15. THE INTERNATIONAL FINANCIAL SYSTEM
Governments and central banks often intervene in the foreign-exchange markets. Developed
countries like the United States and Europe tend to maintain strong currencies while China and
the Asian Tigers tend to weaken their currencies. Thus, international investors prefer to hold
strong currencies, while the Asian countries weaken their currency to boost their export
industries, creating jobs and wealth. This chapter examines a central bank’s intervention in its
currency exchange markets, and the impact of a country’s balance-of-payments upon its
exchange rate. Moreover, the world has used three exchange rate regimes: the gold standard,
Bretton Woods System, and flexible exchange rates. We discuss these exchange rate regimes in
detail along with the international institutions: International Monetary Fund and World Bank.
Balance of Payments
Balance of payments records all transactions between the households, businesses, and
government of one country to the rest of the world. It is a cash flow statement and not a balance
sheet. Economists use balance-of-payments accounts to compare the total flow of money
between one country and the rest of the world, and economists always measure it in a country’s
currency. We show the 2011 balance of payments for the United States in Table 1.
Table 1. U.S. Balance of Payments for 2011
Category Amount
($ millions)
Amount
($ millions)
Current Account
Total Exports, Services, and Income 2,847,988
Total Imports, Services, and Income - 3,180,861
Unilateral Transfers - 133,053
Total - 465 , 926
Financial Account
U.S. Owned Assets Abroad - 483,653
Foreign Owned Assets in the U.S. 1,000,990
Financial Derivatives 39,010
Capital Account - 1,212
Total 555 , 135
Statistical Discrepancy - 89,208
Grand Total 1
Source: Bureau of Economic Analysis (2012)
Balance of payments uses the accounting double entry system, where total debits equal total
credits. A payment by U.S. resident, business, or government to another country represents a