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Environment of Global Finance
There are clear benefits to being open to international trade: trade allows people to produce what they produce best and to consume the great variety of goods and services produced around the world. The key macroeconomic variables that describe an interaction in world markets are exports, imports, the trade balance, and exchange rates. Economies buy and sell goods and services in world product markets, and buy and sell capital assets in world financial markets.
When nations export more than they import, they are said to have a favourable balance of trade. When they import more than they export, an unfavourable balance of trade exists. Nations try to maintain a favourable balance of trade, which assures them of the means to buy necessary imports. Some nations, such as Great Britain in the nineteenth century, basedtheir entire economyon the concept of importing raw materials, processing them into manufactured goods, and then exporting the finished goods.
In addition to visible trade, which involves the import and export of goods and merchandise, there is alsoinvisible trade, which involves the exchange of services between nations. Brazilian coffee is usually transported by ocean vessels because these ships are the cheapest method of transportation. Nations such as Greece and Norway have large maritime fleets, which can provide this transportation service.
The prudent exporter purchases insurance for his cargoes’ voyage. While at sea, a cargo is vulnerable to many dangers, the most obvious being that the ship may sink. In this event, the exporter who has purchased insurance is reimbursed. Otherwise, he may suffer a complete loss. Insurance is another service in which some nations specialize. Great Britain, because of the development of Lloyd’s of London, is a leading exporter of this service,earning fees for insuring other nations’ foreign trade.
Some nations possess little in the way of exportable commodities, but they have a mild and sunny climate. Tourists spend money for hotel accommodation, meals, taxis, and so on. Tourism, therefore, is another form of invisible trade.
In the past twenty years, millions of workers from the countries of southern Europe have gone to work in Germany, Switzerland, France, the Benelux nations, and Scandinavia. The commissions and salaries that are paid to these people represent another form of invisible trade. The workers send money home to support their families. These are called immigrant remittances. They are an extremely important kind of invisible trade for some countries, both as imports and exports.
The main difference between domestic trade and international trade is the use of foreign currencies to pay for the goods and services crossing international borders.
Whenever a country imports or exports goods and services, there is a resulting flow of funds: money returns to the exporting nation, and money flows out of the importing nation. Trade and investment is a two-way street, and with a minimum of trade barriers, international trade and investment usually makes everyone better off.
Investments can have a crucial impact on a nation’s balance of payments. When an investment is made, capital enters a country, enabling it to import manufactured materials to build a new manufacturing plant and to pay workers to build it. Once the plant is operative, it provides both jobs and taxes for the host country and, in time, produces new manufactured goods for export. In this way, investment acts as a catalyst in economic growth for the developing countries throughout the world.
In subsequent years, an investment should yield a profit. Dividends, sums of money paid to shareholders of a corporation out of earnings, can then be remitted to the investing country. From the perspective of the balance of payments, in the year the investment is made, the host country credits income to its balance of payments, and the investing country records a debit. This is reversed in the following years. The dividends then represent an expense for the host country and income for the investing country.
After calculating all of the entries in its balance of payments, a nation has either a net inflow or a net outflow of money.
The nation’s reserves may be compared to an individual’s savings. For a nation, they are maintained in holdings of gold and official deposits in foreign currencies. A deficit in the balance of payments can be accommodated by drawings on (removing some of) the reserves, that is the previous savings. But if a nation’s balance of payments continues in deficit for some time, then the reserves will be insufficient to cover further withdrawals, and additional measures must be taken.
The most direct means of correcting a deficit in the balance of payments and having an immediate impact is by reducing imports. This can be accomplished by imposing tariffs (taxes), quotas (import restrictions), or both. If successful, the cost of imports rises in the local market, and the imported goods are comparatively more expensive to the consumer than locally made goods. When a quota is imposed, the quantity previously imported and paid for is reduced.
In either case, the net effect is the reduction of the nation’s outflow of money. Other measures may limit invisible trade expenditures. For example, citizens may be prohibited from taking more than a specified amount of money with them when they travel abroad.
Capital for investments abroad can be restricted by requiring government approval for any new foreign investments. When the United States encountered serious balance of payments problems in the 1960s, the government restricted the loans that United States banks could extend abroad. This was a large item in its balance of payments because of the United States’ role in world finance. The government also restricted the amount that United States corporations could invest overseas.
If these measures are insufficient, a country may devalue its currency. This immediately makes imports more expensive and exports more competitive, since the importing country can now pay for the first country’s imports with less of their currency than previously. In time, these advantages are eliminated. A nation must at all times combine devaluation with other effective measures to balance its economy, resulting in a reasonable level of employment and low rate of inflation.
Gold has been the traditional reserves. At one time, gold moved freely from country to country, but successive constraints have been imposed in the past years. Today, gold counts as only one form among many in the reserves of a country. A number of countries have an agreement with the Federal Reserve Bank of New York to hold their gold in safekeeping. This makes it possible for these countries to buy gold from or to sell gold to other countries by merely moving the gold from one custodian vault to another at the Federal Reserve Bank of New York.
Free trade agreements often cause disputes between countries, especially when one country thinks the other is engaged in restrictive practices. Occasionally, trade wars erupt, and sanctions or embargoes are imposed on countries, and may not be lifted for long periods. On the other hand European countries closely related economically and enjoying good relations have entered into monetary union and have a single currency.
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