Trade balance or balance of trade is defined as the currency flow between countries. The currency flow is generated via international trade and transactions that arise out of it. In the trade balance, each of the transactions (incoming or outgoing payments) are recorded into the balance of payments and balance of trades.
The balance of trade takes into account anything that might result in currency flows including currency itself, goods and services, economic claims and so on. The balance of trade is basically a statistical record book of the country’s international economic transactions.
As such, the term, balance of trade is defined at the difference between the total exports and imports over time, calculated every quarter and every year.
Trade balance is one of the key economic indicators that do not move the currency prices much yet they do impact the financial markets. Usually, changes in trade balance is slow as a country’s economy does not change significantly over night.
Balance of Trade is calculated as the difference between Total Exports and Total Imports during a specified period of time.
Balance of Trade in Relation to Currency
In theory, countries that have higher imports than exports usually results in their relative currency falling price. This is due to the payment of goods or services, which creates an outward flow of currency.
The contradiction to the above can be seen from the example of Japan’s trade balance during the periods of 1980’s. During this time, Japan’s economy saw very strong growth with the Japanese Yen moving stronger. By 1995, the Japanese Yen was trading at 79 to a Dollar compared to 267 Yen to a dollar back in 1985. During a span of 10 years, the Japanese’s yen managed to rise making it more expensive in comparison. In the subsequent years, Japan saw a steady trade balance yet the Yen didn’t rise in proportion. This example brings to light the fact that there is little to no co-relation between trade balance of a country and its currency.
When considering the balance of trade, the trade surplus is referred to when the BOT is positive, or in other words, when a country exports more than what it imports. Countries such as Canada, Japan for example usually have a trade surplus.
On the contrary, a trade gap or deficit is when the imports are higher than exports. However, a trade budget deficit doesn’t necessarily mean that it is negative data, but is seen more as a cyclic event that strong economies usually tend to experience. For example, recession ridden countries usually see a trade gap as imports increase in order to boost domestic activity.
What is the Balance of Payment
Balance of payments is a different aspect that works differently to balance of trade. Under balance of payments, countries monitor all the international monetary transactions during the particular period and takes into account trades from both public and private sector. Balance of payments is used to determine how much money goes in and out of the country.
When a country receive money as payment for goods or services, it is recorded as a credit. Likewise, payments made for goods and services purchased are recorded as debit. In an ideal scenario the balance of payment should be zero. Or in other words, credits should equal debits to balance the payments but this is rarely the case.
Reading the balance of payment one can tell if the country’s balance is in deficit or surplus and therefore subsequently be able to point out where the discrepancy arises from.
Balance of payments comprises of three main parts:
Currency Account: Used to record the inflow and outflow of goods and services including earnings on private and publich investments as well credit and debits on merchandize trades.
Capital Account: This is used to record international money transfers and refers to acquisition or sale of non financial aspects such as selling of land for example. Capital account is used to record transactions on non produced assets.
Financial Account: This relates to money flows in relation to business, real estate, stocks and bonds (including government owned bonds and forex reserves and special drawing rights held with the IMF).
The balance of payment is done against the current account and a combined capital and financial account.
Current Account – Top Economies