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Requirements
current account balance
capital account balance
“overall” balance
Indicate whether each is a surplus or deficit.
3.Sudden inflows or outflows of money in the capital account are sometimes called “hot money” flows.
A)Which of the following sub-accounts is/are most likely to be subject to hot money flows? Explain.
• Short-term financial assets
• Portfolio investment
• Direct investment
B)What measures could a government take to stop hot money flows?
4. This question is based on the attached article “U.S. Trade Deficit Falls 12%, Aided by Cheaper Oil Imports,” Associated Press, September 19, 2012. Based on the article, fill in the blanks below, indicating “INCREASE” or “DECREASE” for each of the items for the second quarter of 2012 (compared to the previous quarter). [Note: a smaller deficit counts as an INCREASE; a smaller surplus counts as a DECREASE.]
U.S. Balance of Payments
2nd Quarter 2012
Goods exports ____________
Goods imports ____________
Trade balance ____________
Services trade balance ____________
Capital services balance ____________
Current account balance ____________
5.When a currency is devalued (or depreciates), imported goods become more expensive. This is supposed to improve the current account by reducing imports. Under what conditions would devaluation increase the value of imports?
[Hint: Value = price x quantity. Think about price elasticities.]
6.Read the attached article: “The Deficit That Just About Everyone Overlooks,” by Clive Crook, National Journal, February 17, 2001. The “Lawson Doctrine,” which Crook describes, tells you when a current account deficit is good and when it is bad. Was the US current account deficit good or bad in the late 1990s (when the US government budget was in surplus and foreign investment went into stocks)? Is it good or bad today when the US government budget is in deficit and foreign investment goes mostly into Treasury securities? Explain.
Solutions
Solution to 1:
Weyerhaeuser sends $60 million worth of lumber to Japan in exchange for computer equipment worth $60 million (barter deal).
Credit, current account – unilateral transfers: $60 million of lumber
Debit, current account – unilateral transfers: $60 million of computer equipment
The lumber is sent on a Liberian-registered ship owned by a Canadian company. Weyerhaeuser pays for the shipping with a $150,000 check drawn on a Seattle bank.
Credit, short-term capital account: $150,000 check
Debit, current account - services: $150,000 of shipping charges
Your rich uncle in Calgary, Alberta sends you 100 shares of stock in his Canadian oil company as a birthday present. The stock currently trades on the Toronto Stock Exchange at a price equivalent to US$15 per share.
Credit, Official Account: $1500 of shares
Debit, current account – unilateral transfers: $1500 of shares
Later in the year you receive $100 in dividends from your uncle’s oil company. Payment is made in the form of a U.S. dollar check drawn on a Canadian bank.
Credit, current account – services: $100 dividends
Debit, short-term capital account: $100 check
You go to the website of a Canadian airline and buy a $400 ticket to Calgary to go visit your uncle. You pay for the ticket with a credit card.
Credit, short-term capital account: $400 check
Debit, current account - services: $400 of ticket charges
The U.S. government sends $13 million in aid to Nigeria. Payment is made by check drawn on a U.S. bank.
Credit, short-term capital account: $13 million check
Debit, current account – unilateral transfers: $13 million aid money
The Nigerian government uses the money to buy U.S. wheat, paying with a check drawn on its London bank.
Credit, current account - goods: $13 million of wheat
Debit, short-term capital account: $13 million check
A San Francisco real estate firm sells its 51% share of a Vancouver, B.C. real estate development company to a Canadian developer. The Canadian company pays $75 million with a U.S. dollar check drawn on a Canadian bank.
Credit, long-term capital account: $75 million of shares
Debit, long-term capital account: $75 million check
The San Francisco real estate firm deposits the $75 million check in its Bank of America account in San Francisco.
Credit, long-term capital account: $75 million check
Debit, long-term capital account: $75 million check
The new owner of the real estate company hires a Seattle architect to design a shopping mall. The architect is paid with $3 million worth of stock in the real estate company.
Credit, long-term capital account: $3 million of stock
Debit, current account - services: $3 million of architect services
A Japanese-owned U.S. company sells $80 million worth of 90-day commercial paper to a Japanese bank. The Japanese bank pays with a yen check drawn on itself.
Credit, short-term capital account: $80 million commercial paper
Debit, short-term capital account: $80 million check
The Federal Reserve intervenes in the foreign exchange market to keep the U.S. dollar from rising in value versus the Canadian dollar. It sells US$100 million (paying with a check drawn on a commercial bank account) and buys C$120 million.
Credit, official account: $100 million check
Debit, official account: C$120 million
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Solution to 2:
Trade Balance = Amount of goods and services exported - Amount of goods and services imported
= $40 million (Export of mineral products) - $20 million (Import of food)
= $20 million (Surplus)
Current Account Balance = Trade Balance – Interest Payment on Foreign Debt
= $20 million - $5 million = $15 million (Surplus)
Capital Account Balance = Capital Inflows – Capital Outflows
= $30 million – FDI into country (Surplus)
Overall Balance = Current Account Balance + Capital Account Balance
= $15 million + $30 million = $45 million (Surplus)
Solution to 3:
Among the options provided, Short Term Financial Assets is most likely to be subject to hot money flows. As the very concept of the hot money is to speculate and earn in short span of time and leave quickly the country shifting to next speculation profit enabling country. Short Term Financial Assets are those which are held for a short period generally less than a year. The nature and characteristics of such assets is its liquidity and ease of transaction which makes it prone to hot flows. Once an opportunity found, the investor shall invest in the economies having speculative and excess profit potential for an unidentified time span and quickly takes out the moment another better opportunity is found.
Probable measures a government could take to curb hot money flows:
1. A lock-in-period on the investments may be prescribed for the investors investing in the country with a view to fight hot money flows i.e, to say that the investors shall be bound by the rules and time frame.
2. Taxation laws may be made stringent to curb hot flows. Higher tax rates can be prescribed on the transaction in the country where there is a potential of hot money flows.
3. Attractive and alternative schemes can be set in the country so that money flow does not happen to a foreign country.
Solution to 4:
US Balance of Payments (2nd Quarter 2012)
Goods Exports = $394.1 billion (INCREASE)
Goods Imports = $579.9 billion (DECREASE)
Trade Balance = $185.8 billion - Deficit (INCREASE)
Services Trade Balance = $46.5 billion - Surplus (INCREASE)
Capital Services Balance = $184.6 billion - Surplus (INCREASE)
Current Account Balance = $117.4 billion - Deficit (INCREASE)
Solution to 5:
The motive behind devaluation of a currency is to make the exported goods cheaper and imported goods costlier in order to discourage imports and allow people to purchase in their own country. When a currency depreciates, more units of domestic currency shall be spent to purchase foreign currency thereby increasing the outflow of the domestic currency. This results in spending of more units of domestic currency thereby resulting in trade deficit. It is pertinent to note that under no circumstances, the imports become cheaper due to devaluation.
Some of the conditions prevalent would be:
High demand of the product in domestic market
To compete globally with producing cheaper products
To offer a sense of security to the domestic manufacturers
Solution to 6:
Was the US current account deficit good or bad in the late 1990s (when the US government budget was in surplus and foreign investment went into stocks)?
US Current Account Deficit was good in the late 1990’s as compared to the year 1980’s and before that. It is for the reason that the view of the economists changed. The external deficit of trade which was a sign of worry in 1980’s was seen from a different angle. The view was that the flow of the capital drives external balance and not the flow of goods and services. As per the report of Clive Crook in National Journal, financial inflow sustained a higher rate of domestic industrial environment than would otherwise have been possible.
Is it good or bad today when the US government budget is in deficit and foreign investment goes mostly into Treasury securities?
As per the report of Clive Crook in National Journal, Lawson Doctrine which prevailed in Britain had a view that big external deficit is a good thing as long as the capital was drawn in by private investment and not by public borrowing. As per the report, there are instances in some countries of the world where too much of borrowings, inflated asset prices, financial overstretching and collapse - leading in end to severe recession.
It is good to have the foreign investment with treasury securities as there are no chances of default as compared to debt recoveries However, in terms of financial benefits, the latter is better.
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International Balance of Payments. (2016). http://thismatter.com. Retrieved 12 October 2016, from http://thismatter.com/money/forex/international-balance-of-payments.htm
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What is Hot Money?. (2016). Politicapress.com. Retrieved 12 October 2016, from http://www.politicapress.com/2011/08/what-is-hot-money/?lang=en
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