Balance of Trade in Economy - Essay Example

?MONEY AND BNKING Economy of a country depends on various market forces and controls that can boost or depreciate economic performance of the given country. One market force and factor is the balance of trade. Balance of trade refers to the comparison or relativity between a country’s export and import. When the export value of a country exceeds the import value, then that particular country is enjoying positive balance of trade. When the import value by a country exceeds its export value, then the given country will have a negative balance of trade and experience trade deficit. Trade deficit among other effects makes a country spend or export a lot of its currency to the foreign market, which may create shortage of the currency in the local market. Cause of trade deficit may attribute to the practices of by foreign markets or countries lowering the cost of their export to the affected country and increasing cost of importing goods and services from the affected country. This means that the affected country will have to spend a lot of its currency to export goods and services, and spend very little to import goods from the competitor country. From the analysis, it means that trade deficit literally increases supply of a country’s currency in the foreign market making the currency depreciate. This means that it impossible and practical difficult to maintain the value of local currency with negative balance of trade. For example, if supply of US dollar in the Euro market increases, the number of Euro required in buying one dollar will decrease. When the number of Euro required in buying one unit of dollar decreases, the demand for dollar in the foreign Euro markets will increase due to the low prices of dollar. This means that many foreigners in the European countries will be holding large quantities of dollars, as they will not be in demand for the American goods. This effect will result to decrease in the supply of dollar in American economy and subsequent rise in demand for dollar in the same American economy. The general effect of such market trend on the American economy will sharp deflation as locals will be not be willing to spend the little dollars they have in their custody. Economic recession occurs due to scarce supply of local currency in the local market, which affects demand among the local consumers. To correct the shortage, a country can resort to borrowing from foreign countries to spur its production and manufacturing activities. A country can also review its market and monetary policies to attract foreign investors who be returning local currency lost to the foreign markets. The best way that countries exercise control over their value of their respective currencies in the international market is through intervening the foreign exchange market. Foreign exchange market specifically deals with daily and periodical valuation of all international currencies depending on the international flow of the specific country’s currency. Intervening in such a market may mean that an interested country buy its own currency from the international exchange and create shortage of the same in the international market. A country can also intervene by selling its currency in the international market with aim of acquiring another currency with high value. In so doing, the buying country shields it domestic economy from any economic shifts in the foreign market country. This kind of economic practice is common among the developing countries but rare in the stable and industrialized countries. Industrialized countries do not like intervening in the foreign exchange market or various reasons. One of the reasons why industrialized countries do not intervene in the foreign exchange market relates to their developed statuses that makes them perform many manufacturing and production activities that earns them foreign income when exported. This means that they are always in situation of competition for the international market where they export their goods and services. Attempts by anyone of the industrialize countries to intervene the foreign exchange market will mean either reducing or increasing their currencies in the international financial market. When a country increases its currency in the international market, it will be losing since the value of the currency will also depreciate and earn little revenue from the exports. Intervening through buying its own currency to reduce supply of the currency in the international market will escalate the value of the currency. This had the potential to result to decline in the international demand and consumption of the country’s export in the foreign countries due high costs of the products. When this happens, competitors of who do not intervene in the operation of the foreign exchange market will post fair prices for similar products, and attract great demand and foreign consumption. Another reason why industrialized countries do not intervene in the operations of the foreign exchange market relates to the serious need to increase flow of capital in their economies. Most industrialized countries adopt the policy of open capital flow within the economies without strict regulation. The purpose for such practices is usually to encourage saving and expand base of wealth held by the citizens, usually targeted at reducing poverty levels. As it is usually common, government’s intervention in the foreign exchange market results to certain impacts in the domestic economy. When a country buys its currency from the foreign exchange market, it reduces supply of the same in the market making the cost of its exports high above affordability. This means that it will very difficult to dispose the locally produced goods and service, an effect that will result to poor performance of the domestic economy. Similarly, intervening in the foreign market through selling of a country’s currency to increase supply of the same in the international market may depreciate the value of the currency. This means that the cost of a country’s export will decline to disallow domestic businesses from realizing profits but loses. In general, the unlikelihood of the industrialized economies to intervene in the foreign exchange market is usually a deliberate move to cushion the local economy from international or external fiscal shocks. Read More