– Current Blog Posts: International Trade & The Trade Deficit

Two World Wars were sufficient to create a large void in international trade for about 40 years. While a cold war and various hostilities prevailed after the late 1940s, trade resumed and grew remarkably. The fall of the Berlin Wall, symbolic of the end of the cold war, intensified interest and growth in trade in the early 1990s and we find ourselves now in a world where almost all countries feel quite free to trade with any of the others. We trade anything and everything. We trade old and new goods. We trade each other’s financial assets and we open up factories, stores, and offices almost any place we want.

As tourists we enjoy the freedom to go to places that once were taboo behind the Iron Curtain as well as old haunts like Rhine castles in Germany and vineyards in France. Many U.S. cities beckon and enjoy the throngs of foreign tourists who come and enjoy seeing the U.S. Many business executives see the whole world as their opportunity and foreign firms among their main competitors. There is hardly any domestic business that is free from competition from foreign firms.

In this new world of international trade, the playing field is hardly level.

The richer countries have relatively low trade barriers for most goods and commerce, but cling to protection for selected industries, especially their farmers and their airlines.

These countries enjoy the trade advantages of having high quality transportation and communication networks, the best technology, and the most educated workers.

Developing and transforming nations seek equality in infrastructure, capital, and labor, but know it will take decades to catch up. As they transform they also feel the need to have protection from the full frontal force of the industrial nations.

The World Trade Organization and various other world organizations attempt to move the whole world toward freer trade, but the process is slow and uneven. Much progress has been made in the last 50 years, but there is still much to do. Countries use regional trade agreements, bilateral agreements, as well as unilateral changes as they try to get the benefits of freer trade. Like domestic competition, international trade is tumultuous – it rewards the winners generously and requires that the losers either improve or move aside. Developing countries worry that their firms cannot compete against their foreign rivals. But rich countries worry a lot, too. They see many important manufacturing companies moving offshore to take advantage of new global opportunities. They see how the Internet allows for outsourcing of even high value added services to foreign countries. Countries sometimes use social policy to mitigate the harshest impacts on their companies and citizens.  Sometimes they interfere with the process of international trade by any of a number of policies that protect their citizens – things like tariffs, quotas, standards, and currency manipulation.

This note cannot embrace all these issues. There are just too many issues to handle in this short space and time. See the Note on Free Trade and Protectionism for more information about that topic.

This note is largely a primer on international trade and exchange rates. We begin with a discussion of how countries measure trade making sure that you are acquainted with important terms like:

  • trade deficit   
  • current account
  • Financial & capital account
  • national debt

We link these measures to forecasting and policy issues that confront most firms.  We then move to defining concepts relevant to understanding exchange rates, such things as bilateral exchange rates, multilateral exchange rates, nominal, and real exchange rates. We liken exchange rates to prices – special prices that relate foreign currencies to one another – and build a simple supply and demand model that helps us better understand the causes of exchange rate changes. This model also helps us to understand why it is so necessary yet difficult to forecast exchange rate movements.