International Economic Factors

With a solid understanding of how the Fed and the business cycle drive the domestic economy, you can now extend those concepts to the global stage: trade, currency, and how the U.S. economy connects to the rest of the world.

GDP and GNP

Two measures capture the total economic output of a country. The SIE tests the difference between them.

Key points:

• GDP is the more commonly used and tested measure
• Real GDP adjusts for inflation; nominal GDP does not
• Two consecutive quarters of declining real GDP is the commonly cited definition of a recession
• GDP measures production by location (within borders); GNP measures production by ownership (by citizens)

Think of it this way: GDP asks "where was it made?" while GNP asks "who made it?" A Toyota plant in Kentucky adds to U.S. GDP (made here) but Japanese GNP (made by a Japanese company).

Exam Tip: Gotchas

• GDP = within borders (domestic). GNP = by citizens (national). A Japanese auto factory in Ohio counts toward U.S. GDP but NOT U.S. GNP.
• An American tech company's overseas office counts toward U.S. GNP but NOT U.S. GDP for that production.

U.S. Balance of Payments

The balance of payments is a record of all economic transactions between the U.S. and the rest of the world. It has two main components:

Current Account

• Tracks trade in goods and services, income, and transfers
• A trade deficit occurs when imports exceed exports (the U.S. buys more than it sells)
• A trade surplus occurs when exports exceed imports (the U.S. sells more than it buys)
• The U.S. has run a trade deficit for decades

Capital Account

• Tracks investment flows: foreign purchases of U.S. assets (stocks, bonds, real estate) and U.S. purchases of foreign assets
• When foreigners invest heavily in U.S. assets, the capital account shows a surplus

The relationship: A current account deficit (trade deficit) is typically offset by a capital account surplus (foreign investment flowing into the U.S.), and vice versa. The two accounts roughly balance each other out.

Exam Tip: Gotchas

• A trade deficit means the U.S. imports MORE than it exports (not less). "Deficit" here means the U.S. is spending more abroad than it earns from selling goods overseas.
• A current account deficit is typically offset by a capital account surplus. The two sides of the balance of payments move in opposite directions.

Exchange Rates

The exchange rate is the price of one currency expressed in terms of another. Exchange rates directly affect trade, investment returns, and the cost of imported goods.

Strong Dollar (Appreciating)

• Makes U.S. imports cheaper (good for U.S. consumers)
• Makes U.S. exports more expensive (bad for U.S. exporters)
• Makes foreign investments less valuable when converted back to dollars

Weak Dollar (Depreciating)

• Makes U.S. imports more expensive (bad for U.S. consumers)
• Makes U.S. exports cheaper (good for U.S. exporters)
• Makes foreign investments more valuable when converted back to dollars

Think of it this way: A strong dollar is like having a coupon at a foreign store: you get more for your money when buying imports. But it also makes your products look expensive to foreign buyers, which hurts exporters.

What influences exchange rates:

• Interest rates: Higher U.S. rates attract foreign capital, strengthening the dollar
• Inflation: Higher inflation erodes purchasing power, weakening the currency
• Trade balances: A large trade deficit can weaken the dollar over time
• Political stability: Stable governments attract foreign investment, strengthening the currency

Exam Tip: Gotchas

• A strong dollar HURTS U.S. exporters but HELPS U.S. consumers buying foreign goods. A weak dollar does the opposite.
• Think about it from the buyer's perspective: a strong dollar means your dollar buys more foreign currency, so imports are cheaper.

Connecting It All

International economic factors tie directly back to the Fed and the business cycle:

• Fed raises rates → Dollar strengthens → Imports cheaper, exports more expensive → Trade deficit may widen
• Fed lowers rates → Dollar weakens → Imports more expensive, exports cheaper → Trade deficit may narrow
• Strong economic expansion → Rising imports (consumers spending more) → Trade deficit grows
• Recession → Falling imports (consumers cutting back) → Trade deficit shrinks