Question

In: Finance

Suppose that Japanese investors suddenly decide that U.S. investments look unpromising, and unilaterally attempt to “cash...

Suppose that Japanese investors suddenly decide that U.S. investments look unpromising, and unilaterally attempt to “cash out” $500 billion worth of their U.S. investments (stocks, bonds, etc). Keeping the balance of payments identity in mind, can they in fact withdraw their money from the U.S.? (And if so, how?) What is the impact on the exchange rate and on the U.S. balance of payments (i.e., on the current and capital accounts)?

Solutions

Expert Solution

Yes, Japaneses investors can withdraw their money from the U.S. given that they are able to convert all those dollars into yen. Once the investors cash out their investments they would want to convert those proceeds into their domestic currency. This would drastically increase the supply of dollars and the demand for yen in the foreign exchange market which means that the dollar would depreciate against the yen.

This activity would be a debit (-ve) item for the U.S. capital account as money is actually leaving the country. Assuming that there is no intervention by the Federal Reserve in order to keep the exchange rate stable, the capital account deficit should result in a current account surplus in order to satisfy the balance of payments identity.

This happens because the dollars sold by Japanese investors in exchange for yen are usually bought by people (most likely Japanese individuals) looking to buy American goods, services or assets. This is why they are exchanging yens for dollars. The individuals that end up purchasing American assets would credit or increase the U.S. capital account which would offset the capital account deficit created out of Japanese investors cashing out. Others would be purchasing American goods and services which would in turn create a current account surplus.


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