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TERM PAPER

OF
INTERNATIONAL FINANCIAL
MANAGEMENT

Topic: Based on historical data from BEA (www.bea.doc.gov), what is the


relationship US trade balances and the value of the US dollar.

SUBMITTED TO: SUBMITTED BY:

Mr.Sachin Lal Kashyup Preeti Bisht

RT1902-A16

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ACKNOWLEDGEMENT

Accomplishment of any task, howsoever small it may be, is

Not possible without the blessings of the Almighty and without the active

Help of certain individuals.

My special thanks to Mr. Sachin Lal Kashyup, Who motivated me to take up this Term paper.
I’m highly grateful to him for guiding me so affectionately.

And …… last, but not the least, I’m indebted to teachers

For their help, moral support. I hope and wish; I can repay their efforts half as much as they have
effort for me.

- Preeti Bisht

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INTRODUCTION
A balance of payment is a double entry system of record of all economic transactions between
the resident of the country and the rest of the world carried out in a specific period of time.
Balance Of Payments Statement presents classified record of:

• All recipient on account of goods exported


• Services rendered
• Capital received by residents
• Payments made by the residents due to goods imported and services received from
• Capital transferred to non-residents/foreigners.

The IMP publication on, ‘Balance of Payments Manual’, describes the concept of balance
of payments as:

The balance of payments is a statistical statement for a given period showing:

• Transaction in goods and services and income between an economy and the rest of the
world.
• Changes of ownership and other changes in that country’s monetary gold, SDRs, and
claims on and liabilities to rest of the world, and unrequited transfers and counterpart
entries that are needed to balance, in the accounting sense, any entries for the forgoing
transactions and changes which are not naturally offsetting.

Balance of Trade
The balance of trade is a narrow term. It takes into account only merchandise export s and
imports. Thus, balance of trade takes into account only the transactions arising out of the export
and import of visible items. In other words, balance of trade does not take into account the
exchange of invisible items like services of banking sectors, insurance sectors, transport sectors,
tourism industry, and dividend payments and receipt.

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Balance of Payment
The balance of payment takes in to account the export and import of both visible and invisible
items. In other words, it takes into consideration, the export and import of goods of all kinds
including consumer goods, consumer durables, fast moving consumer goods, capital goods,
machinery, technical instruments and services like banking, insurance, tourism, transportation
etc, and payments of salaries, benefits, interests, dividends etc.

Thus, balance of payments is much wider terms as compared to balance of trade. Balance of
trade presents an account of comprehensive economic and financial transactions of a country
with the rest the globe.

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COMPONENTS OF BALANCE OF TRADE
As indicated earlier, these are several items in balance of payments. These items can be
classified as hereunder:

• Current Account
• Capital Account
• Unilateral Payment Account
• Official Settlement Account.

CURRENT ACCOUNT:

Items under current account:

Credits Debits
1. Merchandise Exports(Sales Of Goods) 1. Merchandise Imports(Purchase of
2. Invisible Exports(Sales of Services) Goods)
• Transport services sold abroad 2. Invisible imports(Purchase of
• Insurance services sold abroad Services)
• Foreign tourists expenditure in the • Transport services purchased from
country abroad
• Other services sold abroad • Insurance services purchased from
• Incomes received on loans and abroad
investments abroad • Tourists expenditure abroad
• Other services purchased from abroad
• Income paid on loans and investments
in the home country

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CAPITAL ACCOUNT:

Items under capital account:

Capital Account Credits Capital Account Debits


1. Foreign long-term investments in 1. Long-term investments
home country(less redemptions and
repayments) abroad(less
• Direct investments in the home
country redemptions and repayments)
• Foreign investments in home country
• Other investments of foreigners in • Direct investments abroad
home country
• Foreign Governments loans to the
home country • Investments in foreign securities
• Other investments abroad

1. Foreign short-term investments in


the home country. • Governments loans to the Foreign
country

Unilateral Transfer Account


2 Short-term investments
1. Private remittances received abroad.

from abroad Unilateral Transfer Account

2. Pension payments received 1. Private remittances abroad

from abroad 2. Pension payments abroad

2. Government grants received from 3.Government grants abroad


abroad

Official Settlements Accounts

1. Official sales of foreign Official Settlements Accounts

1. Official purchases of foreign

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currencies or other reserves currencies or other service

assets abroad. assets.

UNILATERAL TRANSFER ACCOUNT

Unilateral transfers are ‘giving the gifts’. These include government grants, reparations, private
remittances, disaster relief etc. Singapore gave grant to Uganda in 1998. This item would be on
the debit side of Singapore’s balance of payments and credit side of Uganda’s balance of
payment.

OFFICIAL TRANSFER ACCOUNT

Official settlements account represents the official sales of foreign currencies and other reserves
to foreign countries or official purchase of foreign currencies or other reserves from foreign
countries.

DISEQUILIBRIA IN BOP
• BOP position is considered favourable, when receipts from foreigners, exceed payments
made to them and unfavourable when payments exceeds receipts.
• Disequilibria is caused by random variations in trade, fluctuations in production of
primary goods resulting in unusual trade in such commodities and are generally
temporary in nature.
• Disequilibria in BOP can also occur as a result of:
○ Technological improvements affecting quality & prices of some products, in
certain parts of the world, resulting in altering pattern of trade.
○ State of economic development of a nation.
○ Drastic change in consumer tastes, as a result of improvements in communication
technologies, information system etc.

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○ Changes in income level of the people of the nation, as a result of high growth
rates, leading to a different level of consumption pattern &higher imports.
○ Inflation, thereby increasing the cost of output of a country, also results in
reduction in exports.

ECONOMIC FACTOR
• POPULATION

In this time of sluggish growth, Singapore's economy continues to grow at a 6.8 percent clip.
The size of the Singapore economy is projected to outstrip Germany's by 2025, and if present
trends continue, Singapore will be the third largest economy in the world by 2035, lagging only
the United States and China. Because of the combination of rapid growth and an expanding
population, economists regard Singapore as an emerging economic global superpower. Thanks
to rapid growth and a young, growing population, Singapore is an emerging economic
superpower.

• DEMOGRAPHICS

According to research from Goldman Sachs, Singapore will add more than 310 million people to
its population between 2000 and 2030--effectively creating another United States.

• SAVINGS RATE

Singapore has one of the highest personal savings rates in the world at 36 percent. While this
bodes well for Singaporean economic security in the long run, it causes short-term problems
because of the lack of domestic spending.

• POVERTY

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More than 40 percent of the population lives below the poverty line. The World Bank estimates
that a third of the world's poor now live in Singapore.

• CORRUPTION

A 2005 survey from Transparency International found that half of Singaporens surveyed had a
personal experience in the bribery of public officials.
DETERMINANTS OF POSITIVE OR NEGATIVE BOP
a. Interest rates (short run).
b. Inflation (long run, PPP theory).
c. Monetary Policy.
d. Central Bank Intervention and CB announcements.
e. Capital Flows (short run if portfolio movement).
f. Expected changes in real output.
g. Current Account influence.
h. Stock market fluctuations.
i. Macro leading indicators and macro fundamentals.
j. Fiscal Policy.
k. Political events.
l. Contagion.
m. Consumer Demand.
n. Strong sterling exchange rate.
o. Weakness of the global economy.

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RELATIONSHIP B/W BOP & CURRENCY
When we do not make ends meet we become less credit-worthy, our currency weakens and so
does its purchasing power. It buys less and prices increase.

As our currency weakens (devalues) so our exports become cheaper abroad but we have to pay
more for imports. This reduces our standard of living relative to others abroad as they find our
produce cheaper while we find there’s more expensive.

We now have to produce and sell a greater volume of exports so as to earn as much foreign
currency as we did before and have to sell even more if we are to improve our position, if we are
to benefit from a devaluating currency. Considering competitiveness abroad, we have seen that
our export prices can rise to the extent that increasing prices are not absorbed internally by a
lowering of the standard of living of some or all of the population.

Hence we become less competitive and may then have to devalue or allow the exchange rate to
adjust itself so as to stay competitive in the short term and to become more competitive in the
long term. In this way we reduce our prices abroad and become more competitive but as we now
get paid less for each item sold we must now sell more items so as to earn as much as we did
before.

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American-Canada Trade and Exchange Analysis

Canada is by far the largest trading partner of the United States, as the U.S.-Canadian
relationship accounts for 20% of all U.S. international trade. If we are going to figure out why
the United States still has a large trade deficit, this would be a good place to start.

The American Dollar has depreciated rapidly relative to the Canadian Dollar. In October 2011,
the next October, a U.S. Dollar would only fetch $1.002. However the balance of trade remained
steady over this period, with a trade deficit of $4.3 billion in October 2009 and $4.9 billion in
October 2010. We would expect the balance of trade to improve over this period, not get worse!

The correlation between the exchange rate and the trade deficit was -0.574 for this period. We
expect that when the exchange rate goes down, the trade should go up. However a negative
correlation between the two indicates that when the exchange rate went down, the trade deficit
became larger. So the data does not at all match our expectations.

American-Canadian Trade and Exchange Data

End Date USD/CAD CDN DEF

30-Jun-09 1.124 -4907.4

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31-Jul-09 1.1286 -5264.5

31-Aug-09 1.0863 -4848.2

30-Sep-09 1.0822 -5038.9

31-Oct-09 1.0542 -3669

30-Nov-09 1.0624 -3847

31-Dec-09 1.0557 -3810

31-Jan-10 1.0436 -5148

28-Feb-10 1.056 -4345

31-Mar-10 1.0244 -4950

30-Apr-10 1.0053 -4071.2

31-May-10 1.0395 -3776.6

30-Jun-10 1.0378 -4341.7

31-Jul-10 1.0447 -4527.6

31-Aug-10 1.0388 -4030.2

30-Sep-10 1.0346 -4303.6

31-Oct-10 1.0181 -3222.5

30-Nov-10 1.0121 -4207.3

31-Dec-10 1.009 -4072.3

31-Jan-11 0.9939 -3527.1

28-Feb-11 0.9878 -3811.3

31-Mar-11 0.9768 -4273.6

American-Mexican Trade and Exchange Analysis

Largely due to geography, Mexico is the United States second largest trading partner, with the
U.S.-Canadian relationship accounting for almost 12% of all U.S. international trade.

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Although the U.S. Dollar has been weak against the Canadian Dollar and the Euro, it has actually
appreciated against the Mexican Peso. One American Dollar bought just over 12 Mexican Pesos
at the beginning of 2011; by October 2010 it bought over 13, an increase of 22%. The trade
deficit has risen from 2.2 billion to 3.5 billion U.S. Dollars during this period, an increase of
57%. The correlation between changes in the Mexican-American exchange rate and the
Mexican-American trade deficit for this period was -0.52, indicating that when the Dollar rose in
value (relative to the peso) that the American trade balance fell. Jumps in the U.S. Dollar relative
to the Mexican Peso occured at the same time as increases in the U.S. trade deficit with Mexico,
which is what we would expect.

While the Canadian-American data explained little, the Mexican-American data gives some
explanation to why the U.S. trade deficit remains so large. For a more complete picture, we'll
need to look at the trade relationships the United States has with Japan and China.

American-Mexican Trade and Exchange Data

End Date USD/MXN MXN DEF


30-Jun-09 13.317 -3526.6
31-Jul-09 13.348 -3271
31-Aug-09 12.997 -3404.1
30-Sep-09 13.386 -3218.9
31-Oct-09 13.244 -3423.4
30-Nov-09 13.112 -3422.2
31-Dec-09 12.823 -3344.2

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31-Jan-10 12.837 -3924.2
28-Feb-10 12.937 -3900.3
31-Mar-10 12.577 -3017
30-Apr-10 12.237 -2793.9
31-May-10 12.706 -2877.4
30-Jun-10 12.716 -3437.1
31-Jul-10 12.828 -3126.4
31-Aug-10 12.741 -3294.6
30-Sep-10 12.821 -3329.8
31-Oct-10 12.43 -3223.4
30-Nov-10 12.308 -3398.2
31-Dec-10 12.382 -3213.8
31-Jan-11 12.136 -3430.7
28-Feb-11 12.049 -2772.7
31-Mar-11 11.995 -2247.9

American-Japanese Trade and Exchange Analysis

Japan and China each account for around 9% of U.S. international trade. Americans have
historically had a large trade deficit with Japan, as American consumers highly value many
Japanese electronic products.

The U.S. Dollar has depreciated significantly against the Japanese Yen for the last 2 years, with
1 U.S. Dollar buying 132 yen at the beginning of 2002 but only 109 yen in October 2003, a drop

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of 17.5%. During this time the trade deficit has become larger, with the third largest trade deficit
in the last 22 months occuring in the last month of the sample. Interestingly
the correlation between movements in the exchange rates and movements in the trade balance is
-.20, indicating that there is no relationship between changes in the two. I'm not sure what this
data is telling us.

American-Japanese Trade and Exchange Data

End Date USD/JPY JPN DEF


31-Mar-11 81.61 -4729.2
28-Feb-11 82.59 -5564.3
31-Jan-11 82.49 -5722.7
31-Dec-10 83.36 -6798.5
30-Nov-10 82.43 -4905.3
31-Oct-10 81.84 -5420.7
30-Sep-10 84.45 -5737.4
31-Aug-10 85.53 -5290.3
31-Jul-10 87.59 -5935.7
30-Jun-10 90.94 -6410.4
31-May-10 92.02 -6403.4
30-Apr-10 93.42 -7061.5
31-Mar-10 90.57 -5220.3
28-Feb-10 90.14 -5315.8

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31-Jan-10 91.37 -5830.6
31-Dec-09 89.76 -5968.5
30-Nov-09 89.22 -4488.3
31-Oct-09 90.34 -5383.8
30-Sep-09 91.45 -5918.8
31-Aug-09 94.98 -4841.1
31-Jul-09 94.45 -5133.8
30-Jun-09 96.7 -6436.6

American-Chinese Trade and Exchange Analysis

Japan and China each account for around 9% of U.S. international trade. The Chinese situation is
significantly different than the Japanese situation, as American consumers tend to by Chinese
goods because of their low cost.

The exchange rates given at the bottom of this article are not a mistake. The Chinese
Government has fixed the value of the Yuan such that 1 U.S. Dollar is worth 6.89 Yuan on
foreign exchange markets. This is caused concern in Washington, as an artificially overvalued
Yuan keeps Chinese imports into the United States artificially inexpensive. This helps explain
the massive increase in the U.S. trade deficit with China, as the size of that deficit has doubled in
the last 22 months.

The refusal of the Chinese government to have a market-determined exchange rate seems to be
causing an increase in the U.S. trade deficit. Not surprisingly, the Chinese Government does not
see it that way, as reported by the Xinhua News Agency:

China's Minister in charge of the State Development and Reform Commission, Ma Kai,
described the imbalance as structural in nature that reflects the changing commerce pattern and a

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high degree of complementarily between the two countries. China's currency exchange rate was
not to blame for the US trade deficit, he said.

American-Chinese Trade and Exchange Data

End Date USD/CNY CHN DEF

7-Jun-09 6.8205 -6846.10

5-Jul-09 6.8228 -6491.30

2-Aug-09 6.8206 -5638.50

6-Sep-09 6.8208 -7553.10

4-Oct-09 6.8172 -8073.00

1-Nov-09 6.8174 -8521.30

6-Dec-09 6.8184 -9365.20

3-Jan-10 6.8202 -10831.60

7-Feb-10 6.8186 -10267.80

7-Mar-10 6.8162 -9492.30

4-Apr-10 6.8179 -10408.80

2-May-10 6.8179 -9575.90

6-Jun-10 6.8209 -9421.30

4-Jul-10 6.7748 -7579.40

1-Aug-10 6.7701 -7669.60

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5-Sep-10 6.7948 -9451.40

3-Oct-10 6.6842 -9861.90

7-Nov-10 6.6605 -9989.50

5-Dec-10 6.6537 -11338.50

2-Jan-11 6.6075 -11699.00

6-Feb-11 6.565 -12691.80

6-Mar-11 6.5612 -13565.50

REFERENCE

http://economics.about.com/cs/analysis/a/trade_deficit.htm

http://www.foreign-trade.com/xchange.htm

http://www.investopedia.com/university/releases/tradebalance.asp

http://www.globalization101.org/uploads/File/Trade/tradeall2010.pdf

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