FX International Payments
By Frances Coppola
The dollar’s rise reflects the weakness of some U.S. trading partners. The European Central Bank (ECB) has cut rates to historic lows and is also doing QE, yet growth remains low, investment subdued and unemployment elevated in much of the Eurozone.3 So although sterling remained stable – with a U.S. dollar exchange rate of US$1.237 on U.S. election day and ending 2016 at $1.2344 – the euro, however, fell from US$1.101 to end the year at US$1.052.5
Meanwhile, falling oil and commodity prices have caused sharp currency depreciations in many developing countries. China, for example, has seen its currency weaken against the dollar as its economy slows: despite belief in some quarters that China depresses the yuan to benefit its own exporters,6 since 2014 it has, if anything, been propping up the yuan,7 selling off its U.S. dollar reserves8 and tightening capital controls.9
But there is a bigger issue too – the implications of the strong dollar for the web of financial relationships around the world that facilitate global trade.
The rising U.S. dollar exchange rate indicates that there is a global shortage of dollars. When the supply of a good or a service is insufficient to meet demand, its price rises. Currencies are no exception: when there is insufficient supply of a currency to meet demand, its exchange rate rises.10
The U.S. dollar is the world’s premier currency for international trade and investment.11 More trade is done in U.S. dollars than any other currency. More trade finance is issued in U.S. dollars than in any other currency. More business investment is financed in U.S. dollars than in any other currency. The world relies on dollars to lubricate the flow of goods and services around the world. So, when there is a shortage of U.S. dollars, global financial flows slow, and this restricts global trade activity; some places may even experience complete blockages.
The underlying cause of the slowdown in global financial flows associated with a strong dollar is restricted bank lending. As Hyung Song Shin of the Bank for International Settlements (BIS) explains, when the world experiences a shortage of dollars (indicated by a rising dollar exchange rate against all currencies), banks become reluctant to lend dollars across borders:
Crucially, the financial channel of exchange rate fluctuations often operates in the opposite direction relative to the net exports channel. For net exports, it is when the domestic currency depreciates that real economic activity picks up. By contrast, the financial channel operates through the liabilities side of the balance sheet of borrowers, so that it is when the domestic currency appreciates that balance sheets strengthen and economic activity picks up. The impact of exchange rates is back-to-front compared with the textbook stories.12
This means that businesses in countries whose domestic currencies are falling versus the dollar can find it difficult to borrow the dollars they need to finance their international trade. The result can be a sharp fall in import-export trade, particularly involving developing countries (whose currencies tend to be more volatile in relation to the dollar), and a consequent decline in global trade.
It’s tempting to regard a rising U.S. dollar exchange rate as unconditionally positive. For Americans, it shows the strength of the U.S. economy. For everyone else, the strong dollar puts the U.S. firmly back in place as “buyer of last resort.” But there also are concerns. Perhaps most importantly, by shrinking dollar lending across borders the strong dollar acts as a drag on global trade. For all these reasons, businesses everywhere may benefit most from a moderation of the dollar’s rise in 2017.
With 17 years’ experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.
1. “Will the dollar rise or fall on a Trump victory?”,The Economist http://www.economist.com/blogs/buttonwood/2016/11/currencies .
2. “Dollar rises after Trump clinches victory”, CNBC http://www.cnbc.com/2016/11/08/forex-news-mexican-peso-dollar-japanese-yen-swiss-franc-in-focus-as-us-election-unfolds.html .
3. Euro area economic forecast November 2016OECD;http://www.oecd.org/eco/outlook/economic-forecast-summary-euro-area-oecd-economic-outlook-november-2016.pdf
4. “XE Currency Charts: GBP to USD”, XE.com; http://www.xe.com/currencycharts/?from=GBP&to=USD&view=1Y
5. XE Currency Charts: GBP to USD,XE.com; http://www.xe.com/currencycharts/?from=EUR&to=USD&view=1Y
6. “Trump’s Chinese currency manipulation”The Wall Street Journal; http://www.wsj.com/articles/trumps-chinese-currency-manipulation-1481155139
7. “China’s yuan devaluation and its impact on global exchange rates and businesses”American Express FXIP Blog; https://www.americanexpress.com/au/foreign-exchange/articles/china-yuan-devaluation-the-impact-on-exchange-rates/
8. “China’s central bank steps in to prop up yuan”The Wall Street Journal; http://www.wsj.com/articles/chinas-central-bank-steps-in-to-prop-up-yuan-1451976779
9. “China bolsters capital controls ahead of Trump presidency”Voice of America; http://www.voanews.com/a/china-bolsters-capital-controls-ahead-of-trump-presidency/3626525.html
10. “Understanding the Relationship Between Inflation and Foreign Exchange Rates”American Express FXIP Blog; https://www.americanexpress.com/us/foreign-exchange/articles/inflation-and-foreign-exchange-rates/
11. “Why the Dollar Is the Global Currency”,The Balance; https://www.thebalance.com/world-currency-3305931
12. “The bank/capital markets nexus goes global”Bank for International Settlements; https://www.bis.org/speeches/sp161115.pdf