Below is a mindmap showing the causes and effects of a fall in the value of a currency. Also looks at how it improves the current account. Good for revision purposes when dealing with exchange rates and trade. Might be useful for the upcoming CIE exams. Adapted from CIE A Level Revision by Susan Grant.
Been doing some revision courses and today we looked at the TWI and floating exchange rates. The exchange rate measures the external value of the NZ$ in terms of how much of another currency it can buy. For example – how many pounds, US dollars or Euros you can buy with NZ$1000. The daily value is determined in the foreign exchange markets (FOREX) where billions of $s of currencies are traded every hour.
A large percentage of the dealing in currencies is purely speculative, that is to say, people trading dollars, yen, euros and sterling seeking to make a profit (or capital gain) from small fluctuations in currency values.
Trade Weighted Index (T.W.I.)
An index that measures the value of $NZ in relationship to a group (or “basket”) of other currencies. The currencies included are from NZ’s major export markets i.e. Australia, USA, Japan, Euro area, UK. – $A, $US, ¥, €, £. Each of the currencies included in the TWI is “weighted” according to how important exports to that country are (= % of total exports)
From the TWI we can see if the $NZ has appreciated or depreciated against our major trading partners currencies overall.
Free, Fluctuating, or Floating Exchange Rates
In a free market the rate of exchange is determined by the market forces of supply and demand. Where these conditions apply the exchange rate is said to free, fluctuating or floating. Therefore the following have a great impact on the rate of exchange in a free market:
An increase in the demand for the $NZ will result from more people wanting get or buy $NZ.
- Increase in the value of exports
- Increase in tourists traveling to NZ
- Increase in foreign investment in NZ (buying assets / companies / depositing savings)
- Increase in NZer’s taking out loans overseas
An increase in the supply for the $NZ will result from more people wanting get or buy other currencies (as they have to supply $NZ to the market to get the other currencies)
- Increase in the value of imports
- Increase in NZer’s travelling to other countries
- Increase in NZ investment overseas
- Increase in NZer’s repaying loans made overseas
Other Factors Effecting $NZ with a Floating Exchange Rate
- Relative Inflation Rates e.g. if NZ’s inflation rate is higher than other countries then the price NZ’s exports will become relatively more expensive and NZ will lose competitiveness and exports will fall.
- Income of countries NZ trades with e.g. Australia is in a recession – NZ exports
- Tastes and Preferences e.g. world news, current events, fashion, trends, popularity effecting NZ’s exports e.g. Sept 11th and an increase in tourists to NZ
- Access to Overseas Market e.g. trade restrictions (protectionist policies e.g. tariff, quotas and regulations) placed on NZ exports by other countries governments.
- Relative Interest Rates e.g. if interest rates in NZ are higher than in other countries, then this will attract people to save in NZ banks, creating demand for the $NZ.
A good summary from the FT – see video below. The Renminbi is permitted to trade 2 per cent on either side of a daily midpoint set by the People’s Bank of China (PBOC). This suggests that the PBOC still has significant control of the renminbi. Basically at 9.15am the Peoples Bank of China (Central Bank) and the SAFE (State Administration for Foreign Exchange) issues a circular to all the trading banks stating that this is the exchange of the Renminbi to the US$. It is then permitted to trade 2 per cent on either side of the midpoint rate. The midpoint set by the PBOC on Monday of Rmb 6.9225 was the lowest since December, when trade tensions were last at fever pitch. The PBOC blamed the tariffs and trade protectionist measures on Chinese goods as the reason why the exchange rate has depreciated.
But is China a currency manipulator? According to the US Treasury a country is a currency manipulator when it does the following 3 things
- A significant bilateral trade surplus with the US.(Check! China’s got that.)
- A material current account surplus of more than 3% of GDP.(China does not have that.)
- Persistent one-sided intervention in its currency market.(China’s move on Monday doesn’t fit this bill, so no.)
But isn’t downward pressure on the Renminbi just part of the what happens to a currency when its economy starts to slow and it’s selling fewer exports.
Winners with a cheaper yuan
1. Chinese exporters are more competitive abroad.
2. Foreign consumers of Chinese products – imported products are more affordable.
3. China’s case for becoming a reserve currency could be bolstered by letting markets determine the exchange rate.
1. Chinese companies that have debt denominated in dollars, or buy things in dollars
like Chinese airlines, or other businesses that rely on imported oil.
2. Companies that compete with Chinese firms – including those in neighboring countries.
3. Companies that depend on exports to China – like the makers of luxury goods and mining companies.
4. Anyone worried about weak inflation in the U.S. or Europe
New Zealand’s annual current account deficit totalled $10.6 billion in the year ended March 2019, up from $8.5 billion a year earlier. As a proportion of GDP, the current account deficit was equivalent to 3.6 percent in the year ended March 2019.
For the NZ Economy the persistent trade deficit has a number of potential causes both short and long term:
- High propensity to buy imported goods and services – there is a tendency for NZ consumers to prefer foreign produced output and in a consumer boom we often see an acceleration in the volume of imports coming into the country
- Lack of productive capacity of NZ firms – if home producers have insufficient capacity to meet demand from consumers then imports will come in to satisfy the excess demand
- Poor price and non-price competitiveness of NZ firms – Cost levels and NZ prices relative to international competitors can measure competitiveness, but non-price factors are also important. These include quality, design, reliability and after-sales service
- Declining comparative advantage in many areas – the advantages that countries have in producing certain goods and services change over time as technology alters and other countries exploit their economic resources and develop competing industries. NZ manufacturing industry has suffered over the years from low cost production in newly Industrialising countries and from other parts of Asia.
- An over valued exchange rate – Some economists suggest that trade problems stem from the exchange rate being at too high a level. This causes NZ export prices to be higher in foreign markets whilst imports into the NZ become relatively cheaper.
- The strength of the NZ$ over recent years has made life difficult for NZ exporters in overseas markets. This is because a rise in the value of NZ$ leads to a rise in the foreign price of NZ exported goods and services. When NZ prices are higher, foreign consumers are less likely to buy our products. The high exchange rate also makes imported goods cheaper inside the NZ. This leads to a rise in the volume of imports and a fall in the share of the NZ market taken up by goods and services from overseas
By end of the century 40% of the world’s population is projected to be living in Africa and still globalisation seems to have a limited impact on its people. In order to make Africa more inclusive policies will have to focus on accelerating regional integration, bridging gaps in labor skills and digital infrastructure, and creating a mechanism to own and regulate Africa’s digital data. Although the first industrial revolution resulted in a significant increase in international trade Africa has been a poor benefactor and this has led to the “great divergence” in income levels between the Global North and South. In the 1980s, the Brandt Line was developed as a way of showing the how the world was geographically split into relatively richer and poorer nations. According to this model:
- Richer countries are almost all located in the Northern Hemisphere, with the exception of Australia and New Zealand.
- Poorer countries are mostly located in tropical regions and in the Southern Hemisphere.
With the advances in technology over the last two decades Asian countries like China, Taiwan and South Korea have been able to narrow the gap with developed nations mainly because of the emergence of complex global value chains. However although Africa might have benefitted from the commodities market developed economies can now produce goods more cheaply and African countries have found it difficult to develop local industries that create jobs.
Unsurprisingly the economic disparity between Africa and richer countries has widened in recent decades, with the ratio of African incomes to those in advanced economies falling from 12% in the early 1980s to 8% today. In order to reverse this trend and enable Africa to benefit more from globalisation, the region’s policymakers should accelerate their efforts in three areas.
Policies to promote growth in Africa:
- Governments should promote further regional integration to make Africa economically stronger and more effective at advancing its agenda internationally. Progress so far is very encouraging.
- Africa must improve its digital infrastructure and technology-related skills to avoid being further marginalised. Moreover, the low-cost, low-skill labour on which Africa has traditionally relied is becoming less of a competitive advantage, given the advent of the Fourth Industrial Revolution
- Africa must create a system for owning and regulating its digital data. In the modern era, capital has displaced land as the most important asset and determinant of wealth.
By 2030, the continent will be home to almost 90% of the world’s poorest people. Unless globalisation works better for Africa than it has in the past, its promise of shared prosperity will remain unfulfilled.
Source: Project Syndicate – Making Globalization Work for Africa May 30, 2019 Ngozi Okonjo-Iweala , Brahima Coulibaly
The direct impact of the US-China trade war has yet to materialise. The global economic slowdown started long before the opening shots were fired in this bitter battle. Central banks are getting ready to cut interest rates, if they haven’t already started, to support growth.
All this to mitigate the fallout from US President Donald Trump’s doctrine of tariffs first, negotiate later. Trade talks with China have broken down; Huawei can’t buy US goods; Trump has threatened tariffs on imported cars from Europe and Japan. Sanctions against Cuba, Iran and Venezuela have yet to yield any benefits. And in his latest move, he has decided Mexico needs to do more to stop immigration. If it doesn’t, there will be tariffs for Mexico as well – a move that’s rattled global markets.
Mexico is the US’s biggest trading partner, exporting $347bn to the US in 2018. A 25 percent tariff would cost about $86bn a year. With many US and international car makers located south of the US border, the auto industry would be the hardest hit. Deutsche Bank estimates vehicle prices could rise on average $1,300 – if tariffs hit 25 percent.
While Trump wants automakers to move back to the US – which is highly unlikely – this could have a devastating impact in Mexico where 839,571 people are employed in the car industry. According to economic consultancy Perryman Group, more than 400,000 US jobs could be lost if the US imposed the 5 percent levy; the net loss to the economy could be $41bn; and the state that’s most dependent on Mexico, Texas, stands to lose more than 100,000 jobs and $7bn in income. If Trump’s trade war with China is anything to go by – the damage to the economy has already been done. The president has signed a $16bn bailout for farmers. Source: Al Jazeera – 9th June 2019
Another PBS video from Paul Solmon about the trade war between the US and China. The trade war hits China more for two reasons:
- Trade makes up a much higher proportion of China’s GDP than that of the USA
- With the Chinese economy slowing there is a big reliance on the export sector as an employer
The Chinese have certain options (see below) open to them which are discussed in the video below.
- Bond dump
- Squeezing US firms in China
- Pull back on the number of Chinese coming to US for education
- Devalue their currency
- China might make sweetheart trade deals with other countries leaving out the US
With the 29th March deadline approaching UK farmers are particularly opposed to a no-deal Brexit; customs hold-ups at the borders could ruin fresh produce. And there is concern that new trade deals with countries like New Zealand could lead to a flood of cheap imports and therefore making it harder for British farmers.
The EU bloc receives receives about 60% of UK food exports with 70% of the UK food imports come from the EU bloc. Lamb and beef exports could face export tariffs of at least 40% if the UK reverted to World Trade Organization rules under a no-deal exit. The UK produces approximately 60% of what is required to feed its population with the remainder being imported. The UK’s £110bn-a-year agriculture and food sector is deeply integrated with Europe relying on the bloc for agricultural subsidies of £3.1bn ($4bn) under the CAP – Common Agricultural Policy. The government has promised to pay the equivalent of the CAP subsidies up to 2022, no one is certain what will happen after that.
What is CAP?
At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector has been known as the common agricultural policy – CAP. The CAP was established under Article Thirty Nine of the Treaty of Rome, and its objectives – the justification for the CAP – are as follows:
1. Raise and maintain farm incomes, through the establishment of high prices for food. Such prices are often in excess of the free market equilibrium. This necessarily means support buying of surpluses and raising tariffs on cheaper imported food to give domestic preference.
2. To reduce the wide flutuations that often occur in the price of agriculutural products due to uncertain supplies.
3. To increase the mobility of resources in farming and to increase the efficiency of all units. To reduce the number of farms and farmers especially in monoculturalistic agriculture.
4. To stimulate increased production to achieve European self sufficiency to satisfy the consumption of food from our own resources.
5. To protect consumers from violent price changes and to guarantee a wide choice in the shop, without shortages.
CAP Intervention Price
An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:
1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
2. At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
3. In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
4. There is a contraction in domestic consumption to 0Qd1
Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.
The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.
Throughout most of its four decades of existence, the CAP has had a very poor public relations image. It is extremely unpopular among consumers, and on a number of occasions it has all but bankrupted the EU.
The impact of Brexit on New Zealand depends on what kind of exit agreements are reached between the UK and the European Union. The published provisional deal includes a transition period which runs until the end of 2020. During this time, existing trade conditions for third parties (such as New Zealand) will continue. Below are tables showing the trade relationship between New Zealand and both the EU and the UK. The benefits of two way trade with the EU outweigh those of the UK – US$23,273m against that of the US$5,640m
March 2018 – New Zealand’s total trade balance was a surplus of $4.0 billion in the year – this surplus is up $1.3 billion from the trade surplus in the year ended March 2017.
Total exports of goods and services were $78.0 billion, while total imports were $73.9 billion.
China ($15.3 billion) and Australia ($13.9 billion) were the top export destinations.
The European Union ($13.4 billion) and Australia ($12.1 billion) were the top import sources.
Dairy products and logs to China were New Zealand’s top two export commodities by destination, earning $4.0 billion and $2.6 billion, respectively. This was followed closely by spending by visitors from the European Union ($2.2 billion) and Australia ($2.1 billion).
New Zealand’s negotiations
New Zealand is in negotiations with the UK over a FTA. According to New Zealand Foreign Affairs and Trade NZ wants the following from a FTA:
- Removing tariffs and other barriers that restrict the free flow of goods between our two countries
- Making it easier for traders of all sizes to do business in the UK, including services exporters
Strengthening cooperation and dialogue with the UK in a variety of trade and economic fields
- Reflecting our goals including progress on gender equality, indigenous rights, climate change, and improved environmental outcomes.
- Some key areas in which we will be seeking even closer cooperation with the UK under the FTA include:
- High quality primary sector and goods access to the UK’s market, such as for meat, mechanical machinery and equipment, fruit, pharmaceuticals, forestry, dairy and wine
- Helpful conditions for investment and services providers who operate between the two countries
- Commitments on progressive trade issues including environmental and labour protections, indigenous rights and gender equality.
- Parliamentary Library Monthly Economic Review – December 2018.
- New Zealand Foreign Affairs and Trade.
The recent history of New Zealand’s terms of trade has been largely linked to dairy product export prices although in a longer-term context the price of imported oil has been paramount. Today we can see that the price of powdered milk (export) and the price of brent crude oil (import) are heading in the wrong directions. Powdered milk prices are falling and brent crude oil prices are rising which makes for an unfavourable terms of trade – see graph. This is not a good sign for the terms of trade which reached its peak in March this year.
What is the Terms of Trade.
The terms of trade index measures the value of a unit of exports in terms of the number of imports it can buy, or the purchasing power of our exports. This is similar to comparing the number of sheep exports that will buy a typical imported family car, from one time to another. The formula is:
Formula: Terms of Trade (TOT) =
Export Price Index (Px) x 1000 (base year)
Import Price Index (Pm)
- An increase in the TOT (e.g. from 1050 to 1200) is called “favourable”
- A decrease in the TOT (e.g. from 1050 to 970) is called “unfavourable”
A “favourable” (increase) in the TOT may come about because the average:
– export price rose and import price stayed the same
– export prices rose faster than import prices
– export prices stayed the same and import prices fell
– export prices fell but import prices fell faster
The index number that results tells us whether merchandise export price movements have been favourable relative to import price movements. An increase in the terms of trade from 1000 to 1100 represents an increase in the purchasing power of our exports of 10% which means, other things being equal, we would be able to buy 10% more from overseas. As a country we would be wealthier. A decline in the terms of trade would result in the opposite situation.
Limitations of the Terms of Trade
Terms of trade calculations do not tell us about the volume of the countries’ exports, only relative changes between countries. To understand how a country’s social utility changes, it is necessary to consider changes in the volume of trade, changes in productivity and resource allocation, and changes in capital flows.
The price of exports from a country can be heavily influenced by the value of its currency, which can in turn be heavily influenced by the interest rate in that country. If the value of currency of a particular country is increased due to an increase in interest rate one can expect the terms of trade to improve. However this may not necessarily mean an improved standard of living for the country since an increase in the price of exports perceived by other nations will result in a lower volume of exports. As a result, exporters in the country may actually be struggling to sell their goods in the international market even though they are enjoying a (supposedly) high price. An example of this is the high export price suffered by New Zealand exporters since mid-2000 as a result of the historical mandate given to the Reserve Bank of New Zealand to control inflation.
In the real world of over 200 nations trading hundreds of thousands of products, terms of trade calculations can get very complex. Thus, the possibility of errors is significant.
- A decline in the terms of trade is not necessarily a bad thing. For example, a decline in the terms of trade may occur due to a devaluation in the exchange rate. This devaluation may enable a country to regain competitiveness and increase the quantity of exports.
- The impact of a decline in the terms of trade will depend on the elasticity of demand. If demand is elastic, the lower price of exports will cause a bigger % increase in demand.
- Some Less Developed Countries (LDCs) have seen an improvement in terms of trade because of rising price of commodities and food post 2008. It is not always LDCs who see a decline in the terms of trade.
- It is important to distinguish between a short term decline in terms of trade and a long term decline. A long term decline is more serious for reflecting a fall in living standards.