Financing international trade becomes a critical part of the value of the dollar. Because international trade involves the
participation of other countries, the value of the dollar and exchange rates become crucial when calculating trade val-
ues. When U.S. firms export to foreign countries—for example, Japan—the U.S. firm wants to be paid in dollars while
the Japanese importer prefers the yen. The importer must exchange the yen for dollars before the U.S. export transac-
tion can occur.
The problem of different currencies can be resolved in foreign exchange markets where any one currency can purchase
another currency. International banks back the purchases of various currencies and facilitate the foreign exchange mar-
ket. Suppose a U.S. firm agrees to export $100,000 of television sets to a Japanese firm. Let’s also suppose that the ex-
change rate is $2 for 1 yen. This means that the Japanese importer must pay the equivalent of 50,000 yen for the
$100,000 in television sets. Let’s also assume that all buyers of yen and dollars are in the United States and Japan.
These are the steps that must be taken to form this transaction with exchange rates:
1.To pay for the television sets, a Japanese buyer writes a check for 50,000 yen and sends it to its U.S. exporter.
2.To pay for its costs, the U.S. exporter must convert the yen into dollars by selling the Japanese check to a U.S.
bank, which then gives the exporter $100,000 (the equivalent in yen).
3.The U.S. bank deposits the 50,000 yen check in a Japanese bank for future sale to a U.S. buyer who needs yen.The process the exchange market follows is tedious and precise. Banks can make money off currency as rates fluctuate
on a daily basis. The U.S. banks are willing to buy foreign currencies because they can make money from such transac-
tions. If the U.S. exporter sold the check at a time when the dollar was weak, then the bank would benefit from any
future strength the dollar gained on the yen. Banks make money off exchange market fluctuations. Conversely, banks
can also lose money as a result of exchange market fluctuations.
The Balance of Payments
The balance of paymentsis basically the sum of all transactions that occur between a country’s residents and the resi-
dents of international countries. Transaction examples include tourism, the import and export of goods and services,
and any interest or dividends received or paid internationally. The balance of payment statements for a country include
all internationally originated income and expenditures.
The current accountdescribes a country’s trade in currently produced goods and services. The current account includes
all imports and exports a country is making and receiving. U.S. exports typically have a plus sign next to them on a
balance sheet because they are considered income. U.S. exports typically have a minus sign next to them because they
are considered expenditures in the economy.
A balance of goods describes the relationship between imports and exports. If a nation’s imports outweigh its exports,
then there is an imbalance of goods. The imbalance arises from an unequal monetary value for imported items and
exported items. A country’s exports must earn enough revenue to finance its imports or there will be an imbalance of
trade.
Flexible Exchange Rates
When a nation has an imbalance of trade, the adjustments it makes to correct the imbalance depends on the exchange
rate system in use. The two common exchange rate systems are:
■ Flexible exchange rate system:Guided by the forces of supply and demand. Supply and demand determine the
exchange rates without government intervention.
■ Fixed exchange rate system:Guided or determined by the government. The government is responsible for main-
taining and supervising the country’s exchange rate system.International Economics