -Allows country time to adjust to imports -Ex: U.S. tariff on Chinese tires discussed earlier
International Banking Facilities
An entity (subsidiary) of a U.S. bank that is legally distinct from bank's domestic operations that may only offer international banking services -Don't observe U.S. domestic banking regs (but must follow other rules imposed by Federal Reserve) -May accept deposits/make loans to non-U.S. residents only -Allows U.S. banks to compete better in Euroloan market -highly competitive - Issues Foreign, Euro, and Global bonds
Nontariff Barriers to International Trade (NTB)
Any government regulation, policy, or procedure other than a tariff that has the effect of impeding international trade Include: quotas, tariff rate quotas, numerical export controls, and other NTBs
Who can participate in the foreign exchange market (forex market)?
Anyone who owns money denominated in one currency and wants to convert it into a second currency
Production Costs
Are prices, taxes, rents, labor costs lower? Produce abroad to increase profit margin
Ad valorem tariff
Assessed as percentage of value of imported good -Latin for "according to value" -2.1% AV tariff levied against imported pineapples preserved by sugar
Specific tariff
Assessed as specific dollar amount per unit of weight/other measure -6 cents/kg tariff levied against citrus fruit preserved by sugar -Market value doesn't matter; just weight or other measure
Countries that also float currencies
Australia, Canada, Japan, Switzerland, U.K.
Why doesn't two-point arbitrage happen often?
B/c rush to buy low-priced € in Frankfurt will quickly drive up price to equilibrium ($2.00), erasing profit opportunity
Correspondent Relationship
Banks act as agents for each other in respective countries
Why do we need currency?
Bartering is inefficient; requires you to find someone willing to take exactly what you have in exchange for exactly what they have/you want
Public Choice Analysis
Branch of economics analyzing public decision making
Dollar-Based Gold Standard is also known as
Bretton Woods System
Where does the dominance of the USD come from?
Bretton Woods System
Due to tradition or convenience, in the US how are exchange rates expressed in pounds, yen, and generally?
British pounds quoted on direct basis and Japanese yen quoted on indirect basis Generally, see quotes of foreign currency / US $1 (indirect)
Assume we are operating under the Bretton Woods System. If a currency's value rises above the range required by the system, that country's central bank will______ in the international foreign exchange market.
Buy gold/foreign currency
Competitive Advantages
Can firm better exploit advantages abroad (e.g., brand name)?
Example of TRQ
Canada allows ~3.2 mega tons of butter imports yearly tariff-free* -Foreign producers are allowed to import butter into the country beyond that limit, but for all butter imports >3.2 MT, they must pay a 298% tariff -Rule: Importers pass tariffs onto consumers 🡪 extremely high tariff raises consumer prices a lot 🡪 importers can't sell at those high prices 🡪 no one bothers importing beyond the quota, even though they technically, legally can
What country is the U.S.'s fastest growing source of FDI?
China
Who is the number one exporter in the world?
China
Two economies that will have positive growth this year
China and Taiwan
Uncovered interest arbitrage
Choosing to invest money in foreign country without using forward markets (betting that you know the outcome)
1950's Eurocurrency Market
Communist nations in Central/Eastern Europe needed $ to finance international trade but feared that U.S. govt. would confiscate/block $ holdings in U.S. banks for political reasons -Found European banks willing to hold accounts for them in $ (Hence, Eurodollars) Other intl. banks (in Canada, Japan) also held dollars
Currency future
Contract obligating two parties involved to trade particular amount of currency pair (e.g., $/€) at a predetermined price at some point in future - only 1% of total global forex mkt
monetary policy
Controls monetary supply, interest rates for borrowing money
How did the gold standard function?
Countries agree to buy/sell their paper currencies in exchange for gold on request of any individual/firm and Countries allow free export of gold bullion/coins
Public debt (government debt)
Countries engage in large scale deficit financing to pay for public sector projects using government funding. Nations with large public deficits and debts are less attractive to foreign investors because a large debt encourages more inflation witch translates to lower currency value Debt 🡪 higher inflation 🡪 currency depreciation Surplus 🡪 lower inflation 🡪 currency appreciation
Theory of Absolute Advantage
Countries should completely specialize in (i.e., produce and export only) those goods and services it produces more productively (i.e., using less labor)
Euro-ized
Countries that got rid of their own and adopted the euro -Andorra, Kosovo, Monaco, Montenegro, San Marino, Vatican City
Interindustry trade
Countries trade goods of different types, e.g. wine and clock radios
Intraindustry trade
Countries trade goods of the same type, e.g., cars, consumer electronics, personal-care products
Trade surplus
Country exports more goods and services than it imports
Trade deficit
Country imports more goods and services than it exports
In 1944, why did 44 nations meet in Bretton Wood?
Create system to avoid mistakes preceding WWII; monitor trade, development, international currencies
Eurocurrency
Currency on deposit outside its country of issue
Money earned from investments is recorded in ______________ Account, but ... Investments themselves are recorded in ____________ Account
Current, Capital
Who developed comparative advantage?
David Ricardo
1985 Baker Plan
Debt rescheduling, if you take money the IMF can control of domestic monetary/fiscal policy; didn't work well
Standardized Product Stage
Demand levels off. Firms looking for more ways to reduce costs ex. labor costs. Product is now imported into firms home market (by either firm or its competitors).
Did William Wong partake in stabilizing or destabilizing speculation?
Destabilizing
Which type of speculation is more common
Destabilizing
Intl. Trade Admin. (ITA)
Division of U.S. Dept. of Commerce Determines if unfair trade practice has occurred If yes, pass case to Intl. Trade Commission (ITC)
Marketing Advantages
Does firm benefit from local visibility and ability to claim "local" status as a company for PR reasons?
Key Technology
Does company in which you want to invest already have technology you need?
Natural Resources
Does country contain resources essential to production/business?
Customer Access
Does firm need to be close to customer (e.g., fast-food restaurants)?
Location advantage
Doing business abroad more profitable than doing it at home
What is the primary transaction currency in forex market? why?
Dollar; it's used to facilitate most currency exchange
Eurodollars
Dollars held in banks outside U.S. came to be known as -Other currencies become stronger post-WW2 (¥, ₤, DM), market broadens to include Euro-¥, Euro-₤, etc.
Cross rate
Exchange rate between two currencies calculated through use of third currency -E.g., use ₤ to buy $, then $ to buy ¥
2 types of assets the capital account deals with?
FDI & FPI -Short term: Financial instruments w/maturities ≤1 year (CDs, checking accounts) -Long term: Financial instruments w/maturities ≥1 year (stocks, bonds)
Dunning's Eclectic Theory
FDI Occurs when three conditions are met: 1. Internalization advantage 2. Location advantage 3. Ownership advantage
Firm strategy, structure, and rivalry
Facing hard competition at home preps firms for global competition Many domestic investments are transferrable globally
Factor conditions
Factors of production (resources) affect ability to compete (Land, labor, capital, education of workforce, infrastructure)
European Debt Crisis
Failure of the Euro
Who is Adam Smith?
Father of modern free-market economic theory and argued against mercantilism
Internalization advantage
Firm benefits from controlling business abroad rather than contracting it out
Ownership advantage
Firm owns some unique competitive advantage (e.g., intellectual property) that gives it edge over competitors in foreign markets
The exchange rate system we have today as of 1973
Flexible exchange rate system established
1989 Brady Plan
Focus on debt reduction
Why do Counter Veiling Duties happen (CVD)?
Foreign firm charges lower price b/c of govt. subsidies
Why do Antidumping laws happen (ADL)?
Foreign firm charges lower price by choice or b/c costs lower
Investment controls
Foreign investment/ ownership limited in key industries -Defense, utilities, broadcasting, finance -China ranks 59/62 in OECD FDI Restrictiveness Index -U.S. ranks 38th -Most open: Luxembourg, Portugal, Slovenia, Romania, Czech Republic (globalized, European, small) -Why does China continue to attract so much investment?
Triffin Paradox
Foreigners needed $'s to finance exports/economic growth, but more $'s they had, less they trusted $35/ounce pledge
Spot and Forward Markets
Forex transactions involving payment to be made in future -Include lending activities / purchases on credit It's floating, not fixed so a loan today could be worth more/less a year from now
Convertible currencies
Freely tradable on international markets -Also called hard currencies
What is the best potential explanatory factor for offshore wealth?
Geography. Asian havens attract Asian money; Caribbean havens attract Americas' money; European havens attract European and Middle East money
What is one of the most influential monetary system?
Gold Standard
All of the following are potential problems with adopting the gold standard EXCEPT
Gold has no intrinsic value, so the system would be no more stable than our current system
Why don't economists think we should go back to the gold standard?
Gold is unstable, there's a market of gold that has nothing to do with currency like jewelry (high risk)
Free Trade
Government exerts minimal influence on export/import decisions of private firms/individuals
Industrial Policy
Government identifies key domestic industries critical to country's future growth and promotes policies to increase their competitiveness -Some success: Japan, South Korea But not always ... -Japan: Govt. encouraged analog HDTV, not digital -France: Govt. subsidies funded unprofitable car, computer, military, and aircraft ventures
Numerical export controls
Government restricts domestic producers from exporting certain products to promote industrial policy or competitiveness of other industries Ex.: India bans onion exports after severe flooding causes shortage and ↑ prices Ex.: China restricts exports of rare earth minerals—very controversial
opponents of industrial policies
Govt. can't choose winners; govt. support may be political, not b/c of economic potential
Import substitution strategy
Govt. encourages domestic manufacturing via barriers to imported goods -Post-WW2 Australia, Argentina, India, Latin America
Export promotion strategy
Govt. encourages firms to compete internationally via subsidies and tax breaks -Post-WW2 Singapore, South Korea, Taiwan, Latin America
Compound tariff
Has AV and specific components -6.4% AV tariff + 9.9 cents/kg specific tariff levied against cherries preserved in sugar
Why was Chairman Greenspan keeping interest rates low?
He was afraid of a double dip recession
Regulatory controls
Health, safety, environmental, licensing requirements -Brazil: Requires certain health products / food to be registered with Ministry of Health; approval takes 3-6 months -China: Requires all goods to receive China Compulsory Certification mark -China: Requires animal testing for cosmetics -Russia recently banned Durex condoms b/c paperwork filled out incorrectly (real concern: low birth rates)
Challenges of Mercantilism
Higher taxes to pay for subsidies and Higher prices from decreased competition
Tariff Barriers
Historically used for two reasons -Raise govt. revenue -Act as barrier to foreign goods Now mostly used to punish unfair trade practices
Fiscal Policy
How much a government collects in taxes and how much it can spend
How much is an actual dollar bill worth?
However much we believe it to be
1990s: International Debt Crisis receded via
IMF loans, rescheduling, and economic reforms
Big Max Index
If Big Mac costs 40% less in China🡪yuan is 40% undervalued compared with US $
forward premium
If forward price (using direct quote) is higher than spot price
forward discount
If forward price (using direct quote) is less than spot price
International Fisher Effect
If inflation is Expected to Increase 🡪 Money expected to be worth less in future - higher nominal interest -forward premium shrinks -forward discount widens If inflation is Expected to Decrease 🡪 Money expected to be worth more in future - lower nominal interest -forward premium widens -forward discount shrinks
One potential issue with absolute advantage
If one country is better at producing both goods then it eliminates international trade
Adjustable fixed exchange rate system
If value couldn't be maintained, peg could be adjusted in extraordinary circumstances (e.g., devalue currency to deal with persistent trade deficits)
Intl. Trade Commission (ITC)
Independent govt. agency If majority of members determine firm / industry has suffered "material injury," impose duties on offending imports
Related and supporting industries
Industry can stimulate development of local input suppliers Competition among suppliers 🡪 lower prices, higher quality, and innovation
Multilateral Investment Guarantee Agency
Insures private investors against political risk
Since U.K. reserves fell due to global market intervention
International market feared BOE (Bank of England) would run out of reserves 🡪 dumped ₤ on market 🡪 ₤ value ↓ further
Porter's Theory of National Competitive Advantage
International-trade success comes from interaction of four elements: 1. Factor conditions 2. Demand conditions 3. Related and supporting industries 4. firm strategy, structure, and rivalry
New Trade Theory predicts
Intraindustry trade will be common. Rival MNEs in same industry will battle globally to expand abroad.
Asian Currency Crisis
Investors begin to distrust Thailand's ability to repay foreign loans and maintain value of its currency, baht, which was pegged to dollar-denominated basket of currencies 🡪 baht sell-off in international market (Similar to what happened with UK) and eventually happens to other Asian nations and sell off goes regional
International trade
Involves exchange between residents of two countries
Logistics
Is transport expensive? Produce abroad to lower distribution costs
Foreign bonds
Issued by resident of country A, sold to residents of country B, denominated in country B's currency -Nestlé (Swiss resident) issues bonds denominated in ¥ for primary sale in Japan
Eurobond
Issued in currency of country A but sold to residents of other countries -American Airlines borrows $500 million to finance new aircraft by selling $-denominated bonds in Denmark and Germany
What happened to the supply of USD in the 50s-60s?
It became really large due to the amount of imports US was buying
Since covid, what has happened to FDI in Mexico and Germany?
It has increased
Since covid, what has happened to FDI in China?
It's has a small drop but their economy is rebounding quickly
What about London makes it good to be a large foreign exchange market?
It's the only place in the world where the business day overlaps with every other major city in the world
Affiliated Bank
Joint venture with foreign partner
Global bond
Large, liquid financial asset that can be traded anywhere, anytime -Use pioneered by World Bank
What did banks do with the unspent petrodollars?
Lent them do developing countries and many borrowed more than they could repay
Restricted access to distribution networks
Limit foreign suppliers' access to distribution networks -China: Imported sugar, petroleum must be distributed by state-owned firms -China, EU: Limit U.S. films shown in countries
What is the largest foreign exchange market (forex)?
London, followed by NYC, Tokyo, and Singapore
Current Account
Measures net balance of four components ; the balance of trade between a country and its trading partners
Where and when did the International Debt Crisis begin?
Mexico, August 1982 -Mexico requests debt rescheduling (more time to pay), moratorium on principal payments, IMF loan
What is the World Bank now responsible for?
Mission is to build economies of world's developing countries
Who is mercantilism popular with?
Monarchs and manufacturers of exports
covered interest arbitrage
Most Common -You have $1 million to invest -Spot ₤1 = $2.00 (so, $1 = ₤0.50) -3-mo. forward ₤1 = $1.99 -Before you invest $ in UK, calculate expected profits in UK (Option 2 on previous slide) -Sell amount of expected profits in ₤ on forward market Option 2: Invest in UK @ 12% annual r (=3% for 3 mos.) -First, convert $ to ₤ using spot rate: $1 million 🡪 ₤500,000 (1,000,0000 x 0.50 = 500,000) -After 3 mos., investment = (₤500,000)(1.03) = ₤515,000
Investment Banking
Most banks also provide investment banking services, as do large securities firms (Nomura, Goldman Sachs)
Country Similarity theory suggests
Most trade in manufactured goods should be between countries with similar per capita incomes and intraindustry trade should be common. This theory is particularly useful in explaining trade in differentiated goods such as automobiles, expensive electronics equipment, and personal care products, for which brand names and product reputations play an important role in consumer decision making.
Relationship between volume trade growth and GDP growth
Move in the same direction but trade growth is much more volatile.
Country fund
Mutual fund specializing in investing in a given country's firms
Pre-euro, EEC/EU held fixed rates among themselves within
Narrow range (ERM)
If two countries each devalue their currency by 20 percent, which of the following would happen? Group of answer choices
Neither would gain an advantage because each currency's value relative to the other would remain the same
Inconvertible currencies
Not freely tradable on international markets b/c domestic laws forbid it or foreign investors unwilling to hold them -Also called soft currencies (in countries with political instability)
Quota
Numerical limit on quantity of good that may be imported into country during given time period, e.g., one year (same affect as a tariff)
Forward (future) price
Often differs from spot (current) price -Represents marketplace's aggregate prediction of what spot price of exchange rate will be in future
The value of a good equals the value of what is given up to have that good. The previous statement describes which of the following?
Opportunity cost
Financial Crisis are very similar to
Pandemics
Branch Bank
Part of parent bank
Primary Income
Part of the Current account. + Domestic residents earn $ from foreign investments - Foreigners earn $ from domestic investments
FPI
Passive holdings of securities (e.g., stocks, bonds) Theory suggests FPI driven by attempts to seek higher rates of return and to ↓ risk by international diversification
-Why does China continue to attract so much investment?
Potential return from their large market and fast expanding middle class
Fixed exchange rate
Price of currency does not change relative to other currencies
exchange rate
Price of one currency in terms of another
Proponents of industrial policies
Private sector won't always support cutting-edge industries b/c profits aren't there ex. -U.S. govt. helped develop internet, telecomm, aeronautical/space technology
Trade Barriers
Produce abroad to avoid high tariffs sometimes associated with exports (Chp. 9)
Economic Incentives
Produce abroad to take advantage of policies that encourage FDI
Maturing Product Stage
Product widely adopted and used. spike in domestic demand. Firm decides to lower costs by expanding to manufacturing to meet domestic/foreign demand. Competitors start to come out.
Arbitrage of Money
Professional traders seek to profit from small differences in price of forex in different markets ●Two-Point ●Three-Point ●Covered-Interest
Terms of Trade (ToT)
Ratio comparing export prices to import prices. If a countries exports rise at a greater rate than imports its terms of trade have favorably improved which tends to show currency appreciation. If imports rise at a greater rate than exports their currencies value will decrease. PX↑ > PM ↑ 🡪 ToT improve 🡪 currency appreciation PM↑ > PX ↑ 🡪 ToT worsen 🡪 currency depreciation
The Capital Account
Records purchase and sales of assets between residents of countries
Official reserves balance
Reflects net quantity of country's currency that is demanded and supplied by all market participants, other than domestic central bank -Each balance represents a different perspective on nation's position in global economy -Use each balance depending on IB issue at hand
Balance on services
Reflects service sector's global competitiveness
Unilateral Transfers (aka secondary income)
Remittances, government aid (as opposed to loan, which must be repaid)
Local purchasing requirements
Require foreign firms to purchase goods/services from local suppliers -Indonesia: Ties drug-sale approval to manufacturing drug locally -China: Requires travel agents to use China's state-owned reservation service to book trips for Chinese tourists -Canada: Requires 60% of TV programs to be of Canadian origin -India required domestic purchase of solar products; lost WTO complaint by U.S. in 2016
International investment
Residents of one country supply capital to another country
U.S. Trade Representative
Robert Lighthazer -Coordinates trade policy with other U.S. agencies -Acts as president's principal international trade policy spokesperson -Reports to president and Congress on trade agreements and trade-related issues -Leads all WTO-related negotiations -Gathers data and information on U.S. trade with all trading partners
Swap transaction
Same currency bought/sold simultaneously; delivery made at two different times -Allows use of funds in one currency to fund obligations in another currency; aka "spot against forward" swap -Usually, currencies are first swapped at spot (initial) rate; future rate calculated by adjusting spot price based on forward price for length of time transaction runs
Subsidiary Bank
Separately incorporated overseas from parent bank
Entire current account balance
Shows combined global performance of manufacturing/service sectors -As well as govt. transfers and investment income
Sterling Era
Some countries pegged (tied) currency to ₤ Others pegged to U.S. $ or French franc
SDR
Special Drawing Rights
Another name for Gold Standard?
Sterling-based Gold Standard
Why did London become the dominant financial center?
Strong international trust in ₤, expanding British empire
Law of one price
Such arbitrage activities (buy low/ sell high) continue until price of good is identical in both markets (excluding transaction/transportation costs, taxes, etc.)
What is the difference between supply and quantity supplied?
Supply refers to entire curve (number of factors can cause shift) Quantity supplied - point on the curve (only shifts from change in price)
Tariff
Tax on good traded internationally
Import tariff
Tax on goods entering country -Most common 3 types -ad valorem -specific -compound
Export tariff
Tax on goods leaving country
Transit tariff
Tax on goods passing through country
Product examples that have followed the Product Life Cycle Theory
Tech products (iphones), textiles, cars, etc.
How can we have more surpluses when the United States registered a record trade deficit in 2018 of $879 billion?
That can be because the United States has an enormous trade deficit with China, a deficit that topped $400 billion for the first time in 2018 and was more than fives times the size of the next largest U.S. deficit. It can be because the total U.S. deficit with just seven countries - Mexico, Germany, Japan, Ireland, Vietnam and Italy in addition to China - was equal to more than 85% of the total U.S. deficit in 2018.
Assume we are operating under the Bretton Woods system. The British pound is pegged at US$3.50. Which of the following would NOT occur if the British pound depreciates to US $3.395?
The British government could do nothing as long as the pound remains within 5% of the peg
Transaction costs
The costs of negotiating, monitoring, and enforcing contracts for exporting, licensing, or franchising agreements
Balance of Payments Accounting System (BOP)
The way countries keep track of all goods, services, and assets that flow through them every year
What if everyone devalues and ↑ tariffs?
They cancel each other out. "Beggar Thy Neighbor": No one wins WW2 🡪 Trade collapse
What is the only thing that has any intrinsic value ?
Time
Which of the following is NOT one of the objectives included in the IMF's Articles of Agreement?
To lengthen the duration of disequilibrium in the international economic system
What matters more for overall policy? Surplus/deficit or trade balance
Trade Balance
Political Factors
Trade Barriers Economic Incentives
What is the difference between trade balance and surplus/deficit?
Trade balance- a ratio between exports and imports surplus/deficit is the difference between the two
What is the main factor that determines whether a firm will internalize or externalize their operations?
Transaction Costs
What did G-10 do in December 1971 at the Smithsonian Conference?
Tried to make a Bretton woods type system. -Devalued $ to $38/ounce -$ remained inconvertible to gold -Peg allowed currencies to fluctuate ±2.25% around par values (as opposed to ±1% under BW)
Which of the following signified the growing fear that the United States could not live up to its Bretton Woods obligations?
Triffin Paradox
With the increase of USD supply in the global market, countries had to trust that the US had enough gold for all of the dollars its giving out which lead to the
Triffin Paradox
Why were most firms willing to be paid in pounds or gold?
U.K. was world's dominant economic/military power
Bretton Woods Par value of USD
U.S. $ = $35 per ounce of gold (i.e., $1 = 1/35 ounce of gold)
U.S. Sugar TRQ: Above-quota tariff ~88% for raw sugar, ~75% for refined sugar
U.S. Sugar TRQ... 1) ↑ consumer prices in itself by limiting supply 2) ↑ input prices for businesses that use sugar 3) As input prices ↑, supply of sugar-using products ↓ further 🡪 ↑ consumer prices even more Note: The few U.S. sugar producers benefit. But... -Estimated annual NET loss to economy = ~$1 billion
Since the supply of USD increased, international markets had to trust that the U.S.
U.S. would/could honor pledge to redeem all those $'s floating around @ $35/ounce gold should it be asked since gold supply doesn't increase in the short run
some nations peg currencies to
USD or Euro
Which country has the most power in IMF?
United States
Who is the number one importer in the world?
United States
Economic Development
Used primarily in developing countries
how are classical trade theories still helpful?
Useful for describing trade in commodities based on price, not brand
Offshore Financial Centers
Usually smaller countries -Focus on offering banking and other financial services to nonresident customers -MNEs often use offshore financial centers for obtain low-cost Eurocurrency loans -Efficiency of offshores in attracting global $ and customers is important factor in growing globalization of capital market
One challenge of the Bretton Woos System in the 1960s is
Value of ₤ weakened (fell below 1% range) 🡪 Bank of England sold gold/ foreign currency to buy ₤ (buy ₤ off market to ↓ supply and ergo ↑ its price)
Trade
Voluntary exchange of goods, services, assets, or money
Demand Conditions
What are your customers at home like? Consumer base that stimulates supply of innovative products allows firms to fine-tune products for global market
Remittance
When someone works in one country but sends their income ack to their home country
What question does Internalization Theory answer?
Why do firms enter markets via FDI, rather than exporting or licensing to foreign firms?
Customer Mobility
Will firm's customer build factory abroad? Following customer ↑ supply chain support for that customer
If a country has a comparative advantage in the production of one good, the other country must have
a comparative advantage in the production of the other good.
Current Account Deficits
a country is importing goods/services more than it is exporting them then borrows capital from foreign sources to make up the deficit causing its currency to depreciate Deficits 🡪 currency depreciation Surpluses 🡪 currency appreciation
Differentials in Inflation
a country with a typically lower inflation rate exhibits a higher purchasing power value and a country with a typically higher inflation rate see depreciation in their currency's value avg relative Lower inflation 🡪 currency appreciation avg relative Higher inflation 🡪 currency depreciation
Dollarized countries:
adopted the U.S. $ as their national currency -Ecuador, East Timor, El Salvador, Marshall Islands, Micronesia, Palau, Turks and Caicos, British Virgin Islands, Zimbabwe
When U.S. imposed quota on Japanese cars in mid-1980s,
average car price increased by about $1,000 (adjusted for inflation, ~$2,350 today)
Wholesale Market
banks buy currency in bulk for themselves or large customers (just like walmart buys goods in bulk) Interbank transactions, usually of ≥ $1million account for majority of forex transactions
Euroloan Market
banks make loans of eurocurrencies -Is extremely competitive, with lenders operating on razor-thin margins -Euroloans often quoted on basis of LIBOR (London Interbank Offered Rate) -Is low-cost source of loans for large, creditworthy borrowers (govts., large MNEs) b/c loans 1. Are free of costly govt. regs. (e.g. reserve requirements) 2. Are large, so avg. cost is small 3. Have lower risk premium b/c of borrowers' creditworthiness
leverage
borrowing money to amplify the outcome of a deal
Japanese won't sell their yen if they don't want to
buy foreign stuff/currencies
Forex market consists of
buyers and sellers of currencies issued by world's countries
What is the difference between demand and quantity demanded?
change in demand- shift in entire curve (influence in a number of factors) change in quantity demanded - shift along the curve (influenced only by price)
Crawling pegs allow value to
change over time
As fixed system, gold standard can eliminate ability to
conduct traditional monetary policy
Changes in exchange rates affect
consumer prices, markets where they shop, and firms' profits
Indirectly, every currency is
convertible into gold bc every currency can be converted into the dollar
Additional borrowing allowed under IMF conditionality which means
countries agree to make economic reforms in exchange for funds
If value fell outside of range (+/- 1%)
country intervened in international foreign exchange market to bring it back in range
Are Capital inflows recorded as credits or debits in BOP? Which 2 ways can they occur?
credits; 1. Foreign ownership of domestic assets ↑ -Ex: Israeli drug manufacturer buys PA-based pharma -Israeli co. sends $ to U.S. co. in exchange for company assets 2. Domestic ownership of foreign assets ↓ -Ex: Ford Motor sells its Jaguar/Land Rover to India's Tata Motors -Ford gives its company assets to Tata in exchange for $ sent to U.S. co. In these two cases, money (capital) is coming into U.S.
What does it mean to let a currency float?
currency's value determined by its supply/demand
Are Capital outflows recorded as credits or debits in BOP? Which 2 ways can they occur?
debits; 1. Domestic ownership of foreign assets ↑ -Ex: Pepsi buys 74% of Russian beverage co. OAOL -Pepsi sends money out of U.S. to Russian co. in exchange for company assets 2. Foreign ownership of domestic assets ↓ -Ex: German mutual fund sells stock in GM to U.S. resident -U.S. resident sends money out of U.S. to German mutual fund in exchange for GM assets In these two cases, money (capital) is leaving the U.S.
How do you increase the value of a currency?
decrease the supply by selling reserves to buy your own currency back
Each member of the IMF pays
deposit, partly in gold, partly in domestic currency, called quota
if ₤ is selling at a forward discount, forex market believes ₤ will
depreciate over time
Demand for yen is ______________ because the demand comes from _____________.
derived demand; foreigners desire to buy Japanese goods, services, and assets
Supply of Yen is derived from
desire of Japanese to acquire foreign goods, services, and assets
Inflation
devaluation in the purchasing power of the monetary unit
During the Sterling Era, what did countries do to stimulate growth?
devalued currencies and ↑ tariffs on imports; Recall that cheaper currency 🡪 exports cheaper abroad 🡪 exports ↑ 🡪 boosts domestic economy
in 1980, 1/3 of international trade exports came from
developing/ emerging economies
SDRs ↑ liquidity but
did NOT ↓ glut of $ on intl. market
Currencies of nations with trade deficits or high inflation often sell at a
discount
What was created at the Bretton Woods meeting?
dollar-based gold standard, IMR (International Monetary Fund), and IBRD (International Bank for Recreation and Development a.k.a. World Bank)
Demand curve slopes ______ which means the relationship between price and quantity is _______.
downward; inverse ex. as price of yen falls, quantity of yen demanded rises
intersection of supply (S) and demand (D) yields market-clearing,
equilibrium price and quantity
By 1969, the IMF creates special drawing rights (SDRs) which are
essentially an alternate type of reserve asset (sometimes AKA "paper gold") -Value based on weighted avg. of four key currencies: $, ₤,€, ¥
The equilibrium price is the
exchange rate,
Transacting gold was
expensive and slow
In 1999 what percent of trade with China was exports? imports?
exports 14%; imports 86%
Jinping thinks China needs to be less dependent on _________ and more dependent on __________. He also wants ......
exports; domestic consumption; Hong Kong to be a bigger part of mainland China
Another name for flexible exchange rate system is
floating exchange rate system
New Trade Theory
focuses on economies of scale to explain trade in differentiate goods
Classical Trade theories
focuses on individual country in examining patterns of exports and imports
To buy foreign stuff, Japanese need ____________, which they get by selling ________ and using the proceeds to buy __________________.
foreign currencies; yen ; foreign currencies
Firms can find low-cost financing in global capital markets and then use ___________________ to convert foreign funds into currency they need
foreign exchange-market
Political stability and economic performance
foreign investors seek out stable countries with strong economic performance to invest their capital. ex. Political turmoil can cause a loss of confidence in a currency and a movement of capital to a more stable country Stability, growing economy 🡪 currency appreciation Instability, weak economy 🡪 currency depreciation
international foreign exchange markets are mostly, but not completely
free (Called a "managed," or "dirty," float)
The International Monetary Fund predicts that after 2020..
global trade volume will rapidly increase
One problem with the gold standard is it doesn't work if the world's need for money increased faster than
gold supply
Besides banks, what entities can also buy/sell large quantities of forex?
governments, Corporate treasurers, pension funds, hedge funds, mutual funds, insurance companies
Post-Covid, Chinas exports and imports ______ and trade surplus with the US _______
grow; declines
Competition in Investment Banking (I-banking)
has forced investment bankers to globalize in order to secure capital for clients at lowest possible cost
Differentials in interest rates
higher interest rates offer lenders a higher return RELATIVE to other countries but the impact of higher interest rates is mitigated if the countries inflation is much higher than other countries or if other factors drive their currency down. aka it's relative Higher rates 🡪 currency appreciation (ceteris paribus) Lower rates 🡪 currency depreciation (ceteris paribus)
As China and other developing countries have been exporting more, they have also been
importing more from the rest of the world
tariff rate quotas (TRQ)
impose low tariff on limited amount of imports of good; above that, impose prohibitively high tariff -doesn't legally restrict trade, but restricts with incredibly high tariff (disincentives) -Because TRQs limit domestic supply 🡪 same effects on domestic markets/prices described in slides 35-36 (SUV imports)
What is the main goal of mercantilism?
increase gold/silver by focusing on exports
Wealth of Chinese banks has
increased significantly in recent years
In absolute numbers, our trade deficit with China and other countries has ______ but in relative numbers, it has ___________
increased, improved in our favor
How do you decrease the value of a currency (due to it growing above the 1% Margin?
increasing the supply of reserves by purchasing them with your own currency
Which of the following is cited as one of the causes of the 1997 Asian Currency Crisis?
increasing trade deficits
LIBOR
interest rate that London banks charge each other for short-term Eurocurrency loans -Partly determines interest rates worldwide
Capital account is determined by
international differences in savings and investment opportunities -Capital flows to countries with good returns and good opportunities
Because investors kept dumping pounds onto the market and the U.K. had to spend even more reserves to support the pound, by 1967
it became Vicious cycle resembling run on bank
A country has absolute advantage when...
it can produce the good using less labor than another country
Small changes in GDP growth are associated with
large trade volumes
A large portion of the world's FDI is either
made by or goes to rich nations
As the amount of trust foreigners had in the US$35/ounce pledge decreased,
more investors wanted to exchange $'s for gold which meant they were less likely to be able to honor the pledge (beginning of the end of Bretton Woods System)
Economic pressures of WWI
nations couldn't maintain currencies' par values
AFD is always _________ and am AFP is always __________
negative, positive
If no one wants to buy Japanese stuff,
no one would want Japanese yen
What is the purpose of a subsidy (check from govt to business)?
o Can stimulate exports by ↓ firms' input cost o National, state, local govts. provide economic incentives so firms create local jobs -Georgia offers Kia Motors $400 million in incentives to open factory in West Point, GA -Louisiana, Canada offer tax breaks and incentives for film production o Subsidies may artificially improve competitiveness -W/o subsidies, firms not competitive on global mkt - Pushes out otherwise competitive producers -Ex.: U.S. cotton subsidies contribute to global poverty o Large/poorly targeted subsidies can distort international trade -Shipbuilding, wheat, butter, cotton industries
National Defense
o Country must be self-sufficient in critical raw materials, machinery, tech -Energy supply from domestic/friendly sources -Defense/military contracts to majority-U.S.-owned co.'s o Popular with general public o Sometimes legitimate: Don't want foreigners running sensitive defense contracts o Sometimes not: 1954 Wool Act protects U.S. mohair industry b/c material once used in making uniforms
Covered Interest Arbitrage Effects
o Funds transferred from NYC to UK 🡪 -In NYC: Supply of lendable $ ↓ 🡪 r ↑ -In UK: Supply of lendable $ ↑ 🡪 r ↓ o Spot market: We need ₤ to invest in UK -Demand for ₤ ↑ 🡪 spot price of ₤ ↑ o Forward market: We sell ₤ to cover forex risk -Supply of ₤ ↑ 🡪 forward price of ₤ ↓ o Lendable funds will continue to flow between NYC and UK until return on covered investment = in NYC and UK -Occurs when r difference between two markets = 3-mo. forward discount on ₤
Foreign Trade Zones (FTZ)
o Geographic area where imported/exported goods receive preferential tariff treatment -Used worldwide to spur economic development -May be as small as warehouse, as large as city o FTZs allow firms to ↓, delay, or eliminate tariffs Ex.: Maquiladoras in Mexico -Factories mostly near U.S. border where parts are assembles and re-exported (~80% of Mex. Exports go to U.S.) -Goods get preferential tax treatment Ex.: Azerbaijan, Macedonia FTZs
Antidumping laws
o May impose tariffs to protect local industries from dumping
Export Financing Programs
o Success/failure for exporting big-ticket items (aircraft, drilling rigs) depends on -Product quality -Attractive financing -Reliable repair service after sale o Most nations have govt.-owned agencies to assist domestic firms in financing export sales o U.S. Export-Import Bank (EXIM) provides loan guarantees and export credit insurance where private sector unable/unwilling to do so OPIC (see Chapter 3) provides political risk insurance
Enforce Unfair-Trade Laws?
o Unfair trade laws are supposed to promote competition and protect consumers, but they may o Harm consumers -Some argue predatory pricing rare -Low prices good -Milton Friedman: "If foreign governments want to use their taxpayers' money to sell people in the United States goods below cost, why should we complain? Their own taxpayers will complain soon enough, and it will not last for very long." o govt uses laws to - to erect trade barriers - Be politically motivated - Spark retaliations and further ↓ trade
Par Value
official price in terms of gold
In 1978 - 1979, Shah of Iran deposed which caused
oil prices ↑ again 🡪 more inflation
According to absolute advantage, a country should
only export what they are most productive at producing and import those that they aren't productive at producing
According to Comparative Advantage, a country should
only export what they are relatively more productive at producing and import those that they aren't relatively more productive at producing
What did the World Bank initially finance?
post-WWII reconstruction in Europe
Currencies of nations with trade surpluses or low inflation often sell at a
premium
Direct exchange rate (direct quote)
price of foreign currency in terms of home currency Amount of domestic currency needed to buy or sell one unit of foreign currency ex. $.012978/¥1
Indirect exchange rate (indirect quote)
price of home currency in terms of foreign currency Amount of foreign currency needed to buy or sell one unit of domestic currency Ex: ¥77.06/$1
two-point arbitrage (geographic arbitrage)
profiting from price differences in two geographically distinct markets. Doesn't happen often Ex.: Suppose €1 is trading for $2.00 in NY and $1.80 in Frankfurt -Trader can buy €1 for $1.80 in Frankfurt and immediately resell it in NY exchange market for riskless profit of $0.20
By the late 60s, the supply of the two main reserve assets (gold and US $)
proved inadequate to support the Bretton Woods System (too many dollars, not enough gold)
Mathematically, direct and indirect rates are
reciprocals of each other ex. Direct rate = $.012978 / ¥1 Reciprocal = ¥1 / $.012978 ≈ 77.06 = indirect rate Indirect rate = ¥77.06 / $1 Reciprocal = $1 / ¥77.06 ≈ .012978 = direct rate
IMF predicts in 2021 that the U.S. will
recover but not all losses we incurred in 2020
Balance on merchandise trade
reflects manufacturing sector's global competitiveness
Our Global Trade balance and balance with China has__________ over the last 20 years.
remained very stable
Germanys trade surplus _______ due to covid
shrinks
Japans trade surplus _______ due to covid
shrinks
All of the following helped cause the 1997 Asian financial crisis EXCEPT
significant capital outflows
A Quota reflects
size of economy and member's political importance
How can firm know future value of a currency?
spot and forward markets, currencies can be bought/sold for immediate or future delivery Markets allow swaps, currency futures, currency options -Facilitate international trade and investment by allowing firms to hedge (reduce) forex risks of international transactions
In a Swap, which rates do you need to know?
spot rate, forward rate
_______often signals market expectation re countries' economic policies and prospects
spot vs. forward
In 1950s-1960s, the US
started running large trade deficits (importing a lot more than they were exporting)
Trend of global trade patterns since 1990s
steadily increasing except for dips due to recessions
the price of foreign exchange (foreign currencies) is determined by
supply and demand* (because we have flexible exchange rate system) Note: The supply and demand model is used to analyze international currency markets. When it comes to domestic money supply, we use the IS-LM model, not supply and demand.
Real exchange rate adjusts to ensure
that current account offsets desired capital flows 🡪 As capital flows into U.S. 🡪 D for $ ↑ 🡪 $ value ↑ 🡪 imports ↑ & exports ↓ 🡪 trade deficit ↑ until.... Trade Deficit = Capital Account Surplus.
August 15, 1971: President Nixon announces
that dollars no longer redeemable for gold (ended Bretton Woods System)
With the gold standard, Countries pegged currencies to
the U.S. $: Pledged to maintain value of currencies within ±1% of par value (value in relation to U.S. $)
in 1980, 2/3 of international trade exports came from
the developed world ie. EU, japan, U.S., Australia, etc.
The more money you put into the IMF
the more influence you have
A country has comparative advantage when
the opportunity cost of producing that good in terms of other goods is lower in that country than in the other country
Arbitrage
the riskless purchase of a product in one market for immediate resale in a second market in order to profit from a price discrepancy -Underlying concept: If price of good differs in two markets, people will buy in cheap market and sell in more expensive market (people like to buy low and sell high)
opportunity cost
the value of what is given up to get the good
Because the U.K. used other currencies to buy pounds of the market,
their reserves (needed to maintain currency peg) fell
The reason the Bretton Woods System worked is
there was a lot of Faith in U.S. economy and currency assured system's stability
How has the percentage of U.S. and EU global exports changed since 1980
they have decreased
Special interest groups (lobbyists) often dominate general interest on issues because
they're willing to work harder for favorable laws than public is willing to work against them so Governments sometimes adopt policies benefitting small group, hurting country as a whole
New Product Stage
time when someone is developing new, innovative products to respond to demand or discovering a niche. Focus is on customer reactions and trying to identify strengths and weaknesses. usually a prototype. Domestic Sales.
Country Similarity Theory is useful in explaining
trade in differentiated goods
Current account is
trade in goods, services, and income from investments
Most international forex transactions are denominated in
transaction currencies like the $, €, ₤, ¥ ex. if Israel imports wool from New Zealand, there is no international shekel/NZ dollar market -Convert shekels/NZ dollars into $ or ₤ and conduct transaction
Currency supply curve is
upward sloping (like other supply curves) ex. as price of yen rises, quantity supplied also rises
if value of currency A ↑ in terms of the value of currency B
value of B must ↓ and vice versa
Quotas determine
voting power and borrowing power (each member can borrow up to 25% of its quota) in IMF
The International Monetary Fund predicts that by the end of 2020...
we will have lost 10% in global trade volume
Most rates on loans
were floating; rates rose 🡪 ↑ debt
Deficit spending
what govt spends that is over the amount they've made in taxes
Related to Jones Act—anti-cabotage laws
which keep foreign airlines from serving domestic routes -↓ competition, ↑ prices -Government-sanctioned oligopoly
The International Monetary Fund predicts that world GDP
will shrink by 4.4% by the end of 2020
In 1973, OPEC (Organization of Petroleum Exporting Countries) imposes oil embargo after Israel wins Arab-Israeli War which caused
world oil prices quadruple
To buy Japanese stuff, foreigners need
yen
Does China both imports and exports more today than it did in the 1980s?
yes
Does Law of One Price / PPP hold in real world?
yes; Latvia's adoption of euro in 2014 and showed price convergence within days
To determine how balanced the trade between two countries is,
you switch to division. You divide exports into total trade.
How do exports directly and indirectly affect national economies
ØDirectly add to GDP* ØIndirectly spark additional economic activity domestically (ex. car industry)
How do imports directly and indirectly affect national economies
ØDirectly reduce GDP* ØIndirectly pressure domestic suppliers to cut prices and improve competitiveness (firms have to improve to get your business) ØCan indirectly ↑ GDP
Key points of NTBs in Africa
•Continent loses money to high trade costs -Costs Africa's top grocery chain $20,000/week to secure import permits to distribute in one country -1,600 docs needed to send one truck across regional border -Cost of crossing Congo river—border bet. ROC and DRC—is $40 round trip, 40%-80% of average citizen's monthly income •African nations claim that regional integration is a strategic objective, but in reality this is far from truth, especially re trade policy •Need intra-African trade to boost continental economic growth, reduce poverty, and increase employment opportunities to youth •NTBs include: -High transaction costs -Complicated immigration procedures -Limited capacity of border officials -Costly import/export licensing requirements -Lack of investment in trade associations •Approximately 10% of Africa's trade is intra-continental -EU: 60%; regional trade is engine of growth •High transport costs and logistics especially problematic in rural areas •Unclear policies hamper traders •Underdeveloped infrastructure causes border-crossing delays of days •African consumers pay up to 40% extra for goods b/c of transport costs -10% in ROW -Africa not competitive as a result •Removing barriers could add up to $34 billion in trade annually •Senegal and Mali: Example of facilitating intra-regional trade •Reducing barriers could also mean more doctors, lawyers, accountants, etc., traveling from country to country to offer services -Kenya: Recognizes qualifications from other countries so accountants from, Burundi, Tanzania, Rwanda, etc., can practice in Kenya •Services can move more freely, which is very advantageous. Why? -Creates more jobs, increases global competitiveness, ↓ reliance on Western economies • ↓ trade barriers could also help end food shortages, which affect 240 million people continent-wide •To make changes, need strong partnerships among nations and regional institutions •Need current leaders to take action on existing policies and further free trade policies
Example of three-point arbitrage (comparing cross and direct rate)
₤1 buys $2 in NY, Tokyo, and London $1 buys ¥120 in NY, Tokyo, and London ₤1 buys ¥200 in NY, Tokyo, and London -Cross rate is calculated using 3rd currency (₤1 /$2)($1/¥120) = (₤1/ ¥240)
Example of three-point arbitrage
₤1 buys $2 in NY, Tokyo, and London $1 buys ¥120 in NY, Tokyo, and London ₤1 buys ¥200 in NY, Tokyo, and London -Two-point arbitrage not possible since exchange rate between each pair of currencies is same in each market -However, profit can be made in three steps 1. Convert ₤1 into $2 2. Convert the $2 into ¥240 (b/c $1 buys ¥120, 120x2=240) 3. Convert ¥240 into ₤1.2 (b/c ₤1 buys ¥200, 240/200=1.2) You just turned ₤1 into ₤1.2
If ₤ is selling at a forward premium, forex market believes ₤ will appreciate over time Firms may want to
↑ their holdings of assets in ₤ ↓ their liabilities in ₤
