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Trade Balance

One of the most relied-upon figures to calculate the value of a nation's currency is its trade balance. Nations that run regular trade deficits can expect to see their currency fall. The reason is simple: As the nation's currency flows overseas, it is reconverted. If more of a nation's currency is being sold than being bought, the law of supply and demand dictates that the currency will fall in value. The opposite is true for a nation that runs trade surpluses. The nation's currency is in demand, thus pushing up its value.

The effect of trade balance on a nation's currency, however, is never so clear-cut. A nation can run trade deficits if it continues to attract foreign capital for investment. For example, the U.S. ran trade deficits through most of the 1980s and 1990s. The dollar was propped up, however, because the U.S. attracted enormous amounts of capital. In short, everyone wanted a part of the booming American economy. The question market watchers ask is how long that can be maintained.


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