International Trade and Finance Speech
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International Trade and Finance Speech
The current state of the U.S. macro economy is made up of a plethora of highly involved processes. I am going to attempt to explain some simple terms and concepts focused on international trade and foreign exchange rates.
Foreign Exchange Rates
One needs to have a base level understanding of what defines an exchange rate. According to Investopedia, a foreign exchange rate is “The price of one countrys currency expressed in another countrys currency. In other words, the rate at which one currency can be exchanged for another.”(Investopedia, 2012) The process by which foreign exchange rates are determined is really not any different than any other market function. The supply and demand for different goods determine what their prices are. In this case, substitute currencies for goods. Let us take the case of one foreign currency to understand how this market works. The dollar-rupee exchange rate will depend on how the demand-supply balance moves. When the demand for dollars in India rises and supply does not rise correspondingly, each dollar will cost more rupees to buy. A foreign exchange rate understanding will help one to comprehend how trade between the US and foreign countries affects the GDP.
International Trade and GDP
First of all, Gross Domestic Product (GDP) is the representation of the total dollar value of all goods and services produced over a specific time period (Investopedia, 2012) This is the actual “size” of the economy.
The easiest way to describe the effects of international trade to GDP is through example. Let us use trade between the U.S. and Mexico. “U.S. demand for Mexican imports increases. This increases U.S. demand for pesos. U.S. demand for pesos raised the price of the peso in dollars. When Americans purchase more imports from Mexico–holding all else equal–U.S. net exports (and GDP and employment) will decrease. However, the change in the exchange rate will automatically correct this situation, because a) as the price, in dollars, of Mexican imports rises, U.S. demand for Mexican imports will fall, and b) as the price, in pesos, of U.S. exports to Mexico falls, Mexican demand for U.S. products will rise.” (Gorma, T, 2003) When U.S. exports to Mexico rise (because they are cheaper), it will reverse the trend that began when U.S. demand for Mexican products increased. It will also reverse the effect on U.S. net exports, which will increase when exports to Mexico increase.
Tariffs and Quotas on Imports
Countries in trade agreements will impose tariffs and/or quotas on imports to protect the domestic production. It is a balancing act to choose appropriate tariffs and quotas. A country would impose tariffs and quotas to