This paper provides a theoretical interpretation of the countercyclical movements in net exports and the asymmetric correlation between the trade balance and the terms of trade. The authors document these properties in a two-country stochastic growth model where trade fluctuations are driven by capital formation. They find that the general equilibrium perspective is essential: The relationship between the trade balance and the terms of trade depends critically on the source of fluctuations. The paper compares the theoretical model to international data from 11 OECD countries, documenting that both the trade balance and the terms of trade are highly autocorrelated, the trade balance is countercyclical, and the cross-correlation function for net exports and the terms of trade has an asymmetric shape, referred to as the S-curve. The authors explore the role of various parameters and shocks in generating these properties, finding that the dynamics of capital formation play a central role. They also highlight two anomalies in the model's predictions compared to the data: smaller variability in the terms of trade and stronger correlations of output across countries. The paper concludes by discussing the implications of these findings for understanding the dynamics of trade and relative prices.This paper provides a theoretical interpretation of the countercyclical movements in net exports and the asymmetric correlation between the trade balance and the terms of trade. The authors document these properties in a two-country stochastic growth model where trade fluctuations are driven by capital formation. They find that the general equilibrium perspective is essential: The relationship between the trade balance and the terms of trade depends critically on the source of fluctuations. The paper compares the theoretical model to international data from 11 OECD countries, documenting that both the trade balance and the terms of trade are highly autocorrelated, the trade balance is countercyclical, and the cross-correlation function for net exports and the terms of trade has an asymmetric shape, referred to as the S-curve. The authors explore the role of various parameters and shocks in generating these properties, finding that the dynamics of capital formation play a central role. They also highlight two anomalies in the model's predictions compared to the data: smaller variability in the terms of trade and stronger correlations of output across countries. The paper concludes by discussing the implications of these findings for understanding the dynamics of trade and relative prices.