A Weak Dollar Is Not Necessarily Good for Trade

Last updated 2/9/2010 9:29 AM ET (GMT -5) 8 Comments

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Kathy Lien

Director of Currency Research, GFT

Although the global economic calendar is relatively lightthis week, trade is one of the primary focuses. This morning, Germany and the U.K. released their trade numbersand we learned that while the trade surplus in Germany increased, the tradedeficit in the U.K. rose. OnWednesday, the U.S. and Canada will release a report on their latest tradeconditions and based upon the market’s forecasts, economists are looking for thetrade deficits of both countries to shrink.

With so many countries releasing trade numbers this week, wethought it would be interesting to look at how trade balances of various countriescompare. On the most fundamentallevel, currencies move on supply and demand and there is no greater demand forcurrencies than for import and export transactions. If we lived in a world where there was no speculationand currencies only moved based upon import and export transactions, then thecountries with the largest surpluses would see a natural demand by importers tobuy their currencies. Thecurrencies of countries running large trade deficits on the other hand wouldnormally face selling pressure. Yet in reality trade volumes are not the only factors drivingcurrencies. Of the 8 majoreconomies that we follow, the U.S. has the largest deficit, while the Eurozoneand Japan have the largest trade surpluses.

Is a weak dollar goodor bad for trade?

One of the biggest misnomers in the forex markets is that aweak dollar tends to narrow the trade deficit because it encouragesexports. As you can see from thechart below, over the past few years, the U.S. trade deficit has increased eventhough the dollar has fallen. Although this could be partially attributed to the global recessionsapping demand, our chart goes back to 2000 and it is quite clear that thedollar index and the U.S. trade balance actually had a positive and notnegative correlation during this span of time. In other words, the trade deficit increased as the dollarweakened. This relationship stillholds with the rise in the dollar in 2008 coinciding with a sharp improvementin trade. Based upon this correlation, the recent strength in the dollar actuallypoints to a narrow trade balance report tomorrow.

Comments (8)

jetboat

February 09, 2010 at 06:40 PM ET

This is interesting since a weak dollar puts US goods on sale in foreign markets and encourages tourism. What other factors may be working here? Was this relationship true during the 80's and 90's?

Oyster

February 09, 2010 at 10:09 PM ET

Interesting. Thanks.

alexjbrandt

February 10, 2010 at 12:28 AM ET

I think the reason for a positive correlation between the US trade deficeit and dollar strength/weakness can be attributed to the fact that commodities are priced in dollars and we import a lot of the oil we use.

schultzz.at

February 10, 2010 at 02:53 AM ET

The quantity of imported energy-related petroleum products is on a downtrend standing at 314M barrel in November 2009 down from 423M in January 2008.

I think the effect of foreign exchange value fluctuations on trade is overestimated by politicians. The euro was on a steady uptrend versus other major currencies between 2002 and 2008. At the same time German exports were increasing. But this was mainly a reflection of productivity gains and the high quality of German capital goods.

The effects of exchange rate fluctuations may be more visible in tourism and easily substitutable consumer goods.
Tom Schultz.

Oyster

February 11, 2010 at 07:48 AM ET

Thanks, Tom.

Oyster

February 10, 2010 at 08:56 AM ET

Manufacturing PMI (dec) ^, factory orders (dec) ^, durable goods ex transport (dec) ^, plus the positive correlation between strength of dollar and trade, BUT the actual trade deficit widened in dec. Hope someone(including Kathy) could shed some light. Thanks.

schultzz.at

February 10, 2010 at 09:22 AM ET

Looking at the details of the report the value of imported petroleum related products was 25.55B up from 22.97B in November. The quantity was at 348M barrel versus 314M barrel and the average price of crude was up marginally from 72.54 to 73.20.
The energy deficit explains the large part of the deficit increase. There was also an increase in the motor vehicle deficit. The surplus in capital goods increased marginally.
Tom Schultz.

alexjbrandt

February 10, 2010 at 09:25 AM ET

This isn't really relevant to the topic, but looks like China military leaders are urging the political leaders to start a economic warfare with the US:

http://www.reuters.com/article/idUSTRE6183KG20100209

I say bring it, we can buy products from another developing nation such as India, who would probably be glad to get our business.

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.