AP Econ Module 41 Capital Flows Balance Payments - Sunny Hills ...

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A Global Savings Glut? ln the early years 0f the twenty-first century, the United States entered into a massive current account delicit, which meant that it became the recipient of huge capital inllows lrom the rest 0fthe world, especially China,other Asian countries, and the Middle East. Why did that happen? ln an influential speech early in 2005, Ben Bernanke-who was at thal time a governor of the Federal Reserve and who would soon be- come the Fedb chair---{ffered a hypothesis;the United States wasn't responsible, The "principal causes of the U.S. current account deficit," he declared, lie "outside the country's borders." Specifically, he argued that special factors had Nike, like many other companies, has opened plants in China to take advan' tage of low [abor costs and to gain better access to the large Chinese market. Here, two Chjnese employees assemble running shoes in a Nike factory in China. created a "globalsavings glut" that had pushed down interest rates worldwide and thereby led to an excess of investment spending over savings in the United States, What caused this global savings glut? Ac- cording to Bernanke, the main cause was the series of financialcrises that began in Thajland in 1997, ricocheted across much ofAsia, and then hit Russia in 1998, Brazil in 1999, and Argentina in 2002. The ensuing fear and economic devastation led to a fall in investment spending and a rise in savings in many relatively poor countries. As a result, a number ol these countries, which had previously been the recipients of capital inflows from developed countries like the United States, began experi- encing large capital outflows. For the most part, the capital flowed t0 the lJnited States, perhaps because "the depth and sophistication of the counlry's financial markets" made it an attrac- tive destination. When Bernanke gave his speech, it was viewed as reassuring: basically, he argued that the United Slates was responding in a sensible way t0 the availability 0f cheap money in world financial markets. Later, however, it would be- come clear that the cheap money from abroad helped luel a housing bubble, which caused widespread financial and economic damage when it burst, Two-way Capital Flows The loanable funds model helps us understand the direcrion ofrer capital flows the etcess ofinflows into a country over outflows, or vice versa. As we saw in Table 41.2, however, grors flows take place in both directions: for example, the United States both sells assets to foreigners and buys assets from foreigners. Why does capital move in both directions? The answer to this question is that in the real world, as opposed to the simple model we've just conscructed, there are other motives for international capital flows besides seeking a higher rate ofinterest. lndividual investors often seek ro diversify against risk by buying stocks in a number of countries. Srocks in Europe may do well when srocks in rhe United Scates do badly, or vice versa, so investors in Europe try to reduce their risk by buying some U.S, stocks, even as invescors in the United States try to reduce their risk by buying some European stocks. The lesult is capital flows in both directions. Meanwhile, corporations often engage in international invesrment as part of their business strategy-for example, auto companies may Find that they can compete better in a national market iF they assemble some of their cars locally. Such business investments can also lead to two-way capital flows, as, say, European carmakers build plants in the United States even as U.S. computer companies open facilities in Europe. Finally, sorne countries, including the United States, are international banking centers: people from all over the world put money in U.S. financial institutions, which then invest many ofthose funds overseas. The result ofthese two-way flows is that modern economies are typically both debtors (countties that owe money to rhe rest of the world) and creditors (countries to which the rest of the world owes money). Due to years of both capital inflows and outflou,s, ar the end of2008, the United States had accumu- Iated foreign assets worth $19.9 trillion and foleigners had accumulated assets in the United States worth 523.3 rrillion. 418 s e c t i0 n I The Open Economy: lnternationat Trade and Finance
The Golden Age of Capital Flows Techn0logy, it's often said, shrinks the world. Jet planes have put most olthe world's cities within a few hours of one another: modern telecommu- nications transmit information instantly around the globe. So you mightthink that international capitalflows must now be largerlhan ever But if capital fl0ws are measured as a share of world savings and investment, that belief turns out not t0 be kue. The golden age of capital llows actually preceded World War l-it lasted from 1870 to 1914. These capitalllows went mainly lrom Eur0- pean countries, especially Britain, to what were then known as "zones of recent settlement," countries that were attracling large numbers 0f European immigrants. Among the biq recipients 0t capital inflows wereAustralia, Argentina, Canada, and the United States. The large capital tlows reflected differences in investment 0pp0rtunities. Brilain, a mature 41w Soluions appear at the bach ofthe baoh. Check Your Understanding 1. Which ofthe balance ofpayments accounts do the ftrllowing events affecc? a. Boeing, a U.S.-based conpany, sells a newly built airplane to China. b. Chinese invescors buy stock in Boeing frorn Americans. Tackle the Test: Multiple-Choice Questions L The current account includcs which oFthe lollowing? I pa;T nen ts for goods aLtd :ervices II. rransFer paymencs IIL lactor incorne a. I only b. II on\, c. III only d. I and II only e. l, ll, and lll industrial economy with limited natural resources and a sl0wly growing population, offered relatively Iimited opportunities for new investment. The zones 0f recent settlement, with rapidly growing populations and abundant natural resources, offered investors a higher re- turn and attracted capital inflows. Estimates suggest that over this period Britain sent about 40% ol its savings abroad, largely to finance raikoads and other large projects. No country has matched that record in modern times. Why can't we match the capitalflows of our great-great-grandfathers? Ec0n0mists aren't completely sure, but they have pointed to two causes: migration restrictions and political risks. During the golden age of capital flows, capital movements were complementary to population movemeflts;the big recipients 0f capitalfrom Europe were also places to which large numbers of Europeans were moving. These large-scale population movements were possible before World War I because there were lew legal restrictions 0n immigration.ln today's world, by contrast, migration is limited by extensive legal barriers, as any0ne considering a move t0 the United States 0r Europe can tellyou. The other factOrthat has changed is political risk. l\4odern governments otten limit foreign investment because they fear it will diminish their national autonomy. And due t0 politicalor secu- rity concerns, governments sometimes seize toreign property. a risk that deters investors from sending more than a relatively modest share 0ftheir wealth abroad. ln the nineteenth century such actions were rare, partly because s0me major destinations of investment were still European colonies and partly because in those days governments had a habit of sending troops and gunboats to enforce the claims 0f their investors. A Chinese con-rpany buys a used airplane fn;m American Airiines and ships it to China. A Chinese invescor who ou'ns property in the United Statcs buys a corporatejet, which he will keep in che Unircd Srert. so hc .an rrarcl arounJAncr.ita. 2. The balance ofpayments on the currenc account plus the balance ofpaymerrts on the financial accounc is equal to b. one. c- the trade balance. d. net capital florvs. e. the size ofthe trade deficit. module 4l Capital Flows and the Balance ot Payments 479
Page 1 and 2: Module 41 Capital Flows and the Bal
Page 3 and 4: EETililI The Costas' Financial Year
Page 5 and 6: goods alone-not including services.
Page 7 and 8: Equation 41-3 is equivalent to Equa
Page 9: lnternational Capital Flows (a) Uni

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