It should come as no surprise the scale and scope of international exchange has expanded dramatically in the post WW II era since we are in the midst of an irreversible process called globalization. If you have any doubts consider the differences between a day in your life today and that of your parents or grandparents in early 1960s. You are likely to be driving a Japanese car that runs on oil from the Mid East, wearing a shirt made in Central America, relaxing on your Scandinavian furniture watching a movie on your TV/VCR that was made in South Korea, vacationing in Europe, the Caribbean, or Mexico, working for a foreign-owned company, producing goods and services to be consumed outside of the US. In the early 1960s, meanwhile, you would be far more likely to be working for an American owned company producing goods for domestic consumption, driving American cars produced in the Midwest running on oil from the American Southwest, vacationing in Florida or New Hampshire, and watching American produced TVs while resting in American furniture.

Transaction Classification Scheme

US International Transactions

The current account measures the flow of income into and out from a country. In this sense it is similar to an individual's income statement where the credits represent income and debits represent expenses.

What is not evident in the net figures is the substantial growth in exports and imports.  Although imports (2000%) have risen faster than exports (1700%), both have grown consistently faster than GDP (800%). The result has been that their shares of GDP has more than doubled between 1960 and 1997.

As for the balance, the US ran a balance of trade surplus consistently until 1971. After 1971, the trade deficit continued to grow, with only a brief interruption during the 1980-82 recessions, and by 1987 the balance of trade deficit had peaked at 3.5% of GDP. In large part, the ballooning of the trade deficit can be attributed to the precipitous slowdown in the growth of US exports that accompanied a rather dramatic rise in the value of the dollar. In 1986 the value of exports remained virtually unchanged from their 1980 level, while imports had increased by nearly 50 percent. Since 1986, however, exports have rebounded and the balance of trade deficit for 1997 stood at 2.4% of GDP.

In addition to the growth in the levels of international transactions, there has also been a substantial change in its composition. Between 1965 and 1997, there has been nearly a 60% drop in agricultural products' share of exports that has been partially matched by increases in the exports of capital goods and automobiles. In 1997 agricultural products accounted for 10% of US exports, slightly less than the value of automobile exports (10.4%) and substantially less than the 40% share of capital goods.

On the import side, the two most politically sensitive categories are petroleum and automobiles. Petroleum's share of imports in 1992 was 12%, above where it was in 1965 (8%), but sharply lower than the rate in 1980. As a result of the two rounds of OPEC price increases in the 1970s and a fairly inelastic demand for oil, petroleum accounted for nearly one-third of all imports by 1980 (35%). Once the collapse of oil prices began in the recession of 1980-82, however, petroleum's share of exports began its slide back to 9%.  Automobiles, meanwhile, account for 21% of US imports, down sharply from the 35% range in the mid 1980s.  Finally, capital goods represent 37 percent of imports, up sharply from the 6% share in 1965.

A geographic breakdown of imports and exports is provided in the table below. In 1997, the three largest markets for US exports were Canada, Mexico, and Japan. At a more aggregate level we find that Asia was the largest market for US exports (32% of the total), followed by Europe (22%), and Latin America (20%). The pattern of imports, meanwhile, are more heavily skewed toward Asia.  The big three importers in 1997 were Japan, Mexico, and China.  Asia accounted for a full 40% of US imports with Japan and China accounting for nearly one-half.  Imports from the newly industrialized countries of Asia, Taiwan, Singapore, South Korea, and Hong Kong, were approaching the level of imports from Europe's largest industrial nations. 

A less publicized, but more rapidly growing component of the BOPA, is the balance in services. Included here are tourist expenses, transportation costs, and royalties and licensing fees.  In 1992 the balance on the service account was $56.411 billion and by 1997 it had grown to $87.748 billion. 

The third component of the current account is the income received from investments abroad.  In 1970 the inflow of income into the US from control of foreign assets was more than twice the outflow, but by 1997 the imbalance had ended and the US was running a $5.5 billion deficit on this account.  During this twenty-seven year period, the income on foreign assets grew twice as fast as imports and four times the rate of service growth.  By 1997 income on foreign owned assets share of GDP was ten times higher than in 1960. 

The final component of the current account measures unilateral transfers. Included in this item are government transfers and grants and private remittances.  For an industrialized country such as the US, remittances tend to be small and the flow tends to be outward as 'guest workers' send money home.  In 1997 the net outflow totaled $39.691 billion.

When examining the second component of the balance of payments, the capital account, it may be helpful to think of the balance on capital account as the mirror image of the balance on current account. Returning to the case of the individual, if an individual is spending more than she is earning, then she must finance this by borrowing or selling off some of her existing assets. Similarly, if the US is running a trade deficit, the value of imports exceeds the value of exports and there is a flow of dollars out of the country. What will be done with these dollars? The holders of these dollars will try to invest the dollars because it makes no sense just to hold dollars because they earn no interest.  With the exception of the dollars circulating as a world currency, eventually these dollars will make it back into the US as foreign investors attempt to buy US assets with their dollars. In this way the current account deficit will be offset by a capital account surplus.

The capital account consists of the net increase in US assets abroad, primarily an outflow of dollars to purchase foreign assets, and the net increase in foreign assets in the US, an inflow of currency to purchase US assets.  Included in both components of the capital account are figures for acquisitions of the government and private sectors.  Included in the government figure are the net additions/subtractions from the reserve account, the central bank's holdings of foreign currency. The central bank of each country holds a portfolio of international currencies and during any period the level of these reserves is likely to change. 

Capital Account: 1997

US Direct Investment Position Abroad (1997)

US Direct Investment Position Abroad (1997)

Foreign Direct Investment Position in US (1997)

Foreign Direct Investment Position in US (1997)

Before leaving the discussion of the capital account, let's take one final look at the change in the account in 1998 as the financial crises rolled through the world's financial markets.  In the table below there are some significant changes that seemed to have taken place between 1997 and the second quarter of 1998.  [Note: the 1998II figures are annual estimates based on second quarter figures].   By the second quarter of 1998  US purchases of foreign stocks virtually dried up in 1998, but this was offset by an increase in purchases of foreign bonds.  Foreign investors, meanwhile, have increased their holding of US bonds substantially, a factor in the rising price of US Treasury securities in late 1998. 

Capital Account Transactions

What's the bottom line?  Well you will notice the deficit on the current account is not exactly equal to the surplus on the capital account which is usually the case.  In 1997 for example, the current account deficit was $155.2 billion while the capital account surplus was $255 billion. The discrepancy is appropriately entitled, statistical discrepancy (Sd). The double entry accounting system imposes the constraint that the payments and receipts columns equal each other, but the well known problems with the data collection on international transactions ensures that the equality will not be realized. The statistical discrepancy is the residual which ensures the balance and in 1997 equaled $99.724 billion.

We have now looked at the books for international transactions and derived a few measures of the volume of transactions.  It is now time to look at the prices of currencies that are used in these transactions - what you will hear people refer to as the exchange rate.  The price of a currency -  the many dollars you need in order to buy a unit of foreign currency - can be obtained from the business section of any good newspaper.  [If you want some on-line help with making the conversions, check out the Currency Converter site]. In the newspapers section you will find a table that provides the exchange rate between a $ and a wide array of foreign currencies including the mark (Germany), the yen (Japan), the peso (Mexico), the Franc (France), and the pound (UK). For example, you will note that three marks will buy one dollar, or that .333 percent of a dollar will buy a mark. In addition to these individual exchange rates, you will also find the trade-weighted exchange rate which is very much like a price index. It is a weighted sum of a number of exchange rates, where the weights are equal to the country's share of international trade with the US. For this reason, a sharp increase in the yen (Japan) price of the dollar will have a substantially larger impact on the exchange rate of the dollar than a similar increase in the Lira (Italy) price of the dollar because US - Japan trade is larger than US - Italy trade.

As for the history of the value of the dollar, we pick up the story of exchange rates in the late 1960s. Following the freeing of exchange rates in the early 1970s, the value of the dollar began to fall sharply so that by 1980 there was widespread concern over its low value. From its high in the late 1960s, the dollar was down 55 percent against the German mark, 37 percent against the Japanese yen, and 28 percent when using the multi-lateral trade weighted value. The concerns did not last long, however, as the exchange rate began to rise rapidly during the early 1980s. By the time it peaked in 1985, the dollar had regained much of the lost ground. It was up 61 percent against the mark, 5 percent against the yen, and 63 percent based on the multilateral value. At this time there were once again concerns being raised about the dollar's value, but this time it was concern that the dollar was over-valued which made US firms uncompetitive in the world market place. This was a good time to be an American traveling in Europe and not a good time for American firms trying to sell their products to European consumers. By October 1985, there was mounting pressure to impose some forms of protectionism to help American industry that had been badly hurt by the appreciation of the dollar.

In response to concerted international effort, the dollar began its free-fall in 1985. By 1987 the financial pages were full of articles ranging from how to stop the fall to how much further the dollar must fall. In fact, the decline had been so dramatic that the G-7 countries fashioned the Louvre Accord of February 1987 in which they declared the dollar had fallen enough and attempts would be made to stabilize it. As you can see, however, the attempts were not all that successful, at least in the short-run. By 1989 most of the gains had been lost as the exchange rate fell to levels that existed in the late 1970s.

When examining exchange rates, however, care should be taken when using the multilateral trade-weighted exchange rate. As we will see later, the sharp decline in the dollar was not accompanied by the expected improvement in the balance of trade deficit. One explanation centered around the measured exchange rate. The multilateral rate was based on an outdated market basket of trade flows. For example, in the two years ending in early 1987, the FED estimated the dollar to be down 39 percent based on the US's 10 largest trading partners, while the Dallas FED reported a decline of 5 percent using a sample of 131 trading partners. In fact, during the first two years of the dollar's fall when it declined 45 percent against the German mark and Japanese yen, it lost no ground against the Canada, Singapore, and Hong Kong dollars and the Korean won, and rose more than 300 percent against the Brazilian cruzado and the Mexican peso.

Before leaving our discussion of exchange rates we will look at how the Asian Crises of 1997 were reflected in the foreign exchange rates.  Below you will see the exchange rate for Thailand's bhat.  In a relatively short period of time in 1997 the value of the bhat was more than halved.  At the beginning of 1997 it took 25 bhat to buy a US $ and by the beginning of the following year it took 53 bhat. The result was that goods imported from Thailand to the US went down in price while the cost of US goods in Thailand doubled reducing the buying power of Thailand's people. 

And as you know the crisis was not contained in Thailand and we can see in the following diagrams the impact on the Malaysian and Singapore currencies. If you want to construct some of your own graphs you should check out the time-series web site. 

We have now looked at the basic macroeconomic statistics that have been developed to capture the conditions in the four aggregate markets - output, labor, capital, and foreign exchange. It is now time to move to a discussion of the operation of the markets that generate these statistics and examine the interrelationships between the markets and the links between the markets and government policy tools.