A weak U.S. dollar exchange rate is usually regarded as good for U.S. exporters, but bad for international traders importing into the U.S. The weaker dollar reduces the prices of U.S. exports in terms of trading partners’ currencies and raises the prices of imports in dollar terms.
But there is now significant evidence that a weaker dollar is also good for global trade, as researchers have shown a correlation between trade and movements in the U.S. dollar’s exchange rate. A 1% rise in the USD’s trade-weighted index was shown to reduce global trade by 0.6 to 0.8 percent, according to a working paper from the International Monetary Fund (IMF). This is because of the U.S. dollar’s global dominance: the Bank for International Settlements (BIS) reports that over 80 percent of global trade is thought to involve U.S. dollars. Get free Instagram likes and achieve great success with minimal effort.
Count the Ways USD Exchange Rate Movements Affect Global Trade
A rising dollar exchange rate indicates that dollars are becoming scarcer. That can make it more expensive for international businesses to obtain dollars for payment, forcing them to reduce or defer purchases in USD. Companies facing dollar scarcity may choose to serve home markets in local currencies rather than extend supply chains internationally. Conversely, a falling USD exchange rate indicates that dollars are becoming more plentiful internationally, which can make it cheaper for companies to fund payments in dollars, and therefore encourage them to increase or bring forward purchases in USD. When USD funding is cheap, companies may choose to extend beyond their home markets, using the dollar as their international currency.
A rising USD exchange rate also makes it more expensive for banks to fund U.S. dollar lending outside the U.S., which could make it more difficult for companies to obtain USD finance for trade or investment. Conversely, when the USD exchange rate is falling, banks are more willing to lend dollars across borders, enabling international businesses to extend their supply chains and invest in new foreign ventures.
Additionally, when the dollar is strong, some companies may prefer to invest in USD-denominated assets rather than expanding international trade, whereas a falling USD exchange rate encourages companies to divest USD-denominated assets.
New Research Shows How USD Exchange Rates Affect Working Capital
In addition to the above, new research shows that one of the principal ways in which the dollar’s exchange rate movements affect international trade volumes is through credit conditions for working capital. This is different from the bank lending channel described above, since it concerns credit risk rather than dollar-funding costs.
BIS researchers explain how this works: “In the presence of currency mismatches on borrowers’ balance sheets, a weaker dollar flatters the balance sheet of dollar borrowers, whose liabilities fall relative to assets. From the standpoint of bank creditors, the stronger credit position of borrowers reduces tail risk in a diversified credit portfolio of dollar loans and creates spare lending capacity by relaxing the Value-at-Risk (VaR) constraint.”
To understand this, consider what the balance sheet of a Korean business importing goods from the U.S. looks like. It pays for goods in USD and in turn accepts payment for them in Korean won (KRW). To fund its purchases, it obtains working capital finance in USD, which is a short-term liability. And on the asset side of its balance sheet, it has cash and trade receivables in KRW. So its balance sheet has a currency mismatch. Import-export businesses often have currency mismatches of this kind.
When the USD exchange rate falls, the company’s USD-denominated working capital finance shrinks relative to its KRW-denominated assets. In accounting parlance, its debt-to-total-assets ratio has fallen. BIS researchers say that the lower debt-to-total-assets ratio improves the company’s creditworthiness from a bank’s point of view, and therefore enables the company to obtain more USD-denominated working capital finance. As a result, the company can expand its purchases and make more sales. So a falling USD exchange rate can increase global import-export trade by loosening working capital credit conditions for international businesses.
Conversely, if the USD dollar exchange rate rises, the Korean company’s USD-denominated working capital expands, its debt-to-total-assets ratio rises, and banks become less willing to lend it USD. A strong dollar is thus not only unhelpful to U.S. exporters, it can depress global trade volumes.
What Matters is the Broad Trade-Weighted USD Exchange Rate
Importantly, the researchers find that it is general movement in the USD exchange rate that matters (the broad trade-weighted dollar index), not bilateral exchange rates with individual countries. This is because if only one currency moves against the dollar, then companies affected by the movement can fund working capital in other currencies and swap into USD.
Further, the effect of changes in the broad USD exchange rate is significant. The researchers show that a one point increase in the broad dollar index is associated with a decline in the annual growth of accounts receivable by 0.28 percent, a decline in payables growth by 0.62 percent, and a decline in inventory growth by 0.40 percent.
Additional recent research suggests business investment declines when cross-border lending falls, because a rising USD broad exchange rate may wipe out any trade gains for exporters to the U.S.