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Copyright 2008 The McGraw-Hill Companies36-1
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
36Exchange Rates, the Balance of Payments, and Trade Deficits
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Copyright 2008 The McGraw-Hill Companies36-2
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Chapter Objectives• How Currencies of Different Nations
are Exchanged When International Transactions Take Place
• About the Balance Sheet the United States Uses to Account for the International Payments it Makes and Receives
• How Exchange Rates are Determined in Currency Markets
• The Difference Between Flexible Exchange Rates and Fixed Exchange Rates
• The Causes and Consequences of Recent Record-High U.S. Trade Deficits
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Copyright 2008 The McGraw-Hill Companies36-3
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Financing International Trade• U.S. Export Transactions• U.S. Import Transactions• Balance of Payments• The Current Account
–Balance on Goods–Balance on Services–Trade Deficit–Trade Surplus–Balance on Current Account
W36.1
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Copyright 2008 The McGraw-Hill Companies36-4
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Financing International Trade
• Involves different national currencies
• When U.S. firm exports to Mexico, they want to be paid in USDs
• Problem resolved in foreign exchange (currency) markets
• Foreign exchange markets facilitate exports and imports
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Copyright 2008 The McGraw-Hill Companies36-5
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
U.S. Export Transaction
• Assume U.S. is selling to GB• GB buyer draws a check on its
checking account at British bank and sends it to U.S. exporter
• U.S. bank sells its check in pounds to its bank, which is a dealer in foreign exchange
• Bank deposits the pounds into a correspondent London bank for future sale to a U.S. buyer who needs pounds
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Copyright 2008 The McGraw-Hill Companies36-6
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
U.S. Export Transaction
• U.S. exports create a foreign demand for dollars, and the fulfillment of that demand increases the supply of foreign currencies owned by U.S. banks and available to U.S. buyers
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Copyright 2008 The McGraw-Hill Companies36-7
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
U.S. Import Transaction
See p.697
U.S. imports create domestic demand for foreign currencies, and the fulfillment of that demand reduces the supply of foreign currencies
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Copyright 2008 The McGraw-Hill Companies36-8
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
The Balance of Payments
• The sum of all the transactions that take place b/w its residents and the residents of all foreign nations
• Include exports and imports, tourist expenditures, interest and dividends, purchases and sales of financial assets
• Compiled annually• Shows “flows” of in-payments
and out-payments for the U.S.
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Copyright 2008 The McGraw-Hill Companies36-9
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Current Account
• Summarizes U.S. trade in currently produced g/s
• Balance on goods – the difference between its exports and its imports on goods (typically a deficit)
• Balance on services – difference b/w its exports and imports on goods
• Balance on goods and services – will show an overall trade deficit or surplus
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Copyright 2008 The McGraw-Hill Companies36-10
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Balance on Current Account
• Net investment income – difference b/w interest and dividend payments foreigners paid to U.S. for use of exported U.S. capital and the interest and dividends the U.S. paid for the use of foreign capital invested in the United States
• Balance on current account – add all transactions in the current account
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Copyright 2008 The McGraw-Hill Companies36-11
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Capital and Financial Account
• Capital account – a “net” account that mainly measures debt forgiveness
• Financial account – summarizes the purchase or sale of real or financial assets and the flows of monetary payments that accompany them
• Balance on the capital and financial account – sums the capital and financial accounts
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Copyright 2008 The McGraw-Hill Companies36-12
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Payments, Deficits and Surpluses
• Balance of payments must always sum zero, but economists will discuss balance-of-payments deficits and surpluses
• Balance of payments deficit – in some years a nation must make an inpayment of official reserves to its capital and financial account to balance it w/ current account
• Balance of payments surplus – in some years an outpayment of official reserves from the capital and financial account must be needed to balance
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Copyright 2008 The McGraw-Hill Companies36-13
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Financing International Trade
U.S. Trade Balances in Goods and ServicesSelect Nations, 2004
Goods and Services SurplusGood and Services Deficit
Australia
Belgium
Canada
China
Germany
Mexico
Netherlands
+6.8
-66.5
-45.8
+4.4
-162
-45.1
+11.8
Source: BEA
GLOBAL PERSPECTIVE
-10-20-30-40-50-60-70-160 10 20
Japan -75.6
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Copyright 2008 The McGraw-Hill Companies36-14
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Capital and Financial Account
• Capital Account• Financial Account• Balance on the Capital and
Financial Account–Payments, Deficits, and
Surpluses–Balance-of-Payments
Deficits and Surpluses–Official Reserves
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Copyright 2008 The McGraw-Hill Companies36-15
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Flexible Exchange Rates• Flexible or Floating Exchange
Rates• Fixed Exchange Rate system• Depreciation and Appreciation• Determinants of Exchange
Rates–Changes in Tastes–Relative Income Changes–Relative Price-Level Changes
• Purchasing-Power-Parity Theory–Relative Interest Rates–Speculation
G36.1
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Copyright 2008 The McGraw-Hill Companies36-16
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Flexible Exchange Rates
• 2 Types:• 1. flexible- or floating- exchange-
rate system – demand and supply determine exchange rates w/o gov. involvement
• 2. fixed-exchange-rate system – governments determine exchange rates and make necessary adjustments to those rates
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Copyright 2008 The McGraw-Hill Companies36-17
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Depreciation and Appreciation
• If the dollar price of a foreign currency rises, the dollar depreciates in value relative to the foreign currency
• If the dollar price of a foreign currency falls, the dollar appreciates in value relative to the foreign currency
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Copyright 2008 The McGraw-Hill Companies36-18
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Determinants of Exchange Rates
• 3 generalizations:• 1. if demand for a nation’s
currency increases, that currency will appreciate, and vice versa
• 2. if the supply of a nation’s currency increases, the currency will depreciate and vice versa
• 3. if a nation’s currency appreciates, some foreign currency depreciates relative to it
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Copyright 2008 The McGraw-Hill Companies36-19
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Factors that Shift S/D Curves
• Changes in tastes • Relative income changes –
nation’s currency likely to depreciate if its growth of national income is more rapid than that of other nations b/c imports vary directly w/ income level
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Copyright 2008 The McGraw-Hill Companies36-20
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Factors that Shift S/D Curves
• Relative Price-Level Changes – if domestic price levels rise, nation will import more and currency will depreciate
• Relative interest rates – higher interest rates will cause currency to appreciate in nation w/higher rates
• Speculation – self-fulfilling prophecies may result
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Copyright 2008 The McGraw-Hill Companies36-21
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Q0
Do
llar
Pri
ce o
f 1
Po
un
d
Quantity of Pounds
P
Flexible Exchange RatesThe Market for Foreign Currency (Pounds)
Dl
Sl
DollarDepreciates(PoundAppreciates)
DollarAppreciates(PoundDepreciates)
ExchangeRate: $2 = £1
$2
$3
$1
Ql
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Copyright 2008 The McGraw-Hill Companies36-22
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Q0
Do
llar
Pri
ce o
f 1
Po
un
d
Quantity of Pounds
P
Flexible Exchange RatesThe Market for Foreign Currency (Pounds)
Dl
Sl
ExchangeRate: $2 = £1
$2
$3
$1
Ql
D2
ExchangeRate: $3 = £1
BalanceOf Payments
Deficit
Q2
x a
b
c
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Copyright 2008 The McGraw-Hill Companies36-23
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Flexible Exchange Rates
• Flexible Rates and the Balance of Payments
• Disadvantages of Flexible Exchange Rates
• Uncertainty and Diminished Trade
• Terms-of-Trade Changes• Instability
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Copyright 2008 The McGraw-Hill Companies36-24
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Flexible Rates and the Balance of Payments
• Flexible exchange rates automatically adjust and eventually eliminate balance-of-payment deficits or surpluses
• Will affect import/export levels
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Copyright 2008 The McGraw-Hill Companies36-25
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Disadvantages of Flexible Exchange Rates
• Uncertainty and diminished trade
• Terms of trade changes – decline in international value of a nation’s currency will worsen its terms of trade
• Instability – may destabilize domestic economy (export industries)
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Copyright 2008 The McGraw-Hill Companies36-26
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Fixed Exchange Rates
• At times nations have fixed their exchange rates to avoid disadvantages of flexible rates
• Nation will have to alter market demand and supply to avoid rate changes
• How??
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Copyright 2008 The McGraw-Hill Companies36-27
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Fixed Exchange Rates• Use of Reserves
–Currency Interventions• Trade Policies• Exchange Controls and
Rationing–Distorted Trade–Favoritism–Restricted Choice–Black Markets
• Domestic Macroeconomic Adjustments
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Copyright 2008 The McGraw-Hill Companies36-28
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Use of Reserves
• Currency interventions – selling reserves to maintain exchange rates
• Trade policies – control flow trade directly (barriers)
• Exchange Controls and Rationing – U.S. could demand all foreign currencies be sold to the U.S. gov and then rationed
• Major Objections: distorted trade, favoritism, restricted choice, black markets
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Copyright 2008 The McGraw-Hill Companies36-29
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Domestic Macroeconomic Adjustments
• Use fiscal and monetary policy to eliminate shortage of foreign currency
• Contractionary policies would be used, but there is great opportunity cost
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Copyright 2008 The McGraw-Hill Companies36-30
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
International Exchange-Rate Systems
• The Gold Standard: Fixed Exchange Rates–Devaluation–Gold Flows–Domestic Macroeconomic
Adjustments–Collapse of the Gold
Standard
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Copyright 2008 The McGraw-Hill Companies36-31
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
International Exchange-Rate Systems
• The Bretton Woods System– International Monetary Fund
(IMF)– IMF and Pegged Exchange
Rates• Official Reserves• Gold Sales• IMF Borrowing
–Fundamental Imbalances: Adjusting the Peg
–Demise of the Bretton Woods System
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Copyright 2008 The McGraw-Hill Companies36-32
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
International Exchange-Rate Systems
• The Current System: The Managed Float–Managed Floating
Exchange Rates• In Support of the Managed Float
•Concerns With the Managed Float
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Copyright 2008 The McGraw-Hill Companies36-33
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
International Exchange Rate Systems
• Gold Standard• 1879-1974 – major nations of
world were on fixed-rate system of the gold standard
• Each nation had to define its currency in terms of gold, maintain a fixed relationship b/w stock of gold and $ supply, allow gold to be exported and imported
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Copyright 2008 The McGraw-Hill Companies36-34
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Collapse of Gold Standard
• During Great Depression of 1930s• Devaluation of currency
occurred, exchange rates no longer fixed, system broke down
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Copyright 2008 The McGraw-Hill Companies36-35
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
The Bretton Woods System
• Modified fixed-exchange –rate system (adjustable peg system)
• Created the International Monetary Fund (IMF) – now plays a role in loaning to developing nations, nations experiencing crises, and nations transitioning to capitalism
• Bretton Woods system ended in 1971 – US abandons gold standard
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Copyright 2008 The McGraw-Hill Companies36-36
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
The Current System: The Managed Float
• Managed floating exchange rates – rates are free to float to equilibrium market levels but nations occasionally use currency interventions to stabilize or alter market exchange rates
• G8 nations meet regularly to discuss economic issues and coordinate policies (US, CAN, FR, GER, IT, JAP, RUS, UK)
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Copyright 2008 The McGraw-Hill Companies36-37
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Support of Managed Float
• Has functioned well thus far• Has weathered severe economic
turbulence
Can adjust to world events
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Copyright 2008 The McGraw-Hill Companies36-38
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Concerns w/ Managed Float
• Has not eliminated trade imbalances
• Can be volatile
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Copyright 2008 The McGraw-Hill Companies36-39
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Recent U.S. Trade Deficits• Causes of Trade
Deficits• Implications of U.S.
Trade Deficits–Increased Current Consumption
–Increased U.S. Indebtedness
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Copyright 2008 The McGraw-Hill Companies36-40
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Causes of Recent U.S. Trade Deficits
• U.S. growth/growth of imports
• Large trade deficits with China
• Decline in U.S. savings rate
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Copyright 2008 The McGraw-Hill Companies36-41
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Implications of U.S. Trade Deficits
• Increased Current Consumption – benefits U.S. consumer
• Increased U.S. Indebtedness – trade deficit must be financed by borrowing from the rest of world, selling off assets, or dipping into official reserves
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Copyright 2008 The McGraw-Hill Companies36-42
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Speculation in Currency Markets
• Currency Purchases to Purchase Goods and Services
• Contributing to Currency Market Fluctuations
• Speculator’s Role and Activities
• Smoothing Short-Term Fluctuations
• Absorbing Risk• Futures Market at Work• Positive Role Played Overall
Last
Word
Negative or Positive Influence on Currency Markets and Trade
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Copyright 2008 The McGraw-Hill Companies36-43
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Key Terms• balance of payments• current account• balance on goods an
d services• trade deficit• trade surplus• balance on current ac
count• capital and financial a
ccount• balance on capital an
d financial• balance-of-payments
deficits and surpluses
• official reserves
• flexible- or floating- exchange-rate system
• fixed-exchange-rate system
• purchasing-power-parity theory
• currency interventions
• exchange controls• gold standard• devaluation• Bretton Woods syste
m• International Monetar
y Fund (IMF)• managed floating exc
hange rates
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Copyright 2008 The McGraw-Hill Companies36-44
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
Course Review…
FinalDiscussions…
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Copyright 2008 The McGraw-Hill Companies36-45
Financing International Trade
Capital and Financial Account
Flexible Exchange Rates
Fixed Exchange Rates
International Exchange-Rates System
Recent U.S. Trade Deficits
Last Word
Key Terms
End Show
The End
I am going to miss taking notes in Econ omics class!!!!!