Sec. 6. #Equation of international exchange.# Foreign trade of course can take place as barter, and in earlier times, particularly, very commonly did so.  But in the existing monetary economy nearly all trades are expressed in terms of monetary prices.  Both the prices of all the particular objects of international trade and the general levels of prices in any two trading countries come to be pretty definitely interrelated.  Changes in the one country at once compel readjustments in the other.  To understand in the most general way how this occurs, a knowledge at least of the elementary principles of foreign exchange is required, and to this we may now turn.

Let us begin with the proposition known as the equation of international exchange, which is sometimes given thus:  the value of the imports of a country must in the long run equal the value of the exports.  But this proposition (especially the words imports and exports) must be understood in a much broader sense than that of the movements of merchandise merely.  The proposition might better be expressed:  the total credits of a nation (including money actually sent abroad) must just equal its total debits (including money imported).  Into the balance of accounts between any two nations enter many items:  the cash values of the imports and exports of merchandise; freights, insurance premiums, and commissions; the expenses of citizens while traveling abroad; money brought in or taken out by immigrants; the cost of the governmental foreign services (such as the salaries of consuls and of diplomatic representatives); subsidies and war indemnities received from or paid to foreign nations; the investments of foreign capital; and credit items of many kinds, on both sides of the account.

The effect of loans upon the equation differs at different periods according as they are just being made, are continuing, or are being repaid.  When foreign capital is first invested in a country, whether it is loaned to the government or to individuals or to corporations, either gold must be remitted to the borrowing country or goods be sent.  But later the interest payments and the eventual repayment of the principal of the loan act in the opposite direction.  Accruing interest must be offset annually by exports from the debtor country and the repayment of the principal requires that either money or goods be exported equal in value to the original obligations.  In popular opinion an excess of exports of merchandise is an index, if not the real cause, of national prosperity; but evidently it is no true index whatever on this point.  An excess of exports may at any given moment indicate that the country is rich and is lending abroad, or that it is in debt and is paying interest, or that it is repaying the principal.  On the other hand, an excess of imports may indicate either that a country is poor, and is borrowing from abroad, or that it is rich, with many foreign investments, and is receiving the income from them in the form of a regular shipment of goods from the debtors.