| | | | | | | Curiosity 15.2: Why Is There More Than One Exchange Rate? | | | | | | | | | | There are two ways of measuring the exchange rate between U.S. dollars and French francs. Earlier, we defined it as the number of francs per dollar, five francs per dollar, five francs per dollar. Alternatively, we could have defined it as the number of dollars per franc, or 0.2 dollars per franc. They are equivalent ways of expressing the exchange rate; one is just the inverse of the other. Both measures appear in the media. This book uses the former because when that measure of the exchange rate increases to six francs per dollar, for example the dollar becomes more valuable. With the latter measure, however, an increase in the exchange rate corresponds to a fall in the value of the dollar. | | | | | | | | | | If the exchange rate is five francs per dollar and also two marks per dollar, it may appear that there is more than one exchange rate, but the exchange rate between francs and marks should be two and one-half francs per mark, implying that both measures of the value of the dollar are equivalent. Suppose this were not the case, and the franc/mark exchange rate was three francs per mark. People could make easy money by using 100 dollars to buy 200 marks, using the 200 marks to buy 600 francs, and then using the 600 francs to buy 120 dollars. The "arbitrage" activity serves to make all exchange rates consistent with one another. | | | | | |
| | | | | At the most general level, the balance of payments is broken into two accounts, the current and capital accounts, as shown in table 15.1. | | | | | | | | | The current account measures the difference between the demand for and the supply of dollars arising from transactions that affect the current level of income here and abroad. It has three components: | | | | | | | | | 1. The trade balance, or balance on goods and services, which is the sum of the following: | | | | | | | | | a. The merchandise trade balance, the difference between exports and imports of goods (e.g., wheat and automobiles). | | | | | | | | | b. The services trade balance, the difference between exports and imports of services (e.g., insurance premiums, transportation, and tourism). | | | | | | | | | 2. Net investment income from abroad, such as interest and dividend payments. | | | | | | | | | 3. Net transfers from abroad, such as gifts, pension payments, and foreign aid. | | | | | | | | | Typically, the United States has a deficit on merchandise trade it imports more goods than it exports but a surplus on service trade it exports more services than it imports. (This surplus reflects U.S. comparative advantage in services see appendix 15.1.) Overall, the U.S. balance of trade is usually in deficit. | | | | | | | | | In the late 1980s the United States became an international debtor and began sending substantial interest payments abroad each year. Consequently, recent annual U.S. net investment payments have typically been in deficit. Net transfer payments also are typically in deficit because the United States sends more humanitarian and military aid abroad than it receives. An exception occurred in 1991 when other countries transferred funds to the United States to pay their share of the U.S. military operation against Iraq. | | | | |
