Trade Balance mechanism and effect of currencies exchange
We all hear about Balance of trade and imports and exports, and how important it is to international business and to strengthen the economy. It is also known as an international trade balance or simply a trade balance, a balance of trade is a term that is used to describe the relationship between the import of goods into a given nation and the products that the nation exports to other countries. The idea with a balance of trade is to reach a point where the difference between those exports and imports is at a level that is considered desirable in terms of the national economy. A balance of trade does not have to be in the form of an equal amount of exports when compared to imports. More often, the ideal economic condition for a given nation will require that one figure be slightly higher than the other. It is important to note that the balance of trade is typically a major component in a nation’s overall balance of payments*. This means that all sorts of transactions go into the assessment of that balance. A typical trade balance will allow for such debt items as the amount of domestic investments that are trading offshore, the amount of domestic spending that is taking place outside the nation, any foreign aid that is being provided to other countries, and all imported goods. The figure will also account for credit items such as foreign spending that is taking place within the nation, investments by foreign interests in domestic entities, financial aid received from other nations, and all exported goods. *[Please not that a balance of payments is a strategy used to analyze the relationship between money that is flowing into a country and money that is going out of that same country. Keeping this type of record makes it possible for nations to determine if the current balance between imports and exports is acceptable, or if some steps should be made to regulate the process in order to achieve a trade balance that is more favorable. In most cases, a balance of payments is compiled for either a calendar year or the fiscal year recognized by a particular national government.] When the balance of trade indicates that a nation is importing more goods than it is exporting, this is usually known as a trade deficit, since more is coming in than going out. Situations in which a nation is exporting more goods that it is buying from other nations are known as a trade surplus. Depending on what is happening within the national economy, a surplus or a deficit may be desirable for the short term. When a negative balance of trade is present and the exports are consistently lower than the imports, the economy of the country may experience some type of crisis. Inflation may rise significantly, creating financial hardship for the citizens. Along with internal economic difficulties, a severe trade deficit weakens confidence in the nation on the international front, which in turns leads to the currency of the country losing value in comparison to the currencies issued by other nations. A nation that consistently is able to export more than is imported tends to be very stable internally. At the same time, the currency of the country performs well on the foreign exchange market. The foreign exchange market is the global trading of currencies. Currencies are traded on both the large and small scale. Some governments mandate a fixed exchange rate between currencies rather than allowing the free market to set prices. Others use a floating exchange rate, which depends on the foreign exchange market to reach price equilibrium. A multitude of factors affect prices in the foreign exchange market, many of which are essentially unpredictable. With a fixed exchange rate, however, governments set the exchange rate. Fixed exchange rates are preferred by many governments because they can help bring economic stability. For example, a country that is attempting to emerge from a recession will often benefit from a situation where there are more exports than imports, effectively pouring more money into the nation and jump-starting the economy. By contrast, a period where there are more imports than exports can often be an effective tool when it comes to controlling the rate of inflation. Since economic conditions change over time, a trade deficit or a trade surplus may be an ideal situation for one economic period, but actually be a detriment to the stability of a national economy during the following period. In addition to what mentioned above, the currencies exchange price between importer and exporter can affect the trade balance mechanism in regards imports and exports. And for more illustration, let’s take for example two countries; USA and Canada, with their currencies the US dollar and the Canadian dollar respectively. Let say that at a specific period of time $1US Dollar is equivalent to $1.25 Canadian Dollar. And let say that the US Dollar went down against the Canadian Dollar, in other words the Canadian Dollar value has increased against the US Dollar; $1US Dollar = $1.10 Canadian Dollar. With such situation people (Canadians) are more likely to buy American dollars or products, because it is less to pay to get the American Dollar. Hence more demand will be taking place on American Dollars, and more Canadian Dollars to be offered in the market. Also such situation will increase the imports from USA, in other words the American exports will increase toward Canadian market, till the balance will be set again between the two currencies; Because of high demand on US dollars and high offer of Canadian dollars, such mechanism will create again “a reverse” situation of currencies in the market where, US dollars will be more available compared to Canadian dollars, though the demand will increase toward Canadian Dollar, and its value will go up again, and this will create a balance again. Currency exchange rate is important factor among others like inflation, interest rate when talking about trade (imports and exports). And trade balance is an important indicator when talking about a country’s economy and GDP and international business. Entrepreneurs and investors should have enough idea and knowledge about such factors and terminologies before starting business abroad.
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