We study the impact of foreign trade balances and protectionism on exchange rates
Donald Trump will go down in history not only as of the 45th president of the United States but also as a person who decided to change the world order. Over the years, the export-oriented eurozone and China have been building foreign trade surpluses, while the United States, by contrast, has been expanding its negative trade balance. The leading economy of the currency bloc represented by Germany received preferences due to a weaker euro compared to the previously used brand. Due to the orientation of the economy on investment rather than consumption, as in developed countries, China could afford to create industries that work on foreign markets. The United States has been facing a foreign trade deficit for many years, and Donald Trump did not like it.
The balance of trade since the beginning of the functioning of Forex was considered an important factor influencing exchange rates. It represents the difference between exported and imported goods and in the most simplified form reflects the supply and demand for the national currency. Exporters receive foreign exchange earnings, sell it and, thus, generate demand. Importers, on the contrary, need foreign currency, they are behind the supply. Until the moment when non-residents did not buy domestic securities and residents did not buy foreign shares and bonds, the trade balance was a key factor in the exchange rate formation. Subsequently, the monetary policy of central banks and economic growth took on this role.
The trade balance can be compared with the income and expenses of a particular family or person. If they spend more than they earn, then they are forced to get into loans. On the contrary, if household incomes exceed expenses, there is an opportunity to increase savings. In this regard, the life of the United States in a big way is not so bad. They can allow it as long as other countries lend to them. That is, they buy US Treasury bonds.
How is Trump going to change the world order? With the help of import duties! They make deliveries to the American market from abroad more expensive and force consumers to refuse them and pay attention to domestic counterparts. The problem is that other states, in response, introduce or raise their own tariffs. In addition, they can devalue the national currency, which will allow exports to level the factor of import duties.
How do traders win back the trade war factor? There is no consensus on this. Someone thinks that tension makes investors run to the dollar. Someone, on the contrary, draws historical parallels with the 1990s and 2000s, when the greenback weakened against competitors under similar conditions. In my opinion, one must proceed from the degree of impact of trade conflicts on economic growth. As a rule, duties slow it down. It can be especially painful for export-oriented economies. Thus, the truce in the US-EU trade war should be regarded as a “bullish” factor for EUR / USD, and the escalation of the conflict as a “bearish” one.