Forex: Internal and External Economies

There is a market interrelation of the external and internal economies of all trading nations, and it is from this interrelation that foreign exchange developments often arise.

In countries in which foreign commerce is an important part of the economy, as it is in the Netherlands, Belgium, and Denmark, the impact of the external economy upon the internal one is great. Usually the influence of the external economy on the domestic one, and vice-versa, is manifested by changes in income, prices, and interest rates.

A large number of statistical studies have shown a close correlation between national income and imports. As income rises, imports tend to grow and a downward pressure on a nation's rate of exchange may develop. As income falls, imports tend to drop and there is a resulting fall in the demand for foreign currencies and a lessening of the downward pressures on the rates of exchange.

Change sin domestic prices have an important effect on a nation's foreign economic position and are a frequent cause of fluctuation in the nation's rates of exchange and the devaluation or revaluation of its currency. Inflation is usually followed by declining exports and rising imports and brings downward pressure on the rates of exchange. Deflation is likely to have the opposite effect.

The movement of internal interest rates affects a nation's external business. Rising rates stimulate the inflow of capital from abroad and bring upward pressure on rates of exchange; falling rates stimulate the outflow of capital and exert downward pressure on rates off exchange. However, the effect of changes in domestic interest rates on the external economy is not always as clear-cut as are those on income and price changes.

The exports (imports) of one country are the imports (exports) of another; the investment and unilateral transfers inflows (outflows) of one nation are the investment, and unilateral transfers outflows (inflows) of another.

From a global point of view, the internal and external economies are but two sides of the same coin, and declines in the rates of exchange of any one country come across their counterparts in the relative increases in the rates of others. The effect of changes in income, prices, and interest rates in one country may be countered or offset by similar changes on the part of that country's trading partners.

Such an inflow tends to have an inflationary effect and serves to raise incomes and prices as well as lower interest rates, all of which has the effects upon exchange rates that have already been noted. Imports of goods and services and the outflows of unilateral transfers and investments have the opposite effects.