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It cannot be in disequilibrium unless something has not been counted or has been counted improperly Therefore it is incorrect to state that the BOP is in disequilibrium
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Although assets can be identified as belonging to distinct groups, it is easier to think of all assets simply as goods that can be bought or sold (a clock versus a bond)
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The Current Account is typically dominated by the first component which is known as the Balance of Trade (BOT) even though it excludes service trade
Copyright 2010 Pearson Prentice Hall. All rights reserved.
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Exhibit 4.3 U.S. Trade Balance and Balance on Services and Income, 1985-2007 (billions of US dollars)
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The Capital Account is minor (in magnitude), while the Financial Account is significant
Copyright 2010 Pearson Prentice Hall. All rights reserved.
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Portfolio Investment in which the investor has no control over the assets
Other Investment consists of various shortterm and long-term trade credits, cross-border loans, currency deposits, bank deposits and other A/R and A/P related to cross-border trade
Copyright 2010 Pearson Prentice Hall. All rights reserved.
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Direct Investment
This is the net balance of capital dispersed from and into the US for the purpose of exerting control over assets. Foreign direct investment arises from 10% ownership of voting shares in a domestic firm by foreign investors. The source of concern over foreign investment in any country focuses on two topics: control and profit. Some countries possess restrictions on foreigners may own in their country. The general rule or premise is that domestic land, assets and industry should be owned by residents of the country. Concerns over profit stem from the same argument.
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Portfolio Investment
This is the net balance of capital that flows in and out of the U.S. but does not reach the 10% threshold of direct investment. The purchase of debt securities across borders is classified as portfolio investment because debt securities by definition do not provide the buyer with ownership or control. Portfolio investment is motivated by a search for returns rather than to control or manage the investment.
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Exhibit 4.5 The United States Financial Account 1985-2007 (billions of US dollars)
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These reserves are normally composed of the major currencies used in international trade and financial transactions (hard currencies).
The significance of official reserves depends generally on whether the country is operating under a fixed exchange rate regime or a floating exchange rate system.
Copyright 2010 Pearson Prentice Hall. All rights reserved.
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The BOP Interaction with Key Macroeconomic Variables A nations balance of payments interacts with nearly all of its key macroeconomic variables Interacts means that the BOP affects and is affected by such key macroeconomic factors as:
Gross Domestic Product (GDP) The exchange rate Interest rates Inflation rates
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Exhibit 4.8 Trade Balance Adjustment to Exchange Rate Changes: The J-Curve
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Capital Mobility
The degree to which capital moves freely across borders is critically important to a countrys balance of payments The financial account surplus has probably been one of the major reasons that the U.S. dollar has been able to maintain its value over the past 20 years
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Capital Mobility
The authors argue that the post-1860 era can be subdivided into four distinct periods with regard to capital mobility.
1860-1914 continuously increasing capital mobility as the gold standard was adopted and international trade relations were expanded 1914-1945 global economic destruction, isolationist economic policies, negative effect on capital movement between countries 1945-1971 Bretton Woods era say a great expansion of international trade 1971-2002 floating exchange rates, economic volatility, rapidly expanding cross-border capital flows
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Capital Flight
Although no single definition of capital flight exists, it has been characterized as occurring when capital transfers by residents conflict with political objectives. Many heavily indebted countries have suffered capital flight, compounding their debt service problems. Capital can be moved via international transfers, with physical currency, collectables or precious metals, money laundering or false invoicing of international trade transactions.
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Mini-Case Questions: Turkeys Kriz (A) Where in the current account would the imported telecommunications equipment be listed? Would this location correspond to the increase in magnitude and timing of the financial account? Why do you think that net direct investment declined from $573 million in 1998 to $112 million in 2000? Why do you think that TelSim defaulted on its payments for equipment imports from Nokia and Motorola?
Copyright 2010 Pearson Prentice Hall. All rights reserved.
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Chapter 4
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Exhibit 4.2 The United States Current Account, 19982007 (billions of U.S. dollars)
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Exhibit 4.4 The United States Financial Account and Components, 1998-2007 (billions of U.S. dollars)
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Exhibit 4.6 Current and Combined Financial/Capital Account Balances United States, 19922007 (billions of U.S. dollars)
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Exhibit 4.7 The United States Balance of Payments, Analytic Presentation, 19982007 (billions of U.S. dollars)
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Exhibit 2 Subaccounts of the Turkish Current Account, 19982000 (millions of U.S. dollars)
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Exhibit 3 Subaccounts of the Turkish Financial Account, 1998 2000 (millions of U.S. dollars)
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