Current account + Capital and finacial =0 WTF (1 Viewer)

[spadey]

I really dont understand why these have to equal zero under a floating exchange rate.

For example during the first year of the asian financial our
exports would have been low, imports high and debt servicing high leading to a high cad.
Yet there wouldnt have been overseas investment here either because of our poor economic outlook.
Therefore they wouldnt have been equal
I So dont undertsand this crappy subject?!?!!?

 

[Blondie]

i hate the cad, too. but what i remember is:

CAD = KAS

this means, the deficit on the current account is equal to the surplus oc the C&F account. they usually ask this in the multi-guesssection, so that works for me...

i dunno WHY, like you asked, but there ya go. sorry im not more help :S

 

[numg]

your textbook should explain this...

under a floating exchange rate:

1. Demand for AUD = Supply of AUD

Demand for AUD= export credits, income credits, investment into Australia etc...

Supply of AUD = import debits, income debits, investment out of australia...

putting them into 1.
export credits+ income credits+ investment into Australia etc...
= import debits+income debits+investment out of australia...

Then rearrange it to show:
net goods + net services +net income = net investment
Thus Current Account = - Capital + Financial

It doesn't make much sense except at the equilibrium price of the AUD (which is the price under a floating exchange rate), demand for AUD=Supply. In the case of the Asian Crisis, foreign investors probably pulled outta Asia like rats leaving a sinking ship, and instead invested in other economies such as Australia. Anyway the economic outlook in Australia has been pretty good as Australia had been achieving sustained rates of growth for several yeas by then, making it a safe place for foreign investors.

 

[Nick]

well think about it..

how can we afford to buy anything unless it is sustained by money coming in..

the deficit on teh current account implies that we are buying more things than we are paying for by selling.. so for us to be able to run a deficit (buy more things than we can afford) we have to borrow, which is why there is a surplus on the capital account..

we cant just run a deficit without paying for it, its just that we pay for it with other people's money, which we then have to pay for (explains why there is a large net income deficit)

 

[timmii]

It's a feature of what they call "double-entry bookkeeping". But to keep it simple, every transaction has 2 equal effects, being recorded on either side of the balance of payments.

For instance if you borrow $1million, your debt increases by $1million, and your cash inflow increases by $1million.

If you don't quite follow that, think of it like this - if either side didn't balance (e.g demand for dollars exceeded supply of dollars), the exchange rate would appreciate/depreciate in a way that would equalise the two accounts, which is why the floating exchange rate is important.

 

[TastesGoodBut]

it doesnt matter if u dont udnerstand it - its just made that way!

 

[AGB]

timmii......i dont understand how the bop is a double entry account keeping system. i know that the abs says it is, and textbooks say it is, but when i tried to figure it out, i cant understand how the principle of double entry applies to the bop???

and furthermore, even if it did, doesn't that mean that the cad would have equaled the kafa prior to 1983??

 

[timmii]

Ok, I'm going to try and give it a go at explaining this, tho bear with me I haven't been taught it either and this is just what I've managed to glean, so it may be a bit off-track.

What makes the balance of payments balance is the ability of the exchange rate to shift so as to balance the 2 sides of the account out. I keep making little pictures in the air trying to explain this now, so i really need a diagram for you - but please excuse my wonky english as i point to imaginary things on my computer screen.

The factors recorded on the BOP are really the movement of currency into and out of australia, i.e they are the determinants of the supply and demand of the dollar and hence the prevailing exchange rate. So if we have a trade deficit of $10million, it means that an additional $10mill of $A is being supplied to the market than what is being demanded. With no influx of investment, the currency would depreciate to the extent such that the value of our imports actually equals the value we pay for them...our exports (ignoring investment etc for the moment), since logic says they must equal. IF I sell you an apple for $1, that apple is worth $1. If you give me US50c for that and i accept it then i believe that apple, $1 and US50c to be equal in worth, then the exchange rate is $A1 for US50c. If I sell you 2 apples and you give me that same 50c, then the exchange rate must now be $1A for US25c....

The alternative is that Australia can attract overseas investment. What this does is create additional demand for the dollar. But really, for any exchange rate/sale to actually take place, supply and demand must be equal. So now we have the same supply of dollars (i.e our level of imports, just to keep it simple for the moment) but there is increased demand for our dollar so the exchange rate rises.

Whenever any factor of supply or demand changes, the exchange rate, obviously changes so as to keep them the same. Think of the balance of payments being alternately the supply and demand of the dollar - they must equal!

Now prior to 1983, the dollar did not float, so there was not this automatic equalisation of supply and demand. It is quite possible that we may have $10million more imports than exports, but rather than our dollar falling in value so as to accommodate this, the level of money in our economy as a whole declined. It may be as though someone literally picked up a bank vault and carried it over to america. (which is why monetary policy was so much more limited - the money supply was influenced by the balance of payments, not only by open market operations).

Just think of it as a scale i suppose.

I dont think i'm explaining this very well, and I'm really sorry if this confuses you. its not meant to. Just accept that it will balance because demand of the australian dollar must equal supply.

 

[timmii]

ooh u asked bout double entry too.

Ok in a basic model:
demand for dollar is: export income + interest payments received + investment inflows

Supply for the dollar is: import spending + interest paid + investment outflows

Since D = S

X + int. (rec) + Inv (rec) = M + int (pd) + Inv (out)
So (X-M) + (int rec - int pd) = Inv (out) - Inv (in)

So when M> X and int pd > int rcvd then investment in> investment out.

 

[Grey Council]

all these knowledge people are makikng me very nervous. lol

but good explanation. Even i understood most of that, and im just starting the hsc course