Nothing is more misunderstood than is world trade. There are two sides to a balance sheet. Everyone focuses on the Current Account---goods and services crossing international boarders--- and seem to ignore the Capital Account which is the flow of payments across international boarders. Someone has to pay for the products or they are without charge---a gift. If we really have a trade deficit that means we aren't paying for the imported goods. Which begs the question: How could I be poorer for accepting something for which I had not paid? Keynesian economics certainly is puzzling because they believe we have just lost when we do not pay for imports. How? As Bastiate said, in the early 19th century, If we import everything and export nothing, how will we be poorer for it? What do you think? Would we be poorer by importing more and exporting less? There are real obstacles to trade so why not focus on them and let the individual businesses determine whether they are making a profit or not. One of these obstacles is the foreign exchange risk. This has been lessened somewhat in recent years because of the common European currency---the Euro. It is none the less with us still. With countries expanding their money supplies in order to pay for ever increasing costs providing cradle to grave coverage of social services, the value of currencies fluctuate with the increase in the volume of currency in circulation. This is the foreign exchange risk. If I make a contract with a European nation to purchase a product at an exchange rate of $1 to 1 Euro but before the exchange takes place the value of one currency changes. The dollar, for example goes up in value. I can now purchase more Euros with the same amount of dollars. The product becomes less expensive to me. The person to whom I made the payment now receives fewer dollars. They essentially received less than the agreed amount for their products. The cost of currency translation---converting one currency to another---is the conversion cost. In this exchange I had a higher profit and the person I paid has a lower profit if not a loss because of the shift in the currencies values. This is foreign exchange risk. The risk can be reduced through the purchase of Futures or Options contracts. You are essentially protecting yourself against the down side, i.e., losing money. The contract guarantees the exchange rate. I buy a contract to purchase 23 tons of soy beans at the spot rate---the current market exchange rate--then it matters not whether the currency devalues. Of course, there is now the risk that the value of my currency will go up and I will not profit as much. The contract may limit my losses but it can potentially reduce my revenues as well. Another problem is that under any circumstances I must take delivery. Futures contracts cover all products and all commodities against sudden monetary value changes. If I bought the contract on speculation, hoping the price of my product goes up for instance, and it doesn't, and I can't sell the contract, I'm in deep trouble. Can you imagine what would happen if I bought a contract for 20 tons of soy beans, with a three month delivery date, and I couldn't sell the contract? The price of soy beans either stabilized or goes down? I better have a big driveway because the beans are now mine! A better way of paying for a contract, in commodities with volatile prices, is the option contract. You purchase an options contract and pay a premium. If the price of beans shifts in a favorable way---the dollar goes up in value---you simply do not exercise your contract. All you then lose is the premium. If the value of the dollar goes down you exercise the contract. At the moment most firms are buying debt contracts in the form of government bonds in the countries in which they are doing business. They buy bonds with a maturity date on the date the payment for the goods or services is due. This gives them a guaranteed exchange rate and a little extra income---the interest paid on the bond. All is then well in accounting Heaven! International trade has many hazards in addition to the exchange risk. Among them are tariffs, transportation costs, communications delays, payment delays, etc. Transportation costs were greatly reduced with the introduction of containers after WWII. Prior to the introduction of containers there were many incidents of breakage and five-fingered-discounts---theft. When loaded by hand, the ship was in port for 17 to 21 days. The introduction of the container cut this time to 10 to 14 days. The development of container ports, with better loading and unloading equipment, has reduced port time to 24 hours or less. Each day in port is expensive because the ship is not carrying cargo and earning money. It also is paying a daily harbor fee. Communications also increased international trade. Before satellites orders were sent via transatlantic cable. The Letters of Credit and Bankers Acceptance---the instruments that guarantee payment followed by ship or plane. Orders could not be placed on the production schedule until these instruments were received. This could delay production by as much as 30 days. When the payment guarantees could be faxed or sent by satellite it increased order versatility, it shortened delivery time as by as much as 45 days. The introduction of electronic signatures, which accompanied the order and the letters of credit, reduced this to virtually no delay in placing the order on the production schedule. Modern container ports can unload and reload a ship in 24 hours or less. The sailors may not be happy but the company most assuredly is! Lowering tariffs and eliminating most quotas also greatly improved trade. This was done initially through GATT---the General Agreement on Tariffs and Trade---and further improved by the World Trade Organization which replaced GATT in 1997. All quotas are supposed to be gone now and we should only have revenue tariffs. Quotas were greatly reduced or eliminated but they are still around. So are tariffs though greatly reduced. Tariffs are an excise tax, a monetary restriction, on imports. It's a tax on imports. There are two types of tariffs: revenue and protective tariffs. Revenue tariffs have little effect on imports. The tax, a relatively small one, is levied to raise funds for harbor maintenance, customs and enforcement of trade regulations. On the other hand, protective tariffs are used to protect domestic industry from foreign competition. They are a fools game. They protect the producer at the expense of the consumer who pays a higher price for products and therefore has his standard of living reduced and cost of living increased. Quotas are a quantity restriction on imports. An example, we might only allow 100,000 bicycles to be imported every year. Each country wanting to export bicycles to the U.S. would be given a portion of that quota. Japan might get 10,000, Germany, 11,000 and the UK 15,000. Once the quota has been met, no more will be allowed into the country. If you arrive at port and the quota has already been met you will have to take them back home or go out beyond the 3 mile limit and dump them. If the dollar appreciates on the world market----it goes up in value---it is called a strong dollar, it buys more foreign exchange (money). If it depreciates on the world market---it goes down in value---it is called a weak dollar. It buys less foreign exchange (money). This is a constraint on trade that must be considered. Trade is nothing more than "I've got something you want and I've got something you want. lets make a deal." This was called the Pareto Positive Theorem. Pareto was the first person to state that both the buyer and the seller must benefit or the exchange wouldn't take place. There are two components to the Balance of Trade concept: the Current Account and the Capital Account. What does each component measure in international trade? These are important concepts in international trade. Remember we are using a Balance Sheet. There are 2 embedded questions.