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Balance of trade
Balance of trade figures are the sum of the money gained by a given economy by selling exports, minus the cost of buying imports. They form part of the balance of payments, which also includes other transactions such as the international investment position.
A positive balance of trade is known as a trade surplus and consists of exporting more (in financial capital terms) than one imports. A negative balance of trade is known as a trade deficit and consists of importing more than one exports. Neither is necessarily dangerous in modern economies, although large trade surpluses or trade deficits may sometimes be a sign of other economic problems.
Factors that can affect the balance of trade figures include:
- Prices of goods manufactured at home (influenced by the responsiveness of supply),
- Exchange rates, and
- Trade agreements or barriers
- other tax, tariff and trade measures
Measuring the balance of payments can be problematic, due to problems with recording and collecting data. As an illustration of this problem, when official data for all countries in the world is added up it appears that the world is running a positive balance of payments with itself. The total reported amount of exports in the world is greater by a few percent than the total reported amount of imports. This cannot be true, because all transactions involve an equal credit or debit in the account of each nation. The discrepancy is widely believed to be explained by transactions intended to launder money or evade taxes, and other visibility problems.
Economic Impact of Balance of Trades
If the balance of trade is positive, then the economy has received more money than it has spent. This may appear to be a good thing but may not always be so. An example of an economy in which a positive balance of payments is generally regarded as a bad thing is Japan in the 1990s. Because Japan had a consistently positive balance of payments, it had more currency than it could effectively invest. This led to huge Japanese overseas purchases of items such as real estate, which were of questionable economic usefulness. Furthermore, the protectionist measures that created the positive balance of trade also caused the price of goods in Japan to be much higher than they would have been had imports been freely allowed.
Negative balances are not necessarily terrible news, either. In particular, an effect known as reserve currency status makes it possible for dominant currencies to run significant trade deficits with limited economic impact. Because the United States dollar is generally regarded to be extremely stable, dollars which are exported are held by persons overseas and there is no pressure to return them to the United States. Furthermore, countries running large trade surpluses (e.g. China and Japan) use these funds to purchase US Treasury Notes, essentially allowing the United States to export monetary paper and get real goods and services in return. The pricing of oil in US dollars also forces nations and institutions to hold some of their reserves in US dollars in order to hedge against the rapid rises and falls in prices of this all-essential energy source.
Reserve currency status, however, is not without its risks. While the United Kingdom enjoyed economic benefits through the 19th Century up until 1914 from the strength of the British Pound and its reserve currency status, the relative weakening of the UK and strengthening of the US economies in the inter-war and post-war periods caused the shift in currency reserves, culminating in a 30% devaluation of the British Pound in 1949 which ended the dominance of the British Pound as a world currency. Weighed down by the debts of fighting World War II, and without the benefits of reserve currency status, the United Kingdom struggled to rebuild its economy, entering a period of economic slowdown and decline that would last over three decades.
If, as some economists are speculating, current weakness in the dollar were to cause the shift of foreign exchange reserves or oil pricing into another currency such as the Euro, then the reserve currency advantage would also switch to the European Union.
Physical trade balance
Monetary trade balance is different from physical trade balance (which is expressed in amount of raw materials). Developed countries usually import a lot of primary raw materials from developing countries at low prices. Often, these materials are then converted into finished products, and an enormous amount of value is added. Although the EU (and other developed countries) has a balanced monetary trade balance, its physical trade balance (especially with developing countries) is negative, meaning that in terms of materials a lot more is imported than exported. That means the ecological footprint of developed countries is much larger than that of developing countries.
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