Chapter 2: International Flow of Funds

The current account balance is composed of (1) the balance of trade, (2) the net amount of payments of interest to foreign investors and from foreign investment, (3) payments from international tourism, and (4) private gifts and grants.

The financial account measures the flow of funds between countries that are due to: (1) direct foreign investment, (2) portfolio investment, and (3) other capital investment.

A high inflation rate tends to increase imports and decrease exports, thereby increasing the current account deficit, other things equal.

This question is intended to encourage opinions and does not have a perfect solution. A negative current account is thought to reflect lost jobs in a country, which is unfavorable. Yet, the foreign importing reflects strong competition from foreign producers, which may keep prices (inflation) low.

If the dollar weakens against all currencies, the U.S. balance of trade deficit will likely be smaller. Some U.S. importers would have more seriously considered purchasing their goods in the U.S. if most or all currencies simultaneously strengthened against the dollar. Conversely, if some currencies weaken against the dollar, the U.S. importers may have simply shifted their importing from one foreign country to another.

International trade volume has increased because of the reduction in trade restrictions over time. It may have also increased for many other reasons, such as increased information flow (via Internet etc.) between firms in different countries. Inefficient firms are adversely affected if they have to face tougher competition from foreign firms as a result of a reduction in trade restrictions.

The euro allowed for a single currency among many European countries. It could encourage firms in those countries to trade among each other since there is no exchange rate risk. This would possibly cause them to trade less with the U.S. The euro can increase trade within Europe because it eliminates the need for several European countries to exchange currencies when trading with each other.

One of South Korea’s primary competitors in exporting is Japan, which produces and exports many of the same types of products to the same countries. When the Japanese yen is weak, some importers switch to Japanese products in place of South Korean products. For this reason, it is often suggested that South Korea’s primary export problem is weakness in the Japanese yen.

The U.S. wine producers benefit from the U.S. tariffs, while the French wine producers are adversely affected. The French government would likely retaliate by imposing tariffs on the U.S. beverage firms, which would adversely affect their value. The French beverage firms would benefit.

The expectations of a strong dollar would discourage U.S. investors from investing abroad. If the dollar is relatively weak now, U.S. investors need more dollars to make purchase foreign currency (when investing). If the dollar strengthens over their investment horizon, they will exchange the foreign currency (as the investment is liquidated) into dollars at a less favorable exchange rate than the exchange rate at which they converted dollars into the foreign currency. That is, the exchange rate effect would reduce the yield that they earn on their investment.

Low U.S. interest rates can encourage U.S.-based MNCs to invest abroad, as investors seek higher returns on their investment than they can earn in the U.S.

The main attraction is potentially higher returns. The international stocks can outperform U.S. stocks, and international bonds can outperform U.S. bonds. However, there is no guarantee that the returns on international investments will be so favorable. Some investors may also pursue international investments to diversify their investment portfolio, which can possibly reduce risk.

A stronger dollar makes U.S. exports more expensive to importers and may reduce imports. It makes U.S. imports cheap and may increase U.S. imports. A weaker home currency increases the prices of imports purchased by the home country and reduces the prices paid by foreign businesses for the home country’s exports. This should cause a decrease in the home country’s demand for imports and an increase in the foreign demand for the home country’s exports, and therefore increase the current account. However, this relationship can be distorted by other factors.

A current account deficit reflects a net sale of the home currency in exchange for other currencies. This places downward pressure on that home currency’s value. If the currency weakens, it will reduce the home demand for foreign goods (since goods will now be more expensive), and will increase the home export volume (since exports will appear cheaper to foreign countries).

In some cases, the home currency will remain strong even though a current account deficit exists, since other factors (such as international capital flows) can offset the forces placed on the currency by the current account.

Some governments offer subsidies to their domestic firms so that those firms can produce products at a lower cost than their global competitors. They may also have very limited environment and child labor restrictions, which allows local firms to produce at a low cost.

When a government imposes lower corporate tax rates, firms may be able to charge lower prices for their products and still make a profit.

Lower tax rates should not be viewed as unfair, unless the government only allows its exporting firms such a tax advantage.