International Accounts
- Why Should I Care?
Most of the things we buy nowadays come from abroad. If they become more expensive, it affects our purchasing power. All of a sudden, what happens in other countries, and how our exchange rate of the Canadian dollar reacts to that, really matters.
- This Lecture Has 2 Parts
- Balance of Payments
- Exchange Rates
- What are International Accounts?
Money coming in and out of our country has a huge impact on how much investment goes on, but also how much our currency is worth to outsiders. This affects everyone by directly changing prices for all sorts of goods such as Korean flat-screen TV’s, Vermontan ice-cream, Italian shoes, or German cars. It also changes the price of Quebec-made regional jets, aluminum, and cheeses.
There is a set of aggregate measurements that help us understand how our economy relates to the rest of the world. This includes the sum of our imports, the sum of our exports, the sum of the foreign investments made by Canadians, and the sum of foreign investments made in Canada. All of these accounts are balanced by our floating exchange rate, which really helps us keep an open economy in Canada.
- Balance of Payments
Money flows between countries for two main reasons: A) the money is paying for goods, or B) the money is being invested. There are funds that are simply sent over the border as gifts, but those amounts are marginal.
The Balance of Payments is a national economic accounting statistic that therefore includes
A) the flows of Goods and Services: Trade Balance of the Current Account
B) the flows of Investments: Investment Balance of the Current Account
C) the flows in national ownership of assets: the Capital Account
The current account measures the country's net income either from net exports, also called the Trade Balance, or from net investments, also called the Investment Balance.
The capital account measures the changes in national ownership of assets. It is actually quite marginal in Canada.
For example, when a Brazilian company (Vale) purchases a Canadian mining company, the asset valuation is accounted for in the capital account. However, when Vale then proceeds to invest 10 billion dollars in new machinery and equipment for its Northern Ontario mines, it is registered as Direct Foreign Investment in the current account. Later, we could expect to Canada to export more nickel as the investment will have improved capacity at the mines.
In theory, all of the receipts (money coming into Canada) should balance with the payments (money leaving Canada). Sometimes, the trade balance is in deficit (X > M). In this case, the investment balance should be in surplus (Out > In). And vice-versa.
If the accounts don’t BALANCE, the situation will force the exchange rate to change, encouraging markets to reallocate funds, and balance the international payments accounts. Briefly stated: the exchange rate does not vary only because of Net Exports. It also varies because of Net Investment. The exchange rate varies because of changes in all of the accounts.
The following table shows the balance of international payments in Canada for 2021. Overall, the trade balance was positive, by 1.07 billion dollars. This means there was 930 billion CAD that came into Canada, and 929 that left the country. The difference is 1 billion CAD that came in (less than half a percent of the total current account), in favour of Canada. This would naturally have a rallying effect on the Canadian exchange rate, which has been appreciating moderately in the past year. Notice that Canada is running a trade surplus, so we are exporting more than we are importing. Inversely, we are running an investment deficit, which means that there are more funds invested by Canadians outside the country, than foreigners investing in Canada.
Table - Balance of International Payments, Canada, 2021
| 2021 annual (M$) |
Receipts | Payments | Balance |
| Total current account | 930,178 | 929,101 | 1,077 |
| Goods and services | 766,271 | 763,843 | 2,428 |
| Income (Investment) |
163,907 | 165,258 | -1,351 |
- The Exchange Rate
This statistic is the value of a currency in terms of another country’s currency. In Canada, the Exchange Rate usually represents the value of the Canadian dollar in terms of US pennies. For example, you might hear on the news that the Canadian dollar is worth 92 cents US. In theory, that means that if a pair of shoes cost 100 dollars in Canada, the same shoes should cost 92 $ in Plattsburgh.
The exchange rate is
EUSA = 92 USD / 100 CAD = $ 0.92 US/CA
We can use this statistic, the exchange rate, to calculate how much a foreign product costs in Canadian dollars.
To calculate the Canadian price of a foreign good, you divide the foreign price by the foreign exchange rate. If a bicycle costs 500 US dollars, and the exchange rate is 0.92, then the Canadian price of that bicycle is
Canadian Price = 500 USD / 0.92 USD/CAD = 543 CAD.
NOTE – The Canadian media prefer to use this version of the exchange rate, because at a glance it is easier to understand. Regular people want to know how much 1 $CA can buy in the US. This is actually called the US Exchange Rate with Canada.
Canadian economists would use something else. The CA Exchange Rate measures how much 1 USD can buy in Canadian currency. It is the exact inverse of what the media uses. It comes out to the same interpretation, but it is sometimes confusing if things are inverted.
When an economist says the CAD exchange rate is 1.087, he is saying the same thing as the anchor on TV (1 CAD = 0.92 USD).
1 / 0.92 = 1.087
1 / 1.087 = 0.92
Some people are professional brokers of foreign exchange, and they do these kinds of transactions daily. They buy and sell from anyone, so the exchange rates are made public, and published in the news. Banks also offer this service, they keep a cut of the transaction to cover their costs. To increase the stability of the foreign sector, some countries such as China fix their exchange rates. Most countries do not, they prefer to let markets decide the rates. This is called a floating exchange rate.
Scenario
You want to buy shoes at Aldo. But you are not sure if you should buy them in Montreal, or in Plattsburgh, USA, because you heard they are much cheaper there. The exchange rate is now 0.88 USD/CAD. Economists are predicting demand for the US currency will drop as the Fed unleashes a third round of expansionary monetary policy to prop up their economy. The Exchange Rate could rise to 0.98 in six months.
|
Location |
Price of shoes |
Exchange rate |
CAD price |
|
Montreal |
CAD 85.00 |
- |
|
|
Plattsburgh today |
USD 75.00 |
0.88 |
CAD 85.23 |
|
Plattsburgh in 6 months |
USD 75.00 |
0.98 |
CAD 76.53 |
As you can see from the table, the shoes will be much cheaper in 6 months, when the exchange rate is basically at par with the US dollar.
CASE
You are the CEO of a Mirabel, Qc, manufacturer. Your final product is exported to Europe. Parts are made in Canada, USA, Mexico, and Spain. All things being equal, the Mexican Peso has dropped in value tremendously over the past decade. It seems to be a permanent slide.
In 2009, 1 CAD bought 9.5 Pesos. In 2018, 15.9 Pesos.
https://www.xe.com/fr/currencycharts/?from=CAD&to=MXN&view=10Y
It helps to calculate the price of the part, depending on the location. Because wages are lower in Mexico, the part costs a lot less to produce there.
|
Part Cost of Production |
||
|
In Canada |
In Mexico |
|
|
|
@10P:1CAD |
@16P:1CAD |
|
1,000 $CA |
5,000 P |
5,000 P |
|
Import Cost |
500 $CA |
312.50 $CA |
You are considering the following:
- Buying more/less parts from Mexico. More
- Opening/Closing a manufacturing plant in Mexico. Open
Assuming the exchange rate is constant at 1 : 16, and assuming other manufacturers will act the same as you, what is the effect on
- Canada’s Trade Balance? X < M = Deficit
- Canada’s Investment Account? Inflows < Outflows
- Canada’s Balance of Payments? Negative Imbalance
- Mexico’s Trade Balance? X > M = Surplus
- Mexico’s Investment Account? Inflows > Outflows
- Mexico’s Balance of Payments? Positive Imbalance
Given the Balance of Payments situation of both countries, how would the exchange rate react?
Both Canadian importers, and investors are demanding Pesos, but Mexicans are not demanding the loonie. At 15, Pesos were cheap. They will be more expensive, so maybe 12.
This would decrease Canada’s imports from Mexico, and decrease the outflow of investments from Canada to Mexico. Both effects would help to balance the payments between the two countries.
- Wrap-Up
Money leaves and enters our country daily, for two reasons: as payment for goods, or as a “pure” transfer of money. If the money leaving the country does not balance the money entering, the exchange rate will be forced to change.
When the exchange rate changes, it may help or hurt producers and buyers, as well as exporters and importers, of different goods. It may change our industrial structure. Understanding the exchange rate helps consumers decide where and when to buy specific goods, especially if they live close to a border.
- Cheat Sheet
Balance of Payments:
National economic account of money flows associated to payment for goods, income, or pure transfers.
Current Account:
The current account measures the country's net income either from net exports, or from net investments.
Capital Account:
The capital account measures the changes in national ownership of assets.
Exchange Rate:
Ratio value of one currency vs. another currency.
- References and Further Reading
Investopedia. (2022). Capital Account Definition. https://www.investopedia.com/terms/c/capitalaccount.asp
Statistics Canada. (2022). Table 36-10-0014-01 Balance of international payments, current account and capital account, annual (x 1,000,000)