THE GLOBAL ECONOMY

FINANCING INTERNATIONAL TRADE Markets exist everywhere there is supply & demand There are markets where dollars can be exchanged for foreign currency

FOREIGN EXCHANGE Def. – Foreign currencies used by countries to conduct international trade. Currencies are bought & sold in the foreign exchange market American companies sometimes accept foreign currencies, and keep currency for when they need it in the future Foreign Exchange Rate – Prices of one country’s currency in terms of another currency.

FIXED EXCHANGE RATES Def. – Values of currency fixed in relation to each other Popular when world was on gold standard Gold was what all currency was compared to Worked until 1960s when America began importing in large quantities Foreign countries exchanged dollars for gold, draining U.S. gold supply Nixon ended gold standard in 1971, ending fixed exchange rates

FLEXIBLE EXCHANGE RATES Def. – Supply & demand determine value of one currency in terms of another Value of currency changes based on supply & demand Excessive imports make value of local currency decline, making imports cost more When value of local currency declines exports go up, imports go down. Opposite is also true

INTERNATIONAL VALUE OF THE DOLLAR Value of the dollar rises & falls often Dollar strong – American imports less expensive, exports expensive for rest of the world Imports rise, exports fall, trade deficit is the result Eventually value of dollar goes back down because it is being spread using it to buy imports

EFFECTS OF A TRADE DEFICIT Continuous trade imbalance can affect income & employment When value of dollar gets low enough the process will reverse itself

STRONG V. WEAK DOLLAR Flexible exchange rates allow trade imbalances to correct itself through supply & demand Strong currency leads to deficit & eventually a decline in value of dollar by encouraging imports Weak currency leads to surplus & eventual increase in value of dollar by encouraging exports When one is helped (imports/exports), the other is hurt U.S. no longer sets economic policy to improve strength of dollar