19. balance of payments

Balance of Payments and

Foreign Exchange

A country with a great deal of trade

will be more likely affected by

external events.

The Balance of Payments indicate how

trade + external events affect a

country’s economy.

Most notably - that of Canada and the United States

International Relationships can be very important

2011

Balance of Payments (BoP)

a summary of all transactions that involve the exchanging of Canadian dollars.

RECEIPTS: (+) PAYMENTS: (-)- all monetary inflows into the Canadian economy

- all monetary outflows from the Canadian economy

i.e. - buying Cdn. exports - buying Cdn. financial assets.

i.e. - Cdns. buy imports - Cdns. invest outside Canada

Also...

RECEIPTS: (+) PAYMENTS: (-) - Payments from foreign accounts - supply of foreign exchange increased (i.e. US$) with demand for local currency (i.e. C$)

- payments to foreign accounts - demand for foreign exchange and increased supply of local currency.

(if American’s are buying C$ we get US$, they get C$)

Balance of Payment AccountsDivided into:

CURRENT ACCOUNT:CAPITAL

ACCOUNT:•tangible goods•services (i.e. tourism)•investment income (i.e. interest, dividends) •transfers (i.e. gifts, inheritance aid)

•foreign transactions of financial assets involving Cdn. $

Two types:Portfolio Investment - invest. (but not controlling interest)Direct Investment - controlling interest in the business.

Canadian current account 2008-2013

The high Canadian dollar has been blamed for this current account deficit.

Capital Account examples:

Purchase of foreign investments by Canadians:

This is the capital outflow

To purchase foreign investments the Canadian must buy foreign currency by selling Canadian dollars.

This becomes a debt (negative) entry in the Capital Account.

This works the same for any item on the current account

PAYMENTSPAYMENTS

Capital Account examples cont’d.

Purchase of Canadian investments by foreign investors:

Referred to as capital inflow

To purchase Canadian assets foreign investors must buy Canadian dollars.

This becomes a credit (positive) entry in the Capital Account.

This works the same for any item on the current

account.

RECEIPTSRECEIPTS

Foreign direct investment into Canada - 2011

Foreign Exchange (forex)Name that symbol

Evolution of the exchange rate system

Until 1934 - Canada and most western nations were on the Gold Standard.

- the value of the currency was set in terms of the amount of gold a country held.

- not adjustable

- this broke down in the Great Depression - gov’ts tried to stimulate economy by depreciating own currencies. (printed more money than was held in gold).

Wait...there’s more!

1945-1970 - The Bretton Woods System - this was, for the most part, using a fixed exchange rate. (We’ll get back to this.)

✴ 1950-1962 - Canada worked toward a floating exchange rate

- but large inflows of foreign investment resulted in value of C$ going up - mostly above US$

- thus impossible to shield the country from inflation.

1962-1970 - fixed rate at US$0.925

Managed Float - 1971-present

Flexible exchange rate system - sometimes requiring short-term intervention.- when necessary and practical the Bank of Canada can buy or sell large amounts of C$ to affect its trading value.

2002 - a new all time low was hit

at $0.6192US

Today - the Canadian dollar is trading at $0.9529US

2007 - a new all time high

was hit at $1.06US

To summarize

Floating Exchange Rates

Exchange rate = the price of a currency in terms of other currencies.

once determined by the amount of gold a country held currency values such as the Canadian dollar are now freely floating

Thus it is based on supply and demand

As Canadian goods and investments are bought by foreigners the demand for the Canadian dollar rises. This effect is also true if Canadians are shying away from foreign markets.

Like all good Supply and Demand models the increased demand will ultimately cause prices to rise enough that demand will begin to decrease.

Of course the same is also true in the reverse. As the foreign markets decrease their demand on Canadian products OR Canadians increase their demand for foreign goods the supply of the Canadian dollar will rise and its value will fall.

And what, in theory, will happen as the value of the Canadian dollar declines? What is the paradox?

However...

if the Canadian dollar were to move in one direction or the other too quickly or for too long the Bank of Canada may intervene by buying and selling its own reserves in the foreign exchange market.

Remember Stephen Poloz? He doesn't like to have to do this.

Fixed or Pegged Exchange Rates.

Occur when a country ties the exchange rate to another country’s currency.

this is used to maintain a currency value within a narrow band.

Why use a fixed rate?

provides greater certainty for exporters and importers.

helps the government maintain low inflation - which also helps keep interest rates down.

generally expected to increase trade and investment.

Who uses the fixed exchange rate?

Well, no one really - but it is used sometimes as a temporary stabilizing measure. (i.e. Canada 1962-1970)

Also - countries that now use the euro - their old currencies still exist for the payment of old bonds. The rates of these currencies are fixed in terms of the euro.

And China - only discontinued the use of a fixed exchange rate in July 2005.

How to calculate foreign exchange

It’s easy - there’s an app. for that.

Or...the old fashioned way

If: The Canadian dollar is priced at .80 U.S.

Then: 1/.80 = $1.25 C$ needed to buy US$

If: A good is being sold for C$20

Then: $20.00 X .80 = $16.00 (US)

If: A good is being sold for US$20

Then: $20.00 X 1.25 = $25.00 (Cdn.)