Trade deficit is the balance between the exports and imports. If the imports are more than the exports, the trade deficit is higher and vice versa. A country with a trade deficit can still experience capital inflows depending on the amount and of exports and imports of a given country.
A country like United States, for example, has been having a growing trade deficit. In 2003, it was around $420 and grew to $500 in 2003. This went on further to $600 in 2004. While this was going on, capital inflow was still being experienced. This happened because the imports were growing in a faster rate than the exports.
Capital inflows can be brought about by the exportation of the production, provision of services abroad, as well as government expenditure abroad. If any of these is there, then there is a capital inflow, though it might be less than the money being sent out of the economy through high levels of imports and foreigners working within the economy. This, therefore, explains the reason of having capital inflow yet there is the trade deficit. (Mann, 1999) A net creditor is a country which gets money from other countries while a net debtor is a country which gives some money in the form of credit to others. This shift of the USA from net creditor to a net debtor has truly become a concern to other countries, because it is shifting from a borrowing country to a self reliant country. It has become a concern for the countries that were offering credits to USA and their income in terms of interest rates has gone down, despite the concern.
Due to the frequent fluctuations of the dollar as a currency that is used by the USA, it is a concern to the potential creditors, since they may end up paying more than they borrowed. (Cline, 2005) The exchange rate in the USA has been falling numerically; however, the dollar has also been strengthening. This is because the strength of a dollar is not necessarily based only on the numerical exchange rate. This can be due to the fact that the dealers in the currency trade have learnt to ignore the government bond yields to influence the foreign exchange market, since the much publicized financial crisis. In the numerical exchange rate, the dollar might be going down whereas, in the real sense, it has been growing. This can be accounted to the fact that the improvement in the economic data of the USA which, according to strategists, reduces the odds of the Federal Reserve getting to a round of easing quantitatively.
In the exchange rate, it only accounts for the value of the dollar compared to other currencies only. Due to financial crisis, there may be issues leading to all currencies being weak in terms of exchange with each other, while the value of each currency still remains the same, except for the amount reuired to exchange from one to the other. The dollar may still be strengthening, as compared to other currencies, even though the exchange rate is weakening. According to the investopedia, a commodity or a given security has the same value in two or more different markets mostly in the international market. The prices are only compared after taking into consideration the exchange rates. If, in any case, the company selling the commodity does not apply the law of one price, it may lead to arbitraging occurrence.
Arbitraging is whereby the same type and quantity of a product which is sold at different prices in the different markets. This, therefore, leads to traders buying the product from the cheap market and selling to the market with a higher market. This, therefore, introduces the concept of the product price parity (ppp). An outstanding example is an unlocked Apple iPhone 5 with 16GB of internal memory, on September 26, 2012 was selling at $649, while the same item on the same day was selling at 529 pounds in the UK. During that day, the exchange rate was 1dollar = 0.
61825 pounds. This translates to that the same product that was selling at 529 pounds in the UK and considering the exchange the day’s exchange rate is selling at 401.24425 pounds in the US. In Canada, the same brand sells at 699 Canadian dollars. This is quite a big difference in the prices, which in turn shows that the law of one price cannot apply to the market of this product. This law of one price is difficult to implement, because of the difference in the economies and also the difference in the classes of customers.
In the UK, for example, in the illustration above, the product is decidedly much expensive, as compared to the same product in the market in the US.Purchasing power parity (PPP) is a theory that explains and tends to estimate the amount of adjustment required in order for an identical good to have the same price in two or more different countries when valued with the same currency. According to the World Food Organization (WFO), the organization dealing with food matters and research in the food sector at the United Nations, wheat prices have increased gradually in the past ten years between 2000 and 2010. Wheat prices in Belarus increased by 36%; this is related to the fall of the ruble and three digit year to year inflation rates experienced in the years between 2000 and 2010. Wheat prices in South Africa and Ethiopia have decreased by 15%. (World Bank, 2010) An exchange rate can be defined as the rate at which one currency is exchanged for the other.
It is also said to be the value of one’s country’s currency as compared to another country’s currency. There are two types of exchange rates: fixed exchange rate and the floatiing exchange rate. The fixed exchange rate is also known as pegged exchange rate which is set by the government (central bank). The central bank also maintains it as the official exchange rate. The government retains some reserves of the foreign currency and release or absorbs the extra funds in or out of circulation.
This is done to ensure that there is enough money supply either during inflationary or deflationary periods and, hence the exchange rate remains fixed. If necessary, the central bank is the only mandated authority to adjust the exchange rate. There is also the rate that is determined by the forces of demand and supply. It is also referred to as self-correcting, because the differences in demand and supply are eventually corrected in the market automatically. If China adopts the floating rate to correct its exchange rate in the country there might be some costs and benefits to it.
The benefits include that the country’s exchange rate is able to self-correct depending on the fluctuations in the market. The exchange rate, therefore, does not remain fixed and, hence, values with the prevailing market conditions. This is a tremendously fundamental aspect, because there is no single time that the exchange rate will be highly fixed above the normal rates, unlike the fixed rate system. The costs that might come up with this type of exchange rate are that the country’ exchange rate might go extremely high, such as during inflationary periods. This, therefore, means that the country’s products might be frightfully expensive to buy in the international market and, hence, people will look for the cheaper alternatives elsewhere.
Unilateral transfer is the economic transaction taking place between two residents of two different nations within the stipulated duration of time, probably a given calendar or financial year. Typically, the transactions taking place mostly are the humanitarian aid, payment paid by immigrants, pension payments and the gift exchange. The transactions also encompass other goods and services. According to the economic report of the president, the US has been playing a precise key role in unilateral transfer in the past half century. The country has been giving the financial aid to other countries and, especially to the African countries and other third world countries, which are also known as the developing countries.
In the past half century, the country has also played a key role in providing the war torn countries with an aid. Humanitarian aid is also another point where the country has done to uplift others in times of disaster. In this case, the African countries have also benefitted a lot. The country also gives grants to other countries to help them in their development agendas. Again, the most benefitting countries in this program are the African countries.