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Foreign ExchangeForeign Exchange

Foreign ExchangeForeign ExchangeForeign money, including paper money and bank deposits that are denominated in foreign currency

Foreign Exchange MarketForeign Exchange MarketA global market in which people trade one currency for another

Exchange RateExchange RateThe price of one country’s currency in terms of another country’s currency

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Trading Trading HoursHours

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Exchange RatesExchange Rates There is one exchange rate for every currency in

terms of every other currency. The U.S. price of a foreign good is:

U.S. price = foreign currency price x exchange rate

If a shirt in a Canadian store costs CAD25 and the U.S. to Canada exchange rate is $0.6825/CAD, then the price in U.S. dollars is

CAD25 x $0.6825/CAD = US$17.06.– It costs $17.06 of our dollars to buy 25 Canadian

dollars at a price of 68 ¼ ¢ per CAD.

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Exchange Rates: March 10, 2003

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Appreciation and DepreciationAppreciation and Depreciation

A currency A currency appreciatesappreciates when it buys when it buys moremore of a foreign currency.of a foreign currency.– AppreciationAppreciation of a nation’s currency makes of a nation’s currency makes

foreign goods cheaper.foreign goods cheaper.– AppreciationAppreciation Imports and Exports . Imports and Exports .

A currency A currency depreciatesdepreciates when it buys when it buys lessless of a foreign currency.of a foreign currency.– DepreciationDepreciation makes foreign goods more makes foreign goods more

expensive.expensive.– DepreciationDepreciation Imports and Exports . Imports and Exports .

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Balance of PaymentsBalance of PaymentsA record of a country’s trade in goods, services, and A record of a country’s trade in goods, services, and financial assets with the rest of the world.financial assets with the rest of the world.

Three Major Accounts:– Current AccountCurrent Account = Merchandise + Services = Merchandise + Services + Income Earned Abroad + Unilateral Transfers+ Income Earned Abroad + Unilateral Transfers

• All international All international paymentspayments (and gifts) related to (and gifts) related to currently produced goods and services, including currently produced goods and services, including labor and capital services.labor and capital services.

– Financial AccountFinancial Account• Records the flows of financial assets and Records the flows of financial assets and

international investment into and out of a country.international investment into and out of a country.– Statistical Discrepancy AccountStatistical Discrepancy Account

Must add to Zero—the BOP must balance!Must add to Zero—the BOP must balance!– Statisical discrepancy makes up the difference.Statisical discrepancy makes up the difference.

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Categories of current account transactions:Categories of current account transactions:

1.1. Merchandise tradeMerchandise trade---- import and export of goods import and export of goods

2.2. Service tradeService trade-- import and export of services-- import and export of services

3.3. IncomeIncome-- both investment income and -- both investment income and employee compensation employee compensation

4.4. Unilateral transfersUnilateral transfers-- gifts to and from foreigners-- gifts to and from foreigners

Current AccountCurrent Account

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Current Account Balance

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Current Account vs. Financial AccountCurrent Account vs. Financial Account

The balance of payments must balance—that is,

Current Account + Financial Account = 0 If there is a current account deficit, then

there must be a financial account surplus that exactly offsets that deficit.– If we buy more goods and services from

foreigners than they buy from us, we have to borrow the difference sell them our IOUs.

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Debtors and CreditorsDebtors and Creditors

A net debtor (nation) owes more to the rest of the world than it is owed.

A net creditor (nation) is owed more than it owes.– The U.S. was an international net

creditor from the end of WWI until the mid-1980s.

– In 1985, the U.S. became a net debtor.