CHAPTER 28 International Finance and the Exchange Rate

Family farm, global market.

Chapter Objective

Understand the linkages between the exchange rate, imports, exports, and international financial flows.

• 28.1 International Trade and Global Financial Flows

  See the connections between the domestic economy and the global economy.

• 28.2 Exchange Rates

  Analyze prices that are quoted in different currencies.

• 28.3 Supply and Demand of Currencies

  Analyze the market for currencies and forecast the nominal exchange rate.

• 28.4 The Real Exchange Rate and Net Exports

  Assess how exchange rates and relative prices affect exports and imports.

• 28.5 The Balance of Payments

  Track how money flows around the world using the current account and the financial account.

In 1893, the Mathison family began a small farm in Washington State, producing enough to feed their family. Over time, the farm grew, and they began selling their crops at local markets. By the 1950s they were selling in markets outside of Washington, but they were struggling. They would load ripe, freshly harvested cherries onto trains packed with ice and hope they would still be good when they made it to their destination. If their fruit made it to New York with little spoilage, they were nearly guaranteed robust demand from the large population of New Yorkers. But if it got hot, spoilage rates were punishingly high. In 1958, they made a mere $88 after producing 100 tons of fruit because most of it rotted en route.

To succeed, the Mathisons needed to solve the problem of spoilage. They worked to improve their packing and transportation methods and by the 1970s, they had built a fruit packing, storage, and shipping facility that kept their fruit cold enough that it could survive a trip across the United States. This innovation not only gave them access to markets as far away as New York, but it also laid the foundation for exporting their fruit around the world. By the 1980s, they were exporting apples and cherries to a handful of countries. Over recent decades their business has grown as they’ve entered more foreign markets. Today, the Mathisons export fruit to 26 countries.

All of this has required the Mathisons to become conversant in exchange rates and international finance. We’ll follow the Mathisons’ decisions in this chapter, analyzing what determines how competitive they’ll be in the global market, and whether it makes sense to sell their produce abroad. International transactions often involve foreign currencies, and so we’ll dive into how exchange rates are determined, how they respond to changing economic conditions, and how they’ll affect the Mathisons’ business. Along the way we’ll see how developments in the global economy affect the prices you’ll pay as you seek goods, services, customers, investments, and investors from around the world. As you read this chapter, keep your eye on the broader theme, which is that increasingly all business is international business, and so the fates of businesses, communities, and countries around the world are becoming increasingly interdependent.