Over the past few weeks, we’ve been looking at the basics behind what makes our economy tick. Last week we took a very simplified look at why trade is important and this week we’ll boil down how it works.
You’ve probably heard the terms “import” and “export” either from someone on the news discussing the economy or perhaps while shopping in a store that boasts imported goods from an exotic location. If you need a brief refresher: exports are goods that leave the home country and are sold to customers in a foreign country while imports are goods that enter the home country from a foreign country. When Apple sells its goods to China it is exporting them from the U.S. When customers in the U.S. purchase goods from Samsung, a company based in South Korea, we are importing them from South Korea to the U.S. When you combine a country's imports and exports together you get what’s known as its balance of payments:
Exports – Imports = Balance of Payments
When we export more than we import our country experiences what is known as a surplus (a positive balance of payments). You can think of this as selling more of your goods than you buy of someone else’s. When we import more than we export our country experiences what is known as a deficit (a negative balance of payments). You can think of this as buying more of someone else’s goods than you sell of your own. This balance of payments alongside a country’s net income makes up something called the “current account.” You can see from this list compiled by the World Bank the status of different country's current accounts around the world. Not surprisingly, China has a large positive number as a major exporter (giving them a surplus or a positive current account) and the US has a large negative number as a major importer (giving them a deficit or a negative current account).
There are many different variables that play into whether a country is a net importer or exporter, one of which is the strength of their currency. You may have heard in the news over the last year or so that the dollar has significantly strengthened. What economists mean when they say this is that the dollar can purchase more goods in a foreign country than it could in the past. For example, consider the relationship between the dollar and the euro (the "exchange rate" in finance-speak). Five years ago 1 U.S. dollar would buy .70 euro. Today 1 U.S. dollar buys .90 euro. Let’s say you had $100 to spend on Ikea furniture (which is made in the Netherlands). Five years ago you could have only purchased €70 worth of furniture, but today thanks to the stronger dollar you can now purchase €90 worth of furniture. That’s €20 more of that sleek modern look!
Of course, it’s important to look at both sides of the coin. A strong dollar is awesome if you are someone looking to travel abroad or purchase some exotic furniture. It’s less awesome if you’re someone who makes furniture in the U.S. (or any other good) because it means that your goods are less competitive because they cost more from the perspective of foreign customers. If it’s cheaper for you to buy European goods, it’s also more expensive for Europeans to buy American goods which makes them less likely to buy from us. This is the balance that has to be struck and something that the leading economists and politicians of our country have to consider when they make decisions regarding the strength of our currency and the competitiveness of our goods.
If you’d like to dig deeper into some economic insights by some of the brightest economists and thought leaders of our day, I highly recommend checking out Project Syndicate. It’s one of my favorite sites to peruse for interesting perspectives about the world written by individuals who are experts on each of their respective topics. If you’re looking for a simpler explanation of our economy, I would encourage you to check out this short video – and Cedarstone favorite - on how our economy is basically a giant collection of transactions.
“Historic Lookup: 1 US Dollar Rates Table.” X-Rates. http://www.x-rates.com/historical/?from=USD&amount=1&date=2011-