The Flow of Goods
Net Exports (NX) or Trade Balance:
The value of exports minus the value of imports.
Trade Deficit:
A situation when net exports (NX) are negative.   (i.e. Exports < Imports)
Trade Surplus:
A situation when net exports (NX) are positive.  (i.e.  Exports > Imports)
Net Foreign Investment (NFI)
Net Foreign Investment:  net capital outflows minus net capital inflows.
Example:  American buys Mexican treasury bonds.  Mexican buys stock in the Ford Motor corporation.
Net Foreign Investment (NFI)
When domestic residents purchase more financial assets in foreign economies than foreigners purchase of domestic assets, there is a net capital outflow from the domestic economy.
If foreigners purchase more U.S. financial assets than U.S. residents spend on foreign financial assets, then there will be a net capital inflow into the U.S.
Net Exports and Net Foreign Investment
For an economy as a whole, NX and NFI balance each other:
NX = NFI
Every transaction that affects one side must also affect the other side by the same.

Bretton Woods Conference
New Hampshire 1944
International Monetary Fund (IMF)
International Bank for Reconstruction & Development (IBRD aka the World Bank)
International Trade Organization
ITO not ratified but set up as GATT, ultimately became the WTO
Bretton Woods System
U.S. $ designated the “International Reserve Currency”
U.S. $ pegged to gold @ $35/oz
Other currencies pegged to USD @ their “par values”
E.g., 1USD = 360JYN
Fixed e-rates
Broke down in 1973

The Nominal Exchange Rate
The nominal exchange rate is the rate at which a person can trade the currency of one country for the currency of another.  It is expressed in two ways:
1.  In units of foreign currency per one U.S. dollar
In units of U.S. dollars per one unit of the foreign currency
http://www.xe.net/ucc/
Purchasing-Power Parity
“a unit of any given currency should be able to buy the same quantity of goods in all countries.”
Based upon The Law of One PriceThe “Law of One Price”“A good must sell for the same price in all locations.”
If the law were not true, unexploited profit opportunities would exist, allowing someone to earn riskless profits by purchasing low in one market and selling high in another.
Example:  Buying coffee in U.S. or Japan
Purchasing-Power Parity
A currency must have the same buying power (i.e. parity) in all countries and it is the exchange rate that assures that this purchasing power is approximately equal across countries.
The nominal exchange rate between the currencies of two countries must reflect the different price levels in those countries.
Limitations of The Purchasing-Power Parity
Two things may keep nominal exchange rates from exactly equalizing purchasing power:
1.  Many goods are not easily traded or shipped from one country to another.
2.  Traded goods are not always perfect substitutes.
Interest Rate Parity
If the nominal interest rate in Spain is higher than in Japan, Japanese investors will demand Spanish pesetas to get the higher return.  The greater demand for (& lower supply of) pesetas, and greater supply of (& higher demand for) yen causes the yen to depreciate
Interest Rate Parity
The greater demand for (& lower supply of) pesetas, and greater supply of (& higher demand for) yen causes the yen to depreciate
Interest Rate Parity
The e-rate adjusts to offset the difference in expected returns between the two countries.
This explains some short term e-rate movements.
PPP explains long term movements.