Capital Flight
Explanation of Graphs
- Capital flight is a large and sudden reduction in the demands for assets located in a country.
- Example: In 1994, the political instability in Mexico led people to remove the assets they had in Mexico to another country.
- To see how this affects the Mexican economy, we follow the three steps of analyzing graphs:
- 1. which curves are affected?
- 2. Which way do these curves shift?
- 3. compare the new and old equilibria
- Capital flight causes price changes
- Capital flight has an impact on the countries that people are taking their money from, but it also has an impact on the countries that they move their money to.
Political Instability and Capital Flight
Side Effects
when the currency is depreciated...
- export is cheaper
- import is more expensive
interest rate goes up
-domestic investment decreases
-future capital hold decreases
-economic growth rate decreases
By Chloe, Gino, and Elizabeth
Case Study: Capital Flows from China
- A nation that experiences an outflow of capital sees its currency weaken in foreign exchange markets, and this depreciation in turn increases the nations net exports. The country into which the capital flows sees its currency strengthen, and this appreciation pushes its trade balance toward deficit.
- In recent years, China has tried to depress the value of its currency in foreign exchange markets to promote its export industries. It does this by accumulating foreign assets (a substantial amount of US gov't bonds. By the end of 2012, China's total reserves of foreign assets was about $3 trillion.
- Because holding down the value of the renminbi makes chinese goods less expensive, thus contributing to the U.S trade deficit and hurting American producers, the US gov't has encouraged China to stop influencing the exchange value of its currency with gov't sponsored capital flows. Some members of congress have even advocated to place a tariff on China's imports unless China stops "capital manipulation."
- However, American consumers benefit. Also the inflow of capital from China lowers U.S interest rates, which then increases investment in the US economy. Thus China is financing U.S economy growth. All things considered, the net impact on the U.S. economy is probably small.
- Why are Chinese leaders interested in producing for export and investing abroad, rather than produce for domestic consumption and investing at home? Maybe China wants to accumulate a reserve of foreign assets on which it can draw in emergencies- a kind of national "rainy- day fund." Perhaps the policy is misguided.
Case Study: Capital Flows from China continued