International Trade in Goods and Services(Measures U.S. Exports and Imports of Goods and Sevices)

Web: http://www.bea.gov/newsreleases/international/trade/tradnewsrelease.htmMonthly revisions going back several months. Annual revisions in June that go back several years.

As the U.S. economy has moved from a relatively closed economy (1950s–1960s) to one with more international commerce, foreign economic events (1997 Asian financial crisis, 1998 Russian foreign loan default) are having are larger impact on the U.S. economy. World trade is an important force shaping the U.S. economy, but unfortunately the trade data is not a good leading indicator. Trade patterns change slowly because of the long lag time between signing a trade contract and shipping the goods. However, import and export flows can give clues about domestic demand, industry earnings, pricing power, foreign demand and potential changes in currency values. U.S. firms have responded to the rise in imports by increasing their efficiency, lowering prices, and pushing to open overseas markets.

Three key forces shaping the U.S. trade balance:1. Relative economic growth rates between the U.S. and the rest of the world (ROW). Imports are a function of where the U.S. economy stands in

the business cycle. Exports are a function of where the ROW stands in their business cycle. If (Y/Y)U.S. > (Y/Y)ROW, then M/M > X/X => trade deficit

2. The U.S. dollar exchange rate (E = euros-to-dollar) E => Price exports, Price imports => quantity demand of exports, quantity demand of imports => exports, imports => worsening trade

balance. Research has shown that a 1% rise in the dollar leads to a $10-15 billion fall in the trade balance over 2 years.3. Relative inflation rates between the U.S. and the rest of the world. (P/P)U.S.=> quantity demand of exports and an quantity demand of imports => declining net exports

Three factors could decrease the U.S. trade deficit:1. (Y/Y)ROW => exports => net exports2. Depreciating dollar => PX & PM => X, M => net exports. (But we could also see rising inflation rates and interest rates with a falling dollar.Recall Purchasing Power Parity;…. $/e = PLU.S./PL E.U.

Recall real exchange rate;…… r = (e/$) x (PLU.S. / PL E.U.)3. U.S. households must increase savings and decrease consumption.

The inflation-adjusted numbers track the actual volume (quantity) of goods traded which impacts real GDP. Traded goods have much more volatility than traded services. Separate tables are broken out for 2 volatile commodities: energy and motor vehicles. Falling oil prices => decrease imports => increase net exports => increase discretionary spending => faster economic growth.

Data is published on 6 principal end-use categories: food & beverage, industrial supplies, capital goods, automotive vehicles, consumer goods, and other goods. To analyze changes in trade patterns it is useful to study changes in the six components. For example, an increase in capital goods => firm productivity and efficiency => jobs => inflation. But an increase in consumer goods => falling net exports and reduced long-term health of economy.

------------------------------------------------------------------------------------------------------------------------------------------------Market Analysis:Bonds: trade deficit => appreciating dollar => (P/P)E

T+1 => DBonds => iBonds

Stocks: exports => net exports => domestic manufacturing => future profits => PStocks

Dollar: trade deficit => Demand for dollars & de Supply of dollars => appreciating dollar

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THE GREAT DEBATE:Stimulus Vs Austerity

J.M. Keynes1883-1946

Father of Modern Macroeconomics“The General Theory of Employment, Interest

and Money”

Advocated the use of fiscal and monetary measures to offset recessions.

AD determines the overall level of economic activity.

The modern capitalist economy does not automatically work at top efficiency, but can be raised to that level by government intervention.

F.A. Hayek1899-1992

1974 Nobel Prize“The Road to Serfdom”

Changing prices communicate signals to enable individuals to coordinate their plans. This leads to an efficient exchange and use

of resources.

Leading critic of collectivism/socialism because it required a central planner that would eventually become totalitarianism.

The free price system is a spontaneous order – the result of human action, but not of

human design.

Central banks do not possess the relevant info to govern the money supply, nor the

ability to use it correctly.

1. We’ve been going back and forth for a century2. [Keynes] I want to steer markets,3. [Hayek] I want them set free4. There’s a boom and bust cycle and good reason to fear it5. [Hayek] Blame low interest rates.6. [Keynes] No… it’s the animal spirits7. [Keynes Sings:]8. John Maynard Keynes, wrote the book on modern macro9. The man you need when the economy’s off track, [whoa]10. Depression, recession now your question’s in session11. Have a seat and I’ll school you in one simple lesson12. BOOM, 1929 the big crash13. We didn’t bounce back—economy’s in the trash14. Persistent unemployment, the result of sticky wages15. Waiting for recovery? Seriously? That’s outrageous!16. I had a real plan any fool can understand17. The advice, real simple—boost aggregate demand!18. C, I, G, all together gets to Y19. Make sure the total’s growing, watch the economy fly20. We’ve been going back and forth for a century21. [Keynes] I want to steer markets,22. [Hayek] I want them set free23. There’s a boom and bust cycle and good reason to fear it24. [Hayek] Blame low interest rates.25. [Keynes] No… it’s the animal spirits26. You see it’s all about spending, hear the register cha-ching27. Circular flow, the dough is everything28. So if that flow is getting low, doesn’t matter the reason29. We need more government spending, now it’s stimulus season

“Fear the Boom and Bust”Lyrics

30. So forget about saving, get it straight out of your head31. Like I said, in the long run—we’re all dead32. Savings is destruction, that’s the paradox of thrift33. Don’t keep money in your pocket, or that growth will never lift…because…34. Business is driven by the animal spirits35. The bull and the bear, and there’s reason to fear its36. Effects on capital investment, income and growth37. That’s why the state should fill the gap with stimulus both…38. The monetary and the fiscal, they’re equally correct39. Public works, digging ditches, war has the same effect40. Even a broken window helps the glass man have some wealth41. The multiplier driving higher the economy’s health42. And if the Central Bank’s interest rate policy tanks43. A liquidity trap, that new money’s stuck in the banks!44. Deficits could be the cure, you been looking for45. Let the spending soar, now that you know the score46. My General Theory’s made quite an impression47. [a revolution] I transformed the econ profession48. You know me, modesty, still I’m taking a bow49. Say it loud, say it proud, we’re all Keynesians now50. We’ve been goin’ back n forth for a century51. [Keynes] I want to steer markets,52. [Hayek] I want them set free53. There’s a boom and bust cycle and good reason to fear it54. [Keynes] I made my case, Freddie H55. Listen up , Can you hear it?Hayek sings:

Keynes’s Viewpoint

56. I’ll begin in broad strokes, just like my friend Keynes57. His theory conceals the mechanics of change,58. That simple equation, too much aggregation59. Ignores human action and motivation60. And yet it continues as a justification61. For bailouts and payoffs by pols with machinations62. You provide them with cover to sell us a free lunch63. Then all that we’re left with is debt, and a bunch64. If you’re living high on that cheap credit hog65. Don’t look for cure from the hair of the dog66. Real savings come first if you want to invest67. The market coordinates time with interest68. Your focus on spending is pushing on thread69. In the long run, my friend, it’s your theory that’s dead70. So sorry there, buddy, if that sounds like invective71. Prepared to get schooled in my Austrian perspective72. We’ve been going back and forth for a century73. [Keynes] I want to steer markets,74. [Hayek] I want them set free75. There’s a boom and bust cycle and good reason to fear it76. [Hayek] Blame low interest rates.77. [Keynes] No… it’s the animal spirits78. The place you should study isn’t the bust79. It’s the boom that should make you feel leery, that’s the thrust80. Of my theory, the capital structure is key.81. Malinvestments wreck the economy

82. The boom gets started with an expansion of credit83. The Fed sets rates low, are you starting to get it?84. That new money is confused for real loanable funds85. But it’s just inflation that’s driving the ones86. Who invest in new projects like housing construction87. The boom plants the seeds for its future destruction88. The savings aren’t real, consumption’s up too89. And the grasping for resources reveals there’s too few90. So the boom turns to bust as the interest rates rise91. With the costs of production, price signals were lies92. The boom was a binge that’s a matter of fact93. Now its devalued capital that makes up the slack.94. Whether it’s the late twenties or two thousand and five95. Booming bad investments, seems like they’d thrive96. You must save to invest, don’t use the printing press97. Or a bust will surely follow, an economy depressed98. Your so-called “stimulus” will make things even worse99. It’s just more of the same, more incentives perversed100. And that credit crunch ain’t a liquidity trap101. Just a broke banking system, I’m done, that’s a wrap.102. We’ve been goin’ back n forth for a century103. [Keynes] I want to steer markets,104. [Hayek] I want them set free105. There’s a boom and bust cycle and good reason to fear it106. [Hayek] Blame low interest rates.107. [Keynes] No it’s the animal spirits

“Fear the Boom and Bust”Lyrics

Hayek’s Viewpoint

“Fight of the Century” Lyrics Written by John Papola and Russ Roberts

KEYNESHere we are… peace out! great recession

thanks to me, as you see, we’re not in a depressionRecovery, destiny if you follow my lesson

Lord Keynes, here I come, line up for the processionHAYEK

We brought out the shovels and we’re still in a ditch…And still digging. don’t you think that it’s time for a switch…

From that hair of the dog. Friend, the party is over.The long run is here. It’s time to get sober!

KEYNESAre you kidding? my cure works perfectly fine…

have a look, the great recession ended back in ’09.I deserve credit. Things would have been worse

All the estimates prove it—I’ll quote chapter and verseHAYEK

Econometricians, they’re ever so piousAre they doing real science or confirming their bias?

Their “Keynesian” models are tidy and neatBut that top down approach is a fatal conceit

REFRAINWhich way should we choose?

more bottom up or more top down…the fight continues…

Keynes and Hayek’s second roundit’s time to weigh in…

more from the top or from the ground…lets listen to the greats

Keynes and Hayek throwing downKEYNES

We could have done better, had we only spent moreToo bad that only happens when there’s a World WarYou can carp all you want about stats and regressionDo you deny World War II cut short the Depression?

HAYEKWow. One data point and you’re jumping for joy

the Last time I checked, wars only destroyThere was no multiplier, consumption just shrankAs we used scarce resources for every new tank

Pretty perverse to call that prosperityRationed meat, Rationed butter… a life of austerity

When that war spending ended your friends cried disasteryet the economy thrived and grew faster

KEYNESYou too only see what you want to see

The spending on war clearly goosed GDPUnemployment was over, almost down to zero

That’s why I’m the master, that’s why I’m the heroHAYEK

Creating employment’s a straightforward craftWhen the nation’s at war, and there’s a draft

If every worker was staffed in the army and fleetWe’d have full employment and nothing to eat

REFRAIN REPEATS

“Fight of the Century”Lyrics HAYEK

jobs are a means, not the ends in themselvespeople work to live better, to put food on the shelves

real growth means production of what people demandThat’s entrepreneurship not your central plan

KEYNESMy solution is simple and easy to handle..

its spending that matters, why’s that such a scandal?The money sloshes through the pipes and the sluices

revitalizing the economy’s juicesit’s just like an engine that’s stalled and gone dark

To bring it to life, we need a quick sparkSpending’s the life blood that gets the flow going

Where it goes doesn’t matter, just get spending flowingHAYEK

You see slack in some sectors as a “general glut”But some sectors are healthy, only some in a rut

So spending’s not free – that’s the heart of the mattertoo much is wasted as cronies get fatter.

The economy’s not a car, there’s no engine to stallno expert can fix it, there’s no “it” at all.

The economy’s us, we don’t need a mechanicPut away the wrenches, the economy’s organic

REFRAIN REPEATSKEYNES

so what would you do to help those unemployed?this is the question you seem to avoid

when we’re in a mess, would you just have us wait?Doing nothing until markets equilibrate?

HAYEKI don’t want to do nothing, there’s plenty to doThe question I ponder is who plans for whom?

Do I plan for myself or leave it to you?I want plans by the many, not by the few.Let’s not repeat what created our troublesI want real growth not a series of bubbles

Stop bailing out loser, let prices workIf we don’t try to steer them they won’t go berserk

KEYNESCome on, Are you kidding? Don’t Wall Street’s gyrations

Challenge your world view of self-regulation?Even you must admit that the lesson we’ve learnedIs more oversight’s needed or else we’ll get burned

HAYEKOversight? The government’s long been in bed

With those Wall Street execs and the firms that they’ve bledCapitalism’s about profit and loss

you bail out the losers there’s no end to the costthe lesson I’ve learned? It’s how little we know,

the world is complex, not some circular flowthe economy’s not a class you can master in college

to think otherwise is the pretense of knowledgeREFRAIN REPEATS

“Fight of the Century”Lyrics

Continued

KEYNESYou get on your high horse and you’re off to the racesI look at the world on a case by case basisWhen people are suffering I roll up my sleevesAnd do what I can to cure our diseaseThe future’s uncertain, our outlooks are frailThats why free markets are so prone to failIn a volatile world we need more discretionSo state intervention can counter depressionHAYEKPeople aren’t chessmen you move on a boardat your whim–their dreams and desires ignoredWith political incentives, discretion’s a jokeThose dials you’re twisting… just mirrors and smokeWe need stable rules and real market pricesso prosperity emerges and cuts short the crisisgive us a chance so we can discoverthe most valuable ways to serve one anotherFINAL REFRAINWhich way should we choose?more bottom up or more top downthe fight continues…Keynes and Hayek’s second roundit’s time to weigh in…more from the top or from the ground…lets listen to the greatsKeynes and Hayek throwing down

Chapter 17: Macroeconomics in an Open Economy

Trade between countries involves the mutual exchange of different currencies (bank deposits denominated in different currencies)

When American firms buy foreign goods, services and assets => U.S. $ exchanged for foreign currency

Bank deposits denominated in U.S. $ bank deposits denominated in foreign currency

This trade takes place in foreign exchange markets

Definitions:

Exchange Rate - price of one currency in terms of another

Spot exchange rate – exchange rate for the immediate (2-day) exchange of bank deposits

Forward exchange rate – exchange rate for the exchange of bank deposits at some specified future date

Appreciation – currency increases in value

Depreciation – currency decreases in value

The Circular Flow Diagram

U.S. Dollar Versus Euro Exchange Rate

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Exchange rates are important because they affect the relative price of domestic and foreign goods.

Example:

The $ price of a German BMW to an American is a function of the interaction of 2 factors:

1.The price of BMWs in Euros (50,000 euros)

2.The exchange rate E = $/euro,

If E = $1/1euro => 50,000 euro x ($1/1euro) = $50,000

If euro appreciates to ($1.20/1euro) => $ depreciates =>

50,000euro x ($1.20/1euro) = $60,000

Currency appreciates => country’s goods prices abroad and foreign goods prices in that country

1. Makes domestic businesses less competitive

2. Benefits domestic consumers

U.S. International TransactionsBalance of Payments

(Comprehensive Measure of U.S.’s Trade and Investment with the Rest of the World)

Web: http://www.bea.gov/international/index.htm#bopModerate quarterly revisions. Annual benchmark changes make in June.

International commerce now makes up more than a quarter of all U.S. business activity. The International Transactions Report tracks cross-border movements in trade in goods and services, imports and exports of investment capital (stocks, bonds, physical assets) and investment income (interest/dividends). Data is seasonally adjusted but not annualized or adjusted for inflation. Data measures quarterly changed in trade and investment flows.

The International Transaction Release contains 3 sections.1. Current Account:

Merchandise Trade Account – goods or visible trade. Trade balance = $X -$MService Trade Account – Invisible trade (investment banking, insurance, engineering, public relations, accounting, advertising, patent/copyright/movie fees).Investment Income Account – interest and dividends. Subcategory of service account. Income receipts are classified as export income because earnings are from overseas investments. Income payments to foreignors are classified as import payments because they are based on capital shipped to the U.S.Unilateral Transfers – One way transfers (foreign aid, government grants, pension payments, worker remittances)

2. Financial Account:Movement of investment capital and loans into and out of U.S.Measures changes in U.S. ownership of foreign stocks, bonds and other assets.Measures changes in foreign ownership of U.S. securities and private assets.Measures changes in central bank’s holdings of foreign currencies and securities.

3. Capital Account: uncommon flows of money. Example includes U.S. residents who emigrate and take assets with them.

Balance of Payments = Current account + Financial Account + Capital Account = 0- represents all economic transactions between U.S. and R.O.W.

Since the 1980s, the U.S. current account balance has been negative, indicating Americans have consumed more than they produced (lived beyond their means) They accomplished this feat by borrowing money from the rest of the world (ROW) to finance their spending. Americans borrow $2 billion per day to finance their spending. The U.S. in now the largest debtor nation. The debt buildup cannot go on forever and could destabilize the U.S. and global economy.

Current account data is found on lines 71-76 of the report. A negative figure reflects how much the U.S. has to borrow from the ROW to finance spending by American consumers, businesses and government.

What is the possibility of a reversal of foreign investor sentiment against the dollar? An in external debt => concentration risk of U.S. assets on foreign balance sheets => foreign investor’s appetite for U.S. stock and bonds => dollar exchange rate => import prices => domestic prices => inflation => interest rates. To compensate for the concentration risk, foreign investors will have to be compensated with higher interest rates.

Does the trade deficits and capital surplus reflect the strength of the U.S. economy? The U.S. has a stable and attractive investment environment (liquid markets, creditworthy borrowers, strong productivity growth)

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Market Analysis:

Bonds: current account deficit => appreciating dollar => (P/P)ET+1 => DBonds => iBonds

Stocks: exports => net exports => domestic manufacturing => future profits => PStocks

Dollar: current account deficit => Demand for dollars & Supply of dollars => appreciating dollar

Current Account Balance

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How Movements in the Exchange Rate Affect Exports

Balance of payments The record of a country’s trade with other countries in goods, services, and assets.

Current account The part of the balance of payments that records a country’s net exports, net investment income, and net transfers.

Balance of trade The difference between the value of the goods a country exports and the value of the goods a country imports.

Financial account The part of the balance of payments that records purchases of assets a country has made abroad and foreign purchases of assets in the country.

Net foreign investment The difference between capital outflows from a country and capital inflows, also equal to net foreign direct investment plus net foreign portfolio investment.

Capital Account The part of the balance of payments that records relatively minor transactions, such as migrants’ transfers, and sales and purchases of nonproduced, nonfinancial assets.

2008 International TradeCurrent Account Balance = - Financial Account Balance

Current Account ($ bil)Exports Imports Balance on Goods/Services

Goods $1,291 -$2,112 -$821Services $544 -$404 $140

Income receipts $755Income payments -$628Net unilateral transfers -$119Current Account Balance -$673 ($ outflow)

(4.72% of GDP)

Financial Account ($ bil)Increase in U.S. owned assets abroad $-52 (outflow)Increase in foreign owned assets in U.S $599Statistical discrepancy $129Financial Account Balance $676 ($ inflow)

Capital Account ($ -3 bil)

Balance of Payments = Current Account Deficit + Financial Account Surplus + Capital Acct = 0Net Exports = Net Foreign Investment = (-Net Capital Inflow)

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Current Account Balance(mil $, SA)

Domestic Saving, Domestic Investment, and Net Foreign Investment

Saving and investment equation An equation showing that national saving is equal to domestic investment plus net foreign investment.

National Saving = Private Saving + Public SavingS = Sprivate + Spublic

whereSprivate = Y – C – T

Spublic = T – G

S = (Y – C – T) + (T – G)S = Y – C – G

Substitute for YS = (C + I + G + NX) – C - G

S = I + NXRecall Net Exports = Net Foreign Investment

S = I + NFI