Balance of Trade

Balance of Trade

What is BoT (Balance of Trade)

The Balance of Trade

The oldest records of international trade date back to the 19th century BC. With the rise of the nation states and the competition for resources, trading local products with foreigners gained a new meaning beyond satisfying needs and became a tool to elevate national wealth and gain influence over other countries. Thus, a country’s economic power and growth potential are based on the effectiveness of its international trade strategy, which is measured through the balance between the values of export and import activities.

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What is the Balance of Trade?

The Balance of Trade (BoT) is the difference between the total value of exports and the total value of imports of a country within a time period. It is also referred to as trade balance, commercial balance or net exports (NX). The Balance of Trade shows whether the country had achieved to sell locally produced goods and services to foreign countries (export) more than it bought products from abroad (import) in the focused period. Therefore, BoT is considered as the main economic indicator of a country’s international commerce activities and an important parameter to assess economic growth.

When the total value of exports is higher than imports, the Balance of Trade is positive and yields a trade surplus. A trade surplus means that the country made profits from international trade. The government can use this extra budget to increase either local investments to enhance the standard of living, or foreign investments to create new income sources for the country.

When the total value of exports is lower than imports, the Balance of Trade is negative and yields a trade deficit. A trade deficit means that the country is spending more than it earns in the global arena. Consequently, the government might be forced to implement new taxes or borrow from other countries or international money organisations like International Money Fund (IMF) to cover for the budget shortage.

BoT is the largest portion of the Balance of Payments (BoP), which is the record of a country’s international finance activities. It is comprised of current account (international trade transactions), which includes BoT, and capital account (international investment transactions).

BoP is the sum of all inbound and outbound transactions between a country’s economic entities and the rest of the world. Theoretically, two accounts should be balancing each other and yield a zero-sum BoP. However, different economic policies and fluctuations in the foreign exchange rates usually cause deviations.

Components of the Balance of Trade

Economic products included in the Balance of Trade calculation are categorised into goods or services, and their prices have direct influence on the export and import values.

Goods are tangible merchandise produced locally, ranging anywhere from food and medicine to automotive and energy.

Services are based on human interactions and involve offering support for or assuming the responsibility of performing a task. The scope of services can range anywhere from entertainment and education to sales and health care.

The prices of goods and services depend initially on the production costs like raw materials, storage, transportation, and personal expenses. For example, price fluctuations in crude oil can lead the manufacturers of oil-based products to adjust their prices to reflect the changes.

Profit margin of the producer is then added according to local supply/demand ratio. Supply and demand volumes can change seasonally and are affected heavily by economic and fiscal conditions like inflation and taxes.

Foreign demand is the final determinant of the prices. Especially if the foreign currency is more valuable than the local currency, companies would naturally prefer to export their products and earn higher profits. As a result, the export prices would continuously rise, so long as they remain feasible for foreign buyers.

On the other hand, an industry with demand surplus would encourage companies to import products, preferably from low-cost countries, and increase the total value of imports. Eventually, the nominal prices in the domestic markets would be driven down and reduce the value of exports.

How to Calculate the Balance of Trade?

As the comparison of imports and exports, the Balance of Trade highlights the efficacy of a country’s international trade activities. The BoT formula is as follows:

TB (trade balance) = X (total export value) – M (total import value)

The computation may differ between countries. For example, the primary Balance of Trade report in the Euro Zone and France include only goods and do not account for the services. French trade balance of services is calculated separately, and two categories are combined in a different report.

How the Balance of Trade Affects the Economy?

The Balance of Trade reveals whether the country is generating extra resources beyond its local capacity to create value. As a major indicator of economic growth potential and an important part of the Gross Domestic Product (GDP), the BoT figures are carefully monitored by governments and central banks to adjust their policies. A trade surplus usually increases the GDP, while a trade deficit weakens it.

Although most countries aim for a positive trade balance, surplus or deficit does not necessarily indicate economic strength or weakness. The BoT figures should be interpreted in the context of the country’s current economic conditions, economic policies and business cycles.

Export- and Demand-led Growth Strategies

In times of economic recession, the government can adopt an expansionary economic policy to stimulate the economy with an export-led growth strategy. The goal is to bring foreign resources home by increasing the volume of foreign sales. Thus, a trade surplus would be considered as an achievement, and a trade deficit would be a shortcoming of the policy.

However, if the economy is already expanding, a contractionary economic policy might be used to keep the inflation rates under control with demand-led growth. Importing more foreign goods and services can encourage price competition in the domestic economy. As a result, a trade deficit would be the healthy natural consequence, while a trade surplus would signify the inefficacy of import activities.

Trade Wars

While economic health and growth are important, there are other factors which could lead the countries astray from their own economic policies. The trade war between the world’s largest consumer and largest producer, the U.S. and China, is a good example of this.

The U.S. has a long-growing trade deficit with China, which reached above $375 billion in 2018. Consequently, President Donald Trump accused China of violating international trade practices with the U.S. through currency manipulation, intellectual property theft and restricted market access.

China countered the allegations by suggesting that Trump is trying to prevent China’s road to becoming an economic powerhouse. As a result, the trade war began when the U.S. decided to apply 25% tariff on several Chinese products and escalated rapidly as more tariffs were imposed on Chinese imports.

Considering that the U.S. adopts a demand-led growth strategy, making imports costly and difficult is a contradiction to their economic policy. As the import figures deteriorate, the trade deficit of the U.S. drops and causes the U.S. Dollar to lose value against other currencies.

The Balance of Trade as an Economic Indicator

The Balance of Trade is a lagging economic indicator and monitors the trading activities only in retrospect. A positive BoT figure indicates that the total value of exports increased more than imports in the focused period, while a negative trade balance report suggests the opposite. There are a few factors which can influence the trade balance:

  • Major domestic industries and their internal conditions like local supply/demand
  • Costs of raw materials and intermediate goods
  • The fluctuations in exchange rates
  • Trade policies, taxes, regulations, and restrictions
  • International relations with major trading partners
  • Custom controls

In the financial markets, BoT is used as an economic indicator of a country’s economic health and proximity to economic policy goals. Traders follow the BoT releases to gauge the international trade performance of the country and infer whether the growth potential is being fulfilled and expanded. It is considered as a strong predictor of GDP and the government’s future fiscal policies.

How to Trade with the Balance of Trade Reports?

The Balance of Trade is a major part of news trading strategies. The report’s effect of the currency value would depend on the economic policies and the market sentiment. An increase in the trade surplus in an export-led economy would affect the currency positively, while for a demand-led economy, the markets would look for a rising trade deficit.

The extent of price movement depends on how much the actual figures deviate from the analysts’ forecasts and the previous results. If the reported numbers are significantly better or worse than the expected or previous figures, the currency can experience high volatility and generate multiple opportunities with high return/risk ratios.

Let’s say that the monthly U.S. trade balance report is going to be published, and the analysts forecast a positive change from the past month’s -$50 billion deficit to a -$49 billion deficit this month. Since the U.S. adopts a demand-led growth, a reduction in the trade deficit can be interpreted as an underperformance and cause USD to lose value.

A downtrend in the trade deficit over a few months can indicate an economic recession, and the U.S. government can decide to stimulate the economy by reducing local investments and encouraging import. Likewise, the U.S. Federal Reserve can raise the interest rates to increase the value of USD and increase its purchase power over foreign products, thereby making import more viable.

Key Balance of Trade Reports Around the World

Each major economy in the world publishes a period trade balance report to inform the public about their foreign income and expenses. The information in the Balance of Trade report can differ according to the country as some include both goods and services while others include only goods.

USA

EU

  • Region: Europe
  • Date of release: Monthly, quarterly, and yearly
  • Issuing Agency: Eurostat
  • Affected Assets: EUR; EuroStoxx50; DAX 30, CAC 40; government bonds of EU-members

UK

  • Region: Europe
  • Date of release: Monthly, quarterly, and yearly
  • Issuing Agency: National Statistics
  • Affected Assets: GBP, EUR; British stocks; FTSE 100; UK Gilts

Canada

  • Region: North America
  • Date of release: Monthly, quarterly, and yearly
  • Issuing Agency: Statistics Canada
  • Affected AssetsCAD; Canadian stocks; S&P/TSX; Canada Marketable Bonds; Crude Oil

Japan

  • Region: Asia
  • Date of release: Monthly, quarterly, and yearly
  • Issuing Agency: The Statistics Bureau of Japan
  • Affected Assets: JPY; Japanese stocks; Nikkei 225; Japan government bonds

China

  • Region: Asia
  • Date of release: Monthly, quarterly, and yearly
  • Issuing Agency: National Bureau of Statistics
  • Affected Assets: CNY, AUD, NZD; Chinese stocks; China A50; Chinese Government Bonds

Australia

  • Region: Oceania, Asia
  • Date of release: Monthly, quarterly, and yearly
  • Issuing Agency: Australian Bureau of Statistics
  • Affected Assets: AUD, NZD; Australian and New Zealand stocks and bonds; ASX 200 index

Prepare for the Balance of Trade Reports with AvaTrade

Each month numerous trade balance reports are released around the world. They inform the markets not only about the international commerce performance of the country but also the changing dynamics of the global economy. After all, one country’s export is another country’s import. Naturally, the range of assets which experience volatility after BoT releases is quite large. AvaTrade offers state-of-the-art trading tools to identify the best assets to trade while managing the risks.

  • When is the next BoT release? Check AvaTrade’s comprehensive economic calendar to see when the trade balances are due this month and note them in your personal calendar.
  • What should I trade with BoT? Each country’s currency, stocks and indices may strongly fluctuate when BoT is released; trade your favourites with AvaTrade’s competitive trading conditions.
  • Should I buy or should I sell? You can always visit this page to check how BoT can affect a country’s assets. Then, open buy or sell CFD positions with AvaTrade, without having to purchase the asset.
  • How do I manage my risk? AvaTrade developed the unique AvaProtect risk management tool for you to hedge BoT trading positions immediately and cut your losses in case things go south.

Now that you learned what Balance of Trade is and how it affects the economy and financial markets, it’s time to skew your own balance of trade towards a portfolio surplus. Get started by imparting knowledge about the next BoT release and export predictions into positions!

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