Macroeconomics – An Overview of Important Concepts

Key Identities

Gross Domestic Product or Output (Y)

„ Y=C+I+G+X–M
„ C= Consumption
„ I= investment
„ G= Government Expenditure
„ X-M= Net exports (Exports – Imports)

Disposable Income (YD)

„ YD = Y + TR –TA
„ TR = Transfer Payments
„ TA = Taxes
„ YD = C + S
„ C = Consumption
„ S = Saving
Aggregate Demand & Supply

Aggregate Demand A
S
„ Effect of
– Govt. Spending
– Income Tax

A
Full D
employ
„ Similar to micro economic equilibrium ment
„ Output represents aggregate level
„ Price level is overall price level in economy
„ Multiplier Effect
Fiscal & Monetary Policy

Fiscal Policy
„ Government Spending/Taxation/Subsidies
„ Rise in Interest Rates (Quantity of Money is same)
„ Crowding Out Effect
– Govt gets the major share of the savings, thus reducing the amount available to
other participants
„ Fiscal Deficit
Monetary Policy
„ Central Bank.Some available tools are
1. Repo/Reverse repo
2. SLR and CRR requirements
3. Capital Exposure norms for banks (This is used for targetting specific segments in
order to reduce speculation in tht segment)
„ Two aims:
– Growth – Lower Interest Rates
– Inflation - Increase Interest Rates
„ We do not follow an inflation target mechanism in which the Central Bank is
mandated to keep the inflation arnd a fixed value
Market Interest rates and Govt Borrowing
„ During the pre lib phase government never borrowed at a market determined rate. It
forced banks to buy its paper through policies such as SLR requirements. This footing
of government expenditure at a low cost by the banks led to them charging a higher
rate for other borrowers. Thus the general interest rates in the economy were very
high. Moreover the secondary market for the government papers was non existent.
During the late 90’s and early 2000,structural changes were carried out to remove this
anamoly.Some of these changes were
1. No more compulsory buying of govt securities by RBI
2. Central Government would borrow at the market determined rates (effective from april
1 2006)
3. A anonymous trading system was developed to increase the trade volumes and hence
liquidity
4. (Spreads in the secondary market for govt sec., is arnd 3 bps)
5. Autonomy to RBI to set the SLR limits rather than having a min 25% SLR
6. Increased participation by players such as MF’s,Pension funds etc.,
7. Fiscal Responsibility Act to reduce Govt deficit.
International Linkages
Balance of Payments
– Forex
„ Increase: +
„ Decrease: -
– Current Account – Goods & Services
„ Exports: + (Credit)
„ Imports: - (Debit)
– Capital Account – Foreign financial assets & liabilities
„ Assets -/Liabilities +: + (Credit)
„ Assets +/Liabilities -: - (Debit)
– Reserves
Exchange Rates
„ Fixed
– The Central bank takes part in selling or buy currencies to keep the exchange
rate constant
„ Floating
– The Market determines the rates.
Most developing economies follow a mechanism of keeping the exchange rate
within a band
„ Currency Appreciation & Depreciation
– Effect on Imports & Exports
„ A currency appreciation leads makes exports costly and this might hurt
exports. Hence SE Asian (pre crisis) had a fixed exchange rate.
„ A currency depreciation on the other hand might make imports costly and
lead to inflation in case it is a good such as Oil.
„ Effect of Interest Rates: Capital Mobility
– The quantity of money that flows from a low interest rate country to high interest
rate one depends on the capital controls,FDI regulations, economies(high int.,
country)future growth.
– Ex: Japan’s low interest rate leading to capital flows out of the country to
emerging markets
Indian Economy
„ India’s economic growth in last 3 years
– Low rates: Consumption growth (Demand Side), Lower borrowing costs for
companies (Corporate profitsÆMarket Boom), Low interest on govt. debt
(deficit under control)
– Inflow of foreign capital huge (Increased by annual average of Rs.100,000
crores in last 3 years)Æ high liquidity in system Æ interest rates remain
low(as supply of money increased)
– Allowed government to raise on an average Rs.75000 crores
annuallyÆ No crowding out
– Now, trade surplus is giving way to trade deficitÆCurrency
depreciatesÆforeign investors become waryÆliquidity crunch in
systemÆinterest rates go up
– Risk of Inflation adds to worries Æ Monetary tightening by RBIÆ Impact on
growth?
Indian Economy
„ Split
– Agriculture: 22% (Population involved- 60%)
„ Issues: Opening of agriculture sector (food processing,
contract farming), Doha round of negotiations, microcredit,
public investment
– Manufacturing: 26%
„ Issues: Labor laws, FDI, IPRs, Infrastructure
– Services: 52%
„ Recent Highlights
– RBI warns of higher inflation
– Correction in Sensex
– Reverse Repo rate increased by 25 bp
– WTO says slowdown in world trade growth likely
– Rupee depreciating steadily
Money Supply

„ Money (M) = Currency (C) + Deposit (D)

„ Money created through credit creation

„ Principal Players
– Central Bank (RBI)
– Commercial Banks (SBI)
– Public

„ Fractional Reserve system

„ The amount of money which the bank lends is more than what it has in its reserves
„ Ex : 100 deposited in a bankÎbank lends 70 and keeps 30Îout of the 70,the borrower
might keep 30 in the bankÎ bank again lends 21 and keeps 7 and this cycle continues
„ Thus the bank has reserves of 37+ whereas it has lent more than 91.

„ High powered money – H = C (held with public) + R ( reserves with RBI)

– One rupee of R with RBI worth more than one rupee of D with commercial banks
– Why are reserves held ? CRR , Excess reserves
– Reserves are used to cover daily demands for money by the depositors

„ Instruments of monetary policy with RBI

– CRR
– Bank Rate
– Repo and Reverse Rate
Inflation, Interest Rate, Money Supply
„ Increase money supply (liquidity) Î Îinterest
rate decreases , Price level increases, inflation Figure 2 The Effects of Monetary Injection
increases (this is due to increased spending)

„ To control inflation, one mechanism is to reduce Value of

MS1 MS2
Price
Money, 1/P Level, P
the demand for money for buying goods. This is
done by increasing interest rates. Which deters (High) 1 1 (Low)

borrowers and also provides an incentive to 1. An increase

save more thus reducing demand for goods and 3
/4
in the money 1.33
reducing prices and inflation. 2. . . . decreases supply . . .
the value of
3. . . . and
money . . . A
12
/ 2 increases
the price
„ Affecting the money supply by raising the level.
monetary base B
14
/ 4
– OPEN MARKET OPERATIONS Money
demand
– FOREX TRANSACTIONS : Foreign (Low) (High)
exchange market activity by which monetary 0 M1 M2 Quantity of
Money
authorities insulate their domestic money
supplies from the foreign exchange
transactions with offsetting sales or Copyright © 2004 South-Western

purchases of domestic assets.

– This is called as Sterilisation
– DEFICIT MONETIZATION
„ RBI prints more money and gives to govt
to cover deficit.
„ Other ways
– Tinker with the repo and reverse repo rates
– Tinker with the bank rate
– Tinker with the reserve requirement ratio
Open Economy
„ Y = C + G + I + NX, NX = Net export = Export – Import

„ Twin Deficit Formula : YD = Y + TR – TA Î (YD – C) + (TA-TR – G) – NX = I

Private Savings + Govt. savings + Foreign Savings =
Investment
„ Exchange rate determined by supply and demand of domestic / foreign currency in the
international market
„ Supply and Demand of domestic currency determined by
– Export / Import
– Capital inflow / outflow
„ Export goes up Æ ? Import goes up Æ ? Interest rate goes up Æ ?
„ Export goes up ,then the exchange rate appreciates thus making imports cheaper and
the imports increase. An increase in exports shifts the IS curve outward leading to an
increase in interest rates (i.e exposts increaseÎincome increases..aggregate demand
increases..thus the intrest rates increase if the money supply is not changed).
East Asian Crisis, 1997 : Build-up
„ Unusually successful economic performance of the ‘Asian Tigers’ Î rapid growth in capital inflows

„ Outward orientation of growth strategies, export led growth

„ Standard macroeconomic indicators good Î inflation moderate, fiscal health good

„ Decline in asset yields in the industrial economies Î Substantial short-term capital inflow to SE countries

„ Export competitiveness lost due to substantial appreciation of dollars from 1995 onwards

„ Overheating of the economy : Signs of asset price inflation in real estate and equity markets
– Lots of speculative short term capital inflow into the banking sector leading to credit boom for the
private sector and increasing foreign liabilities of commercial banks
– Short maturity funds used to finance long duration projects.

„ Lack of transparency and prudent regulation in financial sectors, bad debts, NPAs, corruption

„ In 1997, loss of confidence, speculative attacks on the currencies, panic , flight of capital
„ Thai bhat faced a speculative attackÎ the central bank sold dollars in order to keep the exchange rate
fixedÆ it drew down in forex reserves and was forced to devalue
„ This led to a chain reaction as most of the other countries were put in the same club by foreign investors as
far as risk perception went,and the signs of trouble in one lead to the investrs pulling out thr money in other
countries also

„ This is an example of the negative effects of fixed exchange rate system

Deficits and the Dollar: How
is USA managing its economy

Global Economy of the 21st Century:

Issues and Trends
The US Current Account Deficit
„ The US current account deficit stood at $835 bn, as
at the end of Q1, ‘06
‰ Imports = $2.1 trillion
‰ Exports = $1.3 trillion
„ Imports > Exports by 55%; to keep the trade deficit
from widening further, exports must grow 55% faster
than imports
„ The loan-able funds theory at work:
Y = C + I + G + NX => I – S = CAD
„ A lot of concern from all sectors of the economy,
earlier expressed only by economists. Now echoed
by market participants also.

Global Economy of the 21st Century:

Issues and Trends
The US Current Account Deficit

Global Economy of the 21st Century:

Issues and Trends
Components of the US Current Account
Deficit

Global Economy of the 21st Century:

Issues and Trends
Financing the Deficit
„ Over half of all dollar bills in circulation held outside America's
borders
„ Central banks over the world, particularly in Asia, financing
the US deficit
‰ Almost half of America's Treasury bonds held as reserves by foreign
central banks
„ Oil-exporting countries also putting extra revenues into dollar-
denominated assets, including treasuries
„ Will the funding continue forever – Misplaced optimism?
„ Private investors already turning away from dollar assets: the
returns on investments in America have recently been lower
than in Europe or Japan

Global Economy of the 21st Century:

Issues and Trends
How has the $ maintained its levels
„ Emerging economies hold so many dollars that they fear the capital loss
that they would incur if they encouraged the dollar to drop. Hence, the dollar
has held up as foreign investors have been keen to buy dollar assets
„ Emerging economies also want to keep the value of their currencies down
to help their exports.
„ Vicious Cycle? – The longer emerging market economies continue to pile
up dollars, the bigger the eventual losses
„ If the US economy slows more sharply than expected, their enthusiasm for
the dollar will shrink.
„ Cyclical factors only partly explain why the dollar has been strong; its
attractiveness is based also on structural factors — or on an illusion about
structural differences between the American and European economies

Global Economy of the 21st Century:

Issues and Trends
Will the funding continue forever ?
„ Removal of a temporary prop: Till recently, American companies were
allowed a lower tax rate on profits repatriated from abroad. Now that has been
taken away, reducing support for the external deficit and the dollar
„ International differences in interest rates: Dollar helped by the Federal
Reserve's policy of raising interest rates (a quarter of a percentage point at 16
consecutive meetings after June 2004) at a time when the Europeans held
steady.
„ Now the markets are worried that the Fed will stop at 5%, while the European
Central Bank is raising interest rates and might soon be joined by the Bank of
Japan; recent increases in rates in Britain
„ Change in beliefs about how economies are faring – the pace of America's
economy is expected to slacken, while the slower-growing Euro area and Japan
are thought to be picking up; evident in confidence surveys
„ Fears of inflation – worries that Ben Bernanke will not be able to tackle
inflation with sufficient vigor
„ Foreign central banks have been reducing their purchases of American
Treasuries: official holdings of these rose by only $2 billion in the first seven
months of 2005, against $295 billion in 2004 and $175 billion in 2003.

Global Economy of the 21st Century:

Issues and Trends
The Dollar and its Decline

Global Economy of the 21st Century:

Issues and Trends
The Dollar and its Decline: A Growth
Explanation
„ In 2006, the American economy was forecasted to grow by 3.6% in ‘06 and 3.1% in
‘07; later modified downwards to 3.3% in ‘06 and 2.4% in ‘07.
„ The prices of federal-funds futures suggest that investors think short-term interest
rates are likely to decline within a few months.
„ For the euro area, the forecasts were raised from 2.2% in ‘06 and 2.1% in ‘07 to
2.6% and 2.2% respectively: its fastest pace for six years. There were positive
signals emanating from the most influential economy within EU – Germany.
„ Although EU GDP growth was modest by American standards, it was largely
because of its slower population growth. Official figures of productivity growth, which
should in theory be an important factor driving economic growth, exaggerate
America's lead.
„ If the two are measured on a comparable basis, productivity growth over the past
decade has been almost the same in the euro area as it has in America. Even more
important, the latest figures suggest that, whereas productivity growth is now slowing
in America, it is accelerating in the euro zone.
„ America's growth has been driven by consumer spending. That spending, supported
by dwindling saving and increased borrowing, is clearly unsustainable.
„ That lifted the Euro. This coupled with rapid monetary growth in the euro area,
suggests that the ECB will raise rates, making Euro an even more attractive option
for central banks to hold larger Euro reserves.

Global Economy of the 21st Century:

Issues and Trends
Implications of the Deficit
„ Large purchases of US treasury bonds depressing bond yields,
encouraging households in the United States to take out bigger
mortgages and spend the cash
„ Increasing housing prices has encouraged the US population to
spend more, resulting in abysmally low levels of savings. The US
economy is primarily consumption-led. However, long run
productivity gains from non-residential investments
US Housing market: An accident waiting to happen?
‰ New-home sales fell by 3.2% in October 2006, and the stock of
unsold new properties continued to rise
‰ Sales of existing homes have picked up slightly, but here too the
unsold stock has now increased to 7.4 months' supply
„ Greater number of retirees in the developed countries + high
capital to labor ratios. With low capital to labor ratios in developing
countries, industrial countries should be running current account
surpluses and lending on net to the developing world
„ Growth in export oriented sectors has been has been restricted by
the trade imbalance

Global Economy of the 21st Century:

Issues and Trends
Implications of the Deficit
Global Liquidity Gush
„ Build-up of foreign-exchange reserves
by countries with external surpluses
pumping vast quantities of dollars into
the financial system
„ A large chunk of Asia's reserves and oil
exporters' petrodollars have been used
to buy American Treasury securities,
thereby reducing bond yields.
„ In turn, low bond-market returns have
encouraged bigger inflows into higher
yielding emerging-market bonds,
equities and property, especially in Asia.
„ This gush of global liquidity has not
pushed up inflation. Instead it has
flowed into share prices and houses
around the world, inflating a series of
asset-price bubbles. (Share prices in
emerging economies have risen by
243% on average from their trough in
2003).

Global Economy of the 21st Century:

Issues and Trends
Petro Dollars
„ Although prices have recently dipped,
most analysts expect the tightness of
oil supplies to keep the average price
close to $60 a barrel—three times the
average level in the 1990s.
„ Biggest counterpart to America's deficit
is the combined surpluses of the oil-
exporting emerging economies
„ Expected to run a total current-account
surplus of some $500 billion this year,
dwarfing China's surplus of $200 billion
„ Relative to their economies, the oil
producers' external surpluses look even
bigger: Saudi Arabia, the UAE and
Kuwait have an average surplus of
around 30% of GDP, compared to
China's 8%
„ The cumulative surpluses of oil
exporters could amount to $1.7 trillion
in the coming years, swamping China's
likely surplus of $700 billion.

Global Economy of the 21st Century:

Issues and Trends
Increasing Indebtedness
„ “Rising health-care and Social
Security spending could create a
"vicious cycle" of rising debt and
interest payments and an eventual
fiscal crisis” – Ben Bernanke
„ This discretionary spending currently
amounts to almost half of federal
non-interest spending and 9% of
GDP.
„ The Congressional Budget Office
(“CBO”), projects that health care
spending will rise to 75% of spending
and 19% of GDP by 2050.
„ The debt, would reach almost 100%
of GDP by 2030 according to the
CBO, a level previously reached only
during World War II. The annual
interest on that debt would be 4.6%
of GDP, triple the current level.

Global Economy of the 21st Century:

Issues and Trends
US Profligacy: Consequences
„ America's challenge is not just to reduce its current-account deficit
to a level which foreigners are happy to finance by buying more
dollar assets, but also to persuade existing foreign creditors to hang
on to their vast stock of dollar assets.
„ A fall in the dollar sufficient to close the current-account deficit might
destroy its safe-haven status. If the dollar falls by another 30%, it
would amount to the biggest default in history, wiping trillions off the
value of foreigners' dollar assets.
Final Solution!
„ The world economy might benefit from a gradual slide in the dollar
RER (real exchange rate). It would help to reduce global current-
account imbalances and, by shifting production into America's
tradable sector and would cushion the United States' economy.
„ A weaker dollar will hurt exporters in Europe and Asia. But the
impact on those economies could be offset if central banks hold
interest rates lower than they otherwise would, thereby boosting
domestic demand. This in turn will aid the global rebalancing
process.

Global Economy of the 21st Century:

Issues and Trends
Sidebar: Is the $’s status as the global
reserve currency under threat ?

Global Economy of the 21st Century:

Issues and Trends
History of the Global Reserve Currency
Requirements of a Reserve Currency
„ Reserve currencies need to have a home economy with a large share of global
output, trade and finance.
„ The financial market of the reserve currency country must be deep, open and well
developed.
„ Confidence in the value of the currency is also an important requirement.
„ Single true example of a reserve currency shift: British Pound (Global Reserve
Currency in the Gold Standard Era)
„ But after 1914, after the two wars and two episodes of currency devaluation, Britain
switched from net creditor to net debtor, and by the 1920s the dollar was the only
currency convertible to gold.
„ In the past 30 years, the dollar has had four bouts of marked depreciation. During the
most recent, which began in 2002, it has fallen by 28% against the euro and by 14%
against a broad basket of currencies.
„ Yet, 66% of the world's official foreign-exchange holdings are still in dollars,
compared with 25% in euros, 4% in yen and 3% in pounds.
„ During America's boom, demand for American assets helped keep the dollar strong.
„ It remained so during America's recession — the Japanese downturn kept the yen
down, and the euro remained weak.
„ In early 2002, the dollar began to fall, helped along by America's yawning current-
account and budget deficits.

Global Economy of the 21st Century:

Issues and Trends
Can the Dollar lose its Reserve Currency
Status ?
„ Barry Eichengreen, of the University of California at Berkeley, argues in a recent
paper that whether the dollar retains its reserve-currency role depends mostly
on America's own policies.
„ If America allows its large current-account deficit to persist and its net foreign
liabilities to rise, foreigners will become less willing to hold more dollars.
„ The dollar would depreciate, creating inflationary pressure in America and
making dollar reserves less attractive still, even if the Federal Reserve raised
interest rates.
„ In another recent study, Menzie Chinn, of the University of Wisconsin, and
Jeffrey Frankel, of Harvard, estimate the importance of these factors in
determining the shares of different currencies in the world's total reserves.
„ They take “network externalities” into account: the tendency of each monetary
authority to favor the dominant currency because all others do.
„ Suppose, the dollar loses 3.6% a year against a basket of other currencies,
while the euro gains 4.6% a year—the same rates as in 2001-04. Then, they
reckon, the euro could become the top currency by 2024.
„ If in addition Britain, Sweden, Denmark and all the central and eastern
European countries that joined the European Union last year adopted the euro,
it would supersede the dollar by 2019.

Global Economy of the 21st Century:

Issues and Trends
US Yield Curve Inversion
„ What is a yield curve ?
– It is the yield curve is the relation between the interest rate (or cost of borrowing) and the time to maturity of the
debt for a given borrower in a given currency

„ What does an inverted yield curve signify?

– According to
„ Expectation theory :People are expecting the forward rates to fall in the future Î might imply they are
predicting a slower growth in the future hence lowering of interest rates by central bank
„ Liquidity Preference : People are giving a higher preference to liquidity in the short Î might imply they are
seeing a downturn in the near future(eg., bubble burst),safer to keep the money in hand rather than invest
Inverted Yield Curves have preceeded recessions previously.
„ Inverted yield curves are short term and have reversed themselves
„ This reversal is not linked to a return to a growth phaseÎ the reversal might preceed the growth period few months
before
„ The current inversion on back of a string of fed funds rate hikes
„ Inverted yield curve also might be due to increased confidence in the Central bank’s capability to reign inflation and
keep it stable in the long run
„ Short term raises in interest rates in such a scenario effect the short term interest rates only and not the long term
ones..And a stable long term inflation Î no premium against inflation risk,hence lower long term yields.
„ Thus ,this might not necessarily mean a recession in the making.
Revaluation of Yuan
China’s currency Policy
„ Kept it pegged at 8.28 to a dollar till now
„ On July 21’ 05, China re-valued the Yuan by 2.1 % to USD/Yuan 8.11.
„ The Yuan is now pegged to a basket of currencies and not to the
USD alone, and is allowed to float within a band of plus or minus 3%
of the previous day's closing against non-dollar currencies and 0.3%
against the dollar.

„ Reasons for fixed Exchange Rate previously

– Chinese economy is heavily dependent upon external demand
(exports) and external funding (FDI).

– Since intro of economic reform: growing much faster

Causes of China’s Economic growth

„ 2 main factors:
– large-scale capital investment (financed by large domestic savings and foreign investment)

– Rapid productivity growth.

„ High domestic savings: 42% (profits of SOEs)
„ Productivity gains (i.e., increases in efficiency in which inputs are used)
„ Opened up to competitive forces
„ Trade as a growth engine
– Exports rose from $14 billion in 1979 to $593 billion in 2004, while imports over this period grew
from $16 billion to $561 billion

– In 2004, China surpassed Japan as the world’s third-largest trading economy (after the United
States and Germany)

– Past 11 years, China -- trade surpluses;

„ In 2004 that surplus was $32 billion.
„ Merchandise trade surpluses and large-scale foreign investment have enabled China to
accumulate the world’s second-largest foreign exchange (after Japan), which reached $610
billion at the end of 2004.
Then, why revalue?

„ Before revaluation, the USD/Yuan rate was $1 to 8.28 Chinese Yuan,

maintained by PBC bank since 1994

„ The revaluation has two initial components:

– A 2% revaluation, changing the official value of the Yuan so that $1
would buy 8.11 Chinese Yuan.
– Bank's announcement that it would allow the Yuan’s value to
fluctuate slightly -- a kind of "managed float :
„ 0.3% - $
„ 3% - Others
Why was U.S pushing?
„ Most often cited reason : In order to make exports more costly thus
reducing the deficit

„ Unlikely to have significant impact on the U.S. trade deficit in near

term.

„ In 2004, the US ran a $600 billion trade deficit, of which $162 billion
was with China. China’s share is a small proportion of the entire
deficit.

„ To have any significant effect, the Yuan would have to increase in

value by as much as 20% or 30% against the dollar -- much larger
than the 2% shift -- to have a material impact on the trade deficit.
Policy move or Political Rhetoric

„ Limited Impact on trade deficit (U.S)

„ Chinese officials have time and again emphasized their intention to

liberalize their exchange rate regime only gradually

„ Between July and October this year, the Yuan has appreciated only
about 0.3 percent, standing at under 8.09 Yuan to $1 now, slightly
below 8.11 Yuan immediately on revaluation.
– Seems like a temporary political move
What if it’s a policy shift By Chinese?
„ Positive Effects:

– Cheaper imports due to an appreciated currency

– More expansion and investment overseas

„ The Yuan’s current value makes it expensive for Chinese firms to get involved in
FDI, so the government has done its best to ease the financing of such
projects…..better to promote thru string currency rather than inefficient loan
„ Ex: Chinese bid, by a state oil company for America’s Unocal in 2006.
– Reduces Foreign Debt Obligations
– Monetary Autonomy
„ A Central Bank under fixed exchange rate system in an open economy cannot
perform the monetary functions
– Ex :An increase in Money supply would depreciate the exchange rate and the
central bank in order to appreciate the currency would again buy back the
currency from the market thus reducing the money supply
„ Negative Effects:

– Hard Landing Stops Growth ÎSudden appreciation might hit the

export sector

– Increases Value Of Non-Performing Loans In Banking Sector

„ Chinese government has massive amounts of US dollar assets,
which they used to peg the Yuan. These assets will lose value in
proportion with the revaluation of the yuan.
Impact on U.S:

„ Trade Balance
„ The small size of revaluation: 8.3 Æ 4.4
Since the initial revaluation was only 2.1% and future revaluations are
expected to be limited, the effect of currency revaluation on the trade
imbalance will be extremely small
„ Since America does not produce most of the goods imported from
China, there would not be a decrease in the current account deficit.

„ U.S Interest Rates

– China holds huge amt of Treasury Securities
– An appreciation might lead to chinese by less of securitiesÎIf the Chinese
government reduces the amount of dollars it holds in reserve or slows the
pace at which it buys dollars the revaluation could put upward pressure on
U.S. interest rates.
Effect on regional economies
„ Undervaluation Hard Hits other economies

„ Developing nations in Africa and Asia are also hard pressed to

compete against China, reducing the pace of economic growth
outside of China.

„ Mexico saw its sizable trade surplus with the US shrink as the flow of
imports shifted from Mexico to China.

Hence re-valuation is good for other countries

Some current issues
„ Oil price – rose to $78 a barrel in july , since then fallen to around $ 60 - very volatile

„ Oil price rise was fuelled by :

– Demand from China, America
– Hurricanes, cold winter
– Political unrest in oil supplying countries

„ Fall being attributed to

– Autumn period – between summer and winter
– Placid hurricane season
– Reduced fears of disruption in Iran
– American slowdown Î Chinese slowdown

„ However, cheaper oil may mean that the slowdown may not happen to the extent imagined

„ Amaranth Advisors – Hedge Fund with $ 9.2 bn assets lost $ 6.5 bn in less than a month
Issues to check up on
„ Housing market boom in US : why? Is it over ?

„ Bond Maths

„ Yuan revaluation

„ US Current account deficit

„ India : Capital Account Convertibility

„ Japan : Deflation