Deck 25: The Balance of Payments, Exchange Rates, and Trade Deficits

Question 1

Do all international financial transactions necessarily involve exchanging one nation's distinct currency for another Explain. Could a nation that neither imports goods and services nor exports goods and services still engage in international financial transactions

Answer 1

Not all international transactions necessarily involve exchanging one nation's currency for another.
For instance, within Euro Zone, a common currency is used across different countries. Thus, the international transaction among them does not involve exchanging one nation's currency for another.
However, if the trading partners do not use the same currency, the buyer needs to exchange its currency for the currency that is accepted by the seller.
A nation that neither imports nor exports either goods or services could still engage in international financial transactions, because international financial transactions include international trade and international asset transactions.
• International trade is trade on goods and services.
• International asset transactions are the transfer of property rights to either real or financial assets.
Even though a country does not involve international trade, it may still involve in international asset transactions.

Question 2

Alpha's balance-of-payments data for 2012 are shown below. All figures are in billions of dollars. What are the ( a ) balance on goods, ( b ) balance on goods and services, ( c ) balance on current account, and ( d ) balance on capital and financial account Suppose Alpha sold $10 billion of official reserves abroad to balance the capital and financial account with the current account. Does Alpha have a balance-of-payments deficit or does it have a surplus

Answer 2

Balance of payments:
a.
Company A has exported goods worth of $40 and imported $30.
Thus, the balance on goods is
.
b.
Company A has exported goods worth of $40 and imported $30, and exported service worth of $15 and imported $10.
c.
In addition to the trade balance, the company's net transfer is $10 and net investment is $5.
Thus, the current account balance is given below:
d.
The company has foreign purchase of assets worth of $20, purchase of assets from abroad $40 and capital account balance is $0.
Thus the balance on capital and financial account is given below.
Hence, balance on capital and financial account of -$20.

Question 3

An American company wants to buy a television from a Chinese company. The Chinese company sells its TVs for 1,200 yuan each. The current exchange rate between the U.S. dollar and the Chinese yuan is $1 = 6 yuan. How many dollars will the American company have to convert into yuan to pay for the television

A) $7,200.
B) $1,200.
C) $200.
D) $100.

Answer 3

Exchange rate between Yuan and Dollar:
The exchange rate between the U.S. dollar and Chinese yuan is $1 equals 6 yuan.
Hence, 1 yuan is equal to 0.17 yuan.
Selling price of a TV in Chinese market is 1,200 yuan, the required U.S. dollars to buy a TV in Chinese market is obtained as follows:
Thus, American company will have to pay
buy a TV in Chinese market.
Hence, the option ' c' is correct.

Question 4

Explain: "U.S. exports earn supplies of foreign currencies that Americans can use to finance imports." Indicate whether each of the following creates a demand for or a supply of European euros in foreign exchange markets:
a. A U.S. airline firm purchases several Airbus planes assembled in France.
b. A German automobile firm decides to build an assembly plant in South Carolina.
c. A U.S. college student decides to spend a year studying at the Sorbonne in Paris.
d. An Italian manufacturer ships machinery from one Italian port to another on a Liberian freighter.
e. The U.S. economy grows faster than the French economy.
f. A U.S. government bond held by a Spanish citizen matures, and the loan amount is paid back to that person.
g. It is widely expected that the euro will depreciate in the near future.

Question 5

China had a $214 billion overall current account surplus in 2012. Assuming that China's net debt forgiveness was zero in 2012 (its capital account balance was zero), by how much did Chinese purchases of financial and real assets abroad exceed foreign purchases of Chinese financial and real assets

Question 6

Suppose that a country has a trade surplus of $50 billion, a balance on the capital account of $10 billion, and a balance on the current account of $200 billion. The balance on the capital and financial account will be:

A) $10 billion.
B) $50 billion.
C) $200 billion.
D) $200 billion.

Question 7

What do the plus signs and negative signs signify in the U.S. balance-of-payments statement Which of the following items appear in the current account and which appear in the capital and financial account U.S. purchases of assets abroad; U.S. services imports; foreign purchases of assets in the United States; U.S. goods exports, U.S. net investment income. Why must the current account and the capital and financial account sum to zero

Question 8

Refer to the following table, in which Q d is the quantity of loonies demanded, P is the dollar price of loonies, Q s is the quantity of loonies supplied in year 1, and Q s is the quantity of loonies supplied in year 2. All quantities are in billions and the dollar-loonie exchange rate is fully flexible.

a. What is the equilibrium dollar price of loonies in year 1
b. What is the equilibrium dollar price of loonies in year 2
c. Did the loonie appreciate or did it depreciate relative to the dollar between years 1 and 2
d. Did the dollar appreciate or did it depreciate relative to the loonie between years 1 and 2
e. Which one of the following could have caused the change in relative values of the dollar (used in the United States) and the loonie (used in Canadia) between years 1 and 2: (1) More rapid inflation in the United States than in Canadia, (2) an increase in the real interest rate in the United States but not in Canadia, or (3) faster income growth in the United States than in Canadia.

Question 9

The exchange rate between the U.S. dollar and the British pound starts at $1 = £0.5. It then changes to $1 = £0.75. Given this change, we would say that the U.S. dollar has _______ while the British pound has ______.

A) Depreciated; appreciated.
B) Depreciated; depreciated.
C) Appreciated; depreciated.
D) Appreciated; appreciated.

Question 10

What are official reserves How do net sales of official reserves to foreigners and net purchases of official reserves from foreigners relate to U.S. balance-of-payments deficits and surpluses Explain why these deficits and surpluses are not actual deficits and surpluses in the overall balance-of-payments statement.

Question 11

Suppose that the current Canadian dollar (CAD) to U.S. dollar exchange rate is $0.85 CAD = $1 US and that the U.S. dollar price of an Apple iPhone is $300. What is the Canadian dollar price of an iPhone Next, suppose that the CAD to U.S. dollar exchange rate moves to $0.96 CAD = $1 US. What is the new Canadian dollar price of an iPhone Other things equal, would you expect Canada to import more or fewer iPhones at the new exchange rate

Question 12

A meal at a McDonald's restaurant in New York costs $8. The identical meal at a McDonald's restaurant in London costs £4. According to the purchasing-power-parity theory of exchange rates, the exchange rate between U.S. dollars and British pounds should tend to move toward:

A) $2 = £1.
B) $1 = £2.
C) $4 = £1.
D) $1 = £4.

Question 13

Generally speaking, how is the dollar price of euros determined Cite a factor that might increase the dollar price of euros. Cite a different factor that might decrease the dollar price of euros. Explain: "A rise in the dollar price of euros necessarily means a fall in the euro price of dollars." Illustrate and elaborate: "The dollar-euro exchange rate provides a direct link between the prices of goods and services produced in the eurozone and in the United States." Explain the purchasing-power-parity theory of exchange rates, using the euro-dollar exchange rate as an illustration.

Question 14

Return to problem 3 and assume the exchange rate is fixed against the dollar at the equilibrium exchange rate that occurs in year 1. Also suppose that Canadia and the United States are the only two countries in the world. In year 2, what quantity of loonies would the government of Canadia have to buy or sell to balance its capital and financial account with its current account In what specific account would this purchase or sale show up in Canadia's balance-of-payments statement: Foreign purchases of assets in Canadia or Canadia's purchases of assets abroad Would this transaction increase Canadia's stock of official reserves or decrease its stock

Question 15

Suppose that a country has a flexible exchange rate. Also suppose that at the current exchange rate, the country is experiencing a balance-of-payments deficit. Then would it be true or false that a sufficiently large depreciation of the local currency could eliminate the balance-of-payments deficit.

Question 16

Suppose that a Swiss watchmaker imports watch components from Sweden and exports watches to the United States. Also suppose the dollar depreciates, and the Swedish krona appreciates, relative to the Swiss franc. Speculate as to how each would hurt the Swiss watchmaker.

Question 17

Diagram a market in which the equilibrium dollar price of 1 unit of fictitious currency zee (Z) is $5 (the exchange rate is $5 = Z1). Then show on your diagram a decline in the demand for zee.
a. Referring to your diagram, discuss the adjustment options the United States would have in maintaining the exchange rate at $5 = Z1 under a fixed-exchange-rate system.
b. How would the U.S. balance-of-payments surplus that is caused by the decline in demand be resolved under a system of flexible exchange rates

Question 18

Explain why the U.S. demand for Mexican pesos is downsloping and the supply of pesos to Americans is upsloping. Assuming a system of flexible exchange rates between Mexico and the United States, indicate whether each of the following would cause the Mexican peso to appreciate or depreciate, other things equal:
a. The United States unilaterally reduces tariffs on Mexican products.
b. Mexico encounters severe inflation.
c. Deteriorating political relations reduce American tourism in Mexico.
d. The U.S. economy moves into a severe recession.
e. The United States engages in a high-interest-rate monetary policy.
f. Mexican products become more fashionable to U.S. consumers.
g. The Mexican government encourages U.S. firms to invest in Mexican oil fields.
h. The rate of productivity growth in the United States diminishes sharply.

Question 19

Suppose that the government of China is currently fixing the exchange rate between the U.S. dollar and the Chinese yuan at a rate of $1 = 6 yuan. Also suppose that at this exchange rate, the people who want to convert dollars to yuan are asking to convert $10 billion per day of dollars into yuan, while the people who are wanting to convert yuan into dollars are asking to convert 36 billion yuan into dollars. What will happen to the size of China's official reserves of dollars

A) Increase.
B) Decrease.
C) Stay the same.

Question 20

Explain why you agree or disagree with the following statements. Assume other things equal.
a. A country that grows faster than its major trading partners can expect the international value of its currency to depreciate.
b. A nation whose interest rate is rising more rapidly than interest rates in other nations can expect the international value of its currency to appreciate.
c. A country's currency will appreciate if its inflation rate is less than that of the rest of the world.

Question 21

Suppose that a country follows a managed-float policy but that its exchange rate is currently floating freely. In addition, suppose that it has a massive current account deficit. Does it also necessarily have a balance-of-payments deficit If it decides to engage in a currency intervention to reduce the size of its current account deficit, will it buy or sell its own currency As it does so, will its official reserves of foreign currencies get larger or smaller Would that outcome indicate a balance-of-payments deficit or a balance-of-payments surplus

Question 22

"Exports pay for imports. Yet in 2012 the nations of the world exported about $540 billion more of goods and services to the United States than they imported from the United States." Resolve the apparent inconsistency of these two statements.

Question 23

If the economy booms in the United States while going into recession in other countries, the U.S. trade deficit will tend to__________.

A) Increase.
B) Decrease.
C) Remain the same.

Question 24

What have been the major causes of the large U.S. trade deficits in recent years What are the major benefits and costs associated with trade deficits Explain: "A trade deficit means that a nation is receiving more goods and services from abroad than it is sending abroad." How can that be considered to be "unfavorable"

Question 25

Other things equal, if the United States continually runs trade deficits, foreigners will own _________ U.S. assets.

A) More and more.
B) Less and less.
C) The same amount of.

Question 26

LAST WORD Suppose Super D'Hiver-a hypothetical French snowboard retailer-wants to order 5,000 snowboards made in the United States. The price per board is $200, the present exchange rate is 1 euro = $1, and payment is due in dollars when the boards are delivered in 3 months. Use a numerical example to explain why exchange-rate risk might make the French retailer hesitant to place the order. How might speculators absorb some of Super D'Hiver's risk