Introduction to Finance

DISCUSSION QUESTION 3
What are the risks associated with buying a product directly from a foreign manufacturer?
Export-Import Bank 
bank 
established to aid in fi nancing 
and facilitating trade between the 
United States and other countries
traveler’s letter of credit 
issued 
by a bank to banks in other 
countries authorizing them to cash 
checks or purchase drafts presented 
by the bearer

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6.7 Developments in U.S. International Transactions
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6.7
Developments in U.S. 
International Transactions
GLOBAL
Just as monetary policy plays an important role in the nation’s stability, growth, interest 
rates, and price levels, it also helps keep international fi nancial relationships in balance. Since 
the dollar is widely held as a medium of international exchange, U.S. monetary policy has 
especially signifi cant eff ects on the world economy. No nation is a world unto itself, nor can 
a nation pursue whatever policies it desires without regard to other nations. Policy makers of 
all economies must recognize the interdependence of their actions in attempting to maintain 
a balance in international transactions that is sometimes referred to as international fi nancial 
equilibrium.
Briefl y, the nations of the world attempt to achieve international fi nancial equilibrium 
by maintaining a balance in their exchange of goods and services. In general, international 
trade benefi ts all countries involved. Consumers benefi t by getting lower-cost goods, since the 
goods come from the country where they are produced most effi
ciently. Producers benefi t by 
expanding their markets. Well over one-tenth of the U.S. national income comes from selling 
goods to foreigners, and a like amount of our needs are met through imports. However, indi-
viduals and fi rms make the decisions to import and export, and problems arise if they are out 
of balance over time.
International Business Issues
Exports are sales to foreigners; they are a source of income to domestic producers. Imports 
divert spending to foreign producers and, therefore, represent a loss of potential income to 
domestic producers. When the two are in balance there is no net eff ect on total income in the 
economy. However, an increase in exports over imports tends to expand the economy just as 
an increase in investment or government spending does. An excess of imports tends to con-
tract the economy.
As in the domestic economy, goods and services are not exchanged directly in interna-
tional trade; payment fl ows through monetary or fi nancial transactions. Methods of making 
payments and fi nancing international trade were discussed previously. Other short- and long-
term lending and investment is conducted across national boundaries on a large scale. In addi-
tion, government grants for both military and civilian purposes and private gifts and grants 
are sources of international fi nancial fl ows. These fl ows can have an important impact on 
domestic economies and may aff ect monetary policy.
Since producers, consumers, and investors in diff erent countries use diff erent curren-
cies, the international fi nancial system requires a mechanism for establishing the relative 
values, or exchange rates, among currencies and for handling their actual exchange. Under 
the system of 
fl exible exchange rates
that began in 1973, rates are determined in the actual 
process of exchange: by supply and demand in the foreign exchange market. This system 
reduces the impact of international fi nancial transactions on domestic money supplies. Still, 
changes in exchange rates do aff ect imports and exports and can, thus, aff ect domestic pro-
duction, incomes, and prices. International fi nancial markets strongly infl uence domestic 
interest rates, and vice versa, so that domestic monetary policy still involves international 
considerations. 
Domestic economies are linked to one another in a worldwide economic and fi nancial 
system, and the United States has played a leading role in the development of the system. We 
next turn our attention to international transaction details.
Balance-of-Payments Accounts
The