Curiosity 13.1: What Is Hysteresis?

		Figure 15.1 How Budget Deficits Cause Trade Deficits

		Media Illustrations

		Example 1

		Looking at the data, some people might say the balance of payments has "improved" radically, from a $7 billion current account deficit three years ago to surpluses of $4 billion and $2 billion in the last two years. It is this ongoing current account surplus which led the optimists to predict that the dollar should appreciate.

		What is the logic of this thinking?

		The logic is that the improvement in the current account causes a balance of payments surplus (an excess demand for the dollar on the foreign exchange market), which under a flexible exchange rate system should lead to a rise in the value of the dollar.

		What problem is there with this logic?

		It is careless to identify a change in any subsidiary account of the balance of payments with a change in the balance of payments itself. It could be, for example, that there has been a fall in the capital account offsetting the impact on the balance of payments of the improvement in the current account.

		Example 2

		The link between the current and capital accounts is often misunderstood. Leaving aside the relatively small influence of central-bank intervention in foreign exchange markets, any deficit or surplus on capital account must be matched by an equal and opposite surplus or deficit on current account. It follows that, as long as the U.S. is to be a capital importer, it must have . . .

		To what does the central-bank intervention refer?

		It refers to net purchases or sales of foreign currency by the central bank.

		What is the implication for the balance of payments of this central-bank intervention being very small?

		The implication is that the balance of payments is essentially zero. The magnitude of the balance of payments is measured by the net government sales or purchases of foreign currency.