How foreign trade and protectionism affect exchange rates

Donald Trump will be recorded in history not only as the 45th president of the USA, but as a man who decided to change the world order. Over many years, export-led Euro-area and China had been increasing their foreign trade surplus, while the USA, on the contrary, was expanding its foreign trade deficit. The leading currency block’s economy, Germany, profited from using euro, weaker than the previously used deutsche mark. China was ahead because its economy is focused on investments, rather than on consumption, unlike in the developed countries; so it could afford to establish productions, working for the foreign markets. The USA had been facing foreign trade deficit for many years, and Donald Trump didn’t like it.

Dynamics of the euro-area balance of trade

Source: Trading Economics

Since Forex started, trade balance has been thought a very significant factor, affecting exchange rates. It is the difference in the amount of exports and imports and, in the simplest formulation, shows a demand and offer for a local currency. Exporters get foreign-currency earnings, sell it, and so, generate a demand. Importers, on the contrary, need foreign-currency, and so, they provide offer. Until foreigners started buying a country's securities, and its residents – buying foreign stocks and bonds, balance of trade had been the key factor of Forex pricing. Later, it was replaced by the central banks’ monetary policies and economies expansion.

A balance of trade can be compared to the income and spending of a family or a person. If they spend more than earn, they have to borrow money. On the contrary, if a household's income is more than spending, there is an opportunity to increase the capital. In this respect, the USA living beyond its means is not that bad. It can afford it as long as other countries lend it money. That is, foreigners buy the U.S. Treasury bonds.

Dynamics of the U.S. balance of trade

Source: Trading Economics

How is Trump going to change the world order? By means of import tariffs! Tariffs turn the imported products to be more expensive in the U.S. markets and make U.S. consumers buy domestic products instead of foreign ones. The matter is that other countries retaliate with new tariffs or increase the current ones. In addition, they can devalue their local currencies, which allows the export compensate the factor of import duties.

How traders should treat the factor of trade war? There is no single view in this respect. Someone believes that the trade war tensions make investors buy dollar. Others, on the contrary, draw historical parallels to the 1990s and the 2000s, when dollar was getting weaker against its rivals in the same situation. I think, we should be based on the influence of trade conflicts on economic growth. As a rule, tariffs result in a decline in the economy expansion. It may be especially harmful for the export-led economies. So, the U.S.-EU trade truce should be seen as a bullish factor for the EURUSD, and the conflict escalation – as a bearish one.

 

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Price chart of EURUSD in real time mode

Trade Wars Change the Playing Field

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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