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International topics june 2010

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  • 1. Macroeconomics: The Global Context Robert A. Gough, Jr., Ph.D. Proprietary and Confidential - G-enovation, Inc. - © 2009 1
  • 2. Macroeconomics Is about the overall economic environment …How it works as a whole …How: (1) Output  GDP = C + I + G + (Ex – M) (2) Role of Money (3) Expectations …impact and determine Macroeconomic conditions Proprietary and Confidential - G-enovation, Inc. - © 2009 2
  • 3. Macroeconomics The Global Context is about… • Trade flows • Income flows • People flows Tariffs…Quotas…Terms of trade …Dumping…Protectionism …Trade zones…Exchange rates…Balance of payments… IMF…World Bank…World currency…Purchasing power parity…Current account…Capital account… Proprietary and Confidential - G-enovation, Inc. - © 2009 3
  • 4. International Finance Proprietary and Confidential - G-enovation, Inc. - © 2009 4
  • 5. International Finance Balance of Payments… …a close cousin to GDP accounting • GDP Account = reports a nation’s output and its component parts • BOP Statement = records a nation’s cross-border transactions Proprietary and Confidential - G-enovation, Inc. - © 2009 5
  • 6. International Finance As in a GDP account…all numbers in a Balance of Payments Statement are flows… …indicating the value of: • Exports and Imports • Income Receipts and Payments • New Foreign Borrowing or Lending  …over a particular period of time…like a year. Proprietary and Confidential - G-enovation, Inc. - © 2009 6
  • 7. International Finance A Balance of Payments Statement Current Account • Balance on Trade of Goods & Services • Balance on Merchandise Trade (Goods) • Balance on Trade in Services • Net Income (Net Factor Receipts) • Net Unilateral Transfers Proprietary and Confidential - G-enovation, Inc. - © 2009 7
  • 8. International Finance A Balance of Payments Statement Capital and Financial Account • Net Capital Account • Financial Account • Net Foreign Direct Investment • Net Portfolio Flows • Other Capital Flows, Net • Change in Official Reserves • Errors and Omissions (Statistical Discrepancy) Proprietary and Confidential - G-enovation, Inc. - © 2009 8
  • 9. International Finance A Balance of Payments Statement …is very revealing …offers a unique window on a country’s cross border transactions …summarizes a country’s relationship to the global economy • It tells a story… …just like your personal checkbook …and your library Proprietary and Confidential - G-enovation, Inc. - © 2009 9
  • 10. International Finance Proprietary and Confidential - G-enovation, Inc. - © 2009 10
  • 11. International Finance Proprietary and Confidential - G-enovation, Inc. - © 2009 11
  • 12. International Finance Proprietary and Confidential - G-enovation, Inc. - © 2009 12
  • 13. International Finance Proprietary and Confidential - G-enovation, Inc. - © 2009 13
  • 14. International Finance Proprietary and Confidential - G-enovation, Inc. - © 2009 14
  • 15. International Finance Proprietary and Confidential - G-enovation, Inc. - © 2009 15
  • 16. International Finance A Balance of Payments Statement Some explanations…Capital & Financial Account “Financial Account”… “Changes in official reserves” = reflect increases/decreases in the government’s stockpile of gold and foreign currencies. “Errors & Omissions” = residual category reflecting statistical discrepancies in compiling BOP data. Proprietary and Confidential - G-enovation, Inc. - © 2009 16
  • 17. International Finance Proprietary and Confidential - G-enovation, Inc. - © 2009 17
  • 18. International Finance Exchange Rates… …strongly affected by: (1) A country’s current account balance…trade balance Logic: • If consumer demand for foreign products rises… • A country’s current account balance deteriorates… • …and its currency depreciates • Because higher demand for foreign products bids up price of foreign currencies needed to buy them Proprietary and Confidential - G-enovation, Inc. - © 2009 18
  • 19. International Finance Exchange Rates… “Sustained current account deficits are more typically associated with long-term currency depreciation than with long-term appreciation.” Proprietary and Confidential - G-enovation, Inc. - © 2009 19
  • 20. International Finance Exchange Rates… …strongly affected by: (2) A country’s inflation…purchasing power parity Logic: • If a country experiences consistently higher inflation… • A country’s current account balance deteriorates… • …and its currency depreciates • Because…rising prices for a country’s products reduces demand for those products. Proprietary and Confidential - G-enovation, Inc. - © 2009 20
  • 21. International Finance Exchange Rates… Relationship between inflation and exchange rates viewed through “purchasing power parity”…. • The Law of One Price • The “Big Mac Index” criteria …A unit of currency ($) should always have the same purchasing power in one country as another. …Inflation undermines this parity. Proprietary and Confidential - G-enovation, Inc. - © 2009 21
  • 22. International Finance Exchange Rates… …strongly affected by: (3) A country’s interest rates …regarded by currency traders as the single most powerful driver of exchange rates…in short run. Logic: • Higher interest rates attract foreign capital… • …driving up the value of a country’s currency Proprietary and Confidential - G-enovation, Inc. - © 2009 22
  • 23. International Finance Exchange Rates… Regardless of other models and observations… Law of One Price – “uncovered interest rate parity” A country’s currency tends to appreciate after a rise in its interest rates…and to depreciate after a fall. Proprietary and Confidential - G-enovation, Inc. - © 2009 23
  • 24. International Finance Making Sense of Exchange Rates… • It’s difficult…! • Most important lesson: currency markets are unpredictable… • …and irrational “Ask 10 traders…likely get 10 different explanations!” Proprietary and Confidential - G-enovation, Inc. - © 2009 24
  • 25. International Finance Making Sense of Exchange Rates… But… …exchange rates are still subject to basic pressures of supply and demand. • Exchange rate is the price of one currency in terms of another…like products! • What raises the demand for a currency creates pressure for appreciation…and vice versa Proprietary and Confidential - G-enovation, Inc. - © 2009 25
  • 26. International Finance Making Sense of Exchange Rates… Examples: • Surge in American demand for foreign goods or financial assets…will weaken the dollar. • Burst of European inflation…will weaken the euro…and strengthen the dollar. • Unexpected increase in British interest rates… would strengthen the pound. Proprietary and Confidential - G-enovation, Inc. - © 2009 26
  • 27. International Finance Making Sense of Exchange Rates… Reason why exchange rates are difficult to predict… • Currencies are subject to a myriad of pressures at the same time. Ups and downs in aggregate demand…currency interventions by governments…interest rate movements…inflation…financial panics…political crises…oil shocks…new technologies…abrupt changes in expectations…etc. Proprietary and Confidential - G-enovation, Inc. - © 2009 27
  • 28. International Finance Making Sense of Exchange Rates… Upshot…Rules of Thumb…Best Predictors: (1) Interest rates – for short-term movements …interest rate increases ► rapid appreciation (2) Inflation – for medium-term movements …high inflation ► depreciation (3) Current account imbalances – for longer-term movements …deficits ► depreciation Proprietary and Confidential - G-enovation, Inc. - © 2009 28
  • 29. Macroeconomics Is about the overall economic environment …How it works as a whole …How: (1) Output  GDP = C + I + G + (Ex – M) (2) Role of Money (3) Expectations …impact and determine Macroeconomic conditions Proprietary and Confidential - G-enovation, Inc. - © 2009 29
  • 30. Macroeconomics – The Global Context Is about the global economic environment: ...How various forces ...Summarized by: (1) Balance of Payments (2) Exchange Rates …impact and determine global economic conditions Proprietary and Confidential - G-enovation, Inc. - © 2009 30