BUS 626 Week 6 DQ

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Chapter 19: International Finance and the Foreign Exchange Market: 19-5a Current-Account Transactions Book Title: Macroeconomics: Private and Public Choice Printed By: Maranda Green ([email protected]) © 2018 Cengage Learning, Cengage Learning

19-5a Current-Account Transactions

Current-account transactions involve only current exchanges of goods and services and current income flows (and gifts). They do not involve changes in the ownership of either real or financial assets. Current-account (The record of all transactions with foreign nations that involve the exchange of merchandise goods and services, current income derived from investments, and unilateral gifts.) transactions are dominated by the trade in goods and services. The export and import of merchandise goods are the largest components in the current account. When U.S. producers export their products, foreigners will supply their currency in exchange for dollars in order to pay for the U.S.-produced goods. Because U.S. exports generate a supply of foreign exchange and demand for dollars in the foreign ex- change market, they are a credit (plus) item. In contrast, when Americans import goods, they will demand for-eign currencies and supply dollars in the foreign exchange market. Thus, imports are a debit (minus) item.

In 2015, the United States exported $1,513.5 billion of merchandise goods compared with imports of $2,272.8 billion. The difference between the value of a country’s merchandise exports and the value of its merchandise imports is known as the balance of merchandise trade (The difference between the value of merchandise exports and the value of merchandise imports for a nation. It is also called simply the balance of trade or net exports. The balance of merchandise trade is only one component of a nation’s total balance of payments and its current account.) (or balance of trade). If the value of a country’s merchandise exports falls short of the value of its merchandise imports, it is said to have a balance-of-trade deficit. In contrast, the situation in which a nation exports more than it imports is referred to as a trade surplus. In 2015, the United States ran a merchandise-trade deficit of $759.3 billion (line 3 of Exhibit 5).

The export and import of services are also sizable. Service trade involves the exchange of items like in-surance, transportation, banking services, and items supplied to foreign

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tourists. Like the export of merchandise goods, service exports generate a supply of foreign exchange and demand for dollars. For example, a Mexican business that is insured by an American company will supply pesos and demand dollars to pay its premiums for the service. Thus, service exports are recorded as credits in the balance-of-payments accounts of exporting nations. Conversely, the import of services from foreigners generates a demand for foreign currency and a supply of dollars in the exchange market. Therefore, service imports are a debit item.

As Exhibit 5 illustrates, in 2015, U.S. service exports were $710.2 billion, compared with service imports of $490.6 billion. Thus, the United States ran a $219.6 billion surplus on its service trade transactions (line 6 of Exhibit 5). When we add the balance of service exports and imports to the balance of merchandise trade, we obtain the balance on goods and services (The exports of goods (merchandise) and services of a nation minus its imports of goods and services.) . In 2015, the United States ran a $539.8 billion deficit (the sum of the $759.3 billion merchandise-trade deficit and the $219.6 billion service surplus) in the goods and ser-vices account.

Two other relatively small items are also included in current-account transactions:

net income from investments and

unilateral transfers.

Americans have made substantial investments in stocks, bonds, and real assets in other countries. As these investments abroad generate income, dollars will flow from foreigners to Americans. This flow of income to Americans will supply foreign currency (and create a demand for dollars) in the foreign exchange market. Thus, the net income to Americans is entered as a credit in the U.S. current account. Correspondingly, foreigners earn income from their investments in the United States. This net income to foreigners is recorded as a debit in the U.S. current account because the supply of dollars to the foreign exchange market creates a demand for foreign exchange.

As Exhibit 5 shows, in 2015, Americans earned $783.1 billion from investments abroad, whereas foreigners earned $591.8 billion from their investments in the United States. On balance, Americans earned $191.3 billion more on their investments abroad than foreigners

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earned on their investments in the United States. This $191.3 billion net inflow of investment income reduced the size of the deficit on current-account transactions.

Gifts to foreigners, like U.S. aid to a foreign government or private gifts from U.S. residents to their relatives abroad, generate a demand for foreign currencies and supply of dollars in the foreign exchange market. Thus, they are a debit item. Correspondingly, gifts to Americans from foreigners are a credit item. Because the U.S. government and private U.S. citizens gave $135.6 billion more to foreigners than we received from them, this net unilateral transfer was entered as a debit item on the current account in 2015.

Chapter 19: International Finance and the Foreign Exchange Market: 19-5a Current-Account Transactions Book Title: Macroeconomics: Private and Public Choice Printed By: Maranda Green ([email protected]) © 2018 Cengage Learning, Cengage Learning

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