Understanding Exchange Rates and Their Impact on Global Trade
Understanding Exchange Rates
Exchange rates: The price of one currency in terms of another currency.
How Exchange Rates Affect International Trade
An increase in the exchange rate of the Euro against a foreign currency would appreciate the Euro. This makes imports cheaper but exports more expensive, potentially destabilizing the current account.
Conversely, if the Euro depreciates, exports become cheaper, potentially increasing export volume. However, imports become more expensive. This effect is influenced by price elasticity. For instance, if a country is energy-dependent, it will buy the same amount of oil and gas but at a higher cost. Similarly, if exports have low elasticity, a price reduction may not significantly boost demand.
Factors Influencing Exchange Rate Movements
Market Forces
Currency prices are driven by market forces. If a currency is in high demand, for example, due to strong demand for a country’s products, its price will increase, assuming the money supply remains constant. Conversely, if investors decide to sell assets denominated in a particular currency, this can lead to its depreciation.
Central Bank Interventions
Central banks possess tools to influence exchange rates. They can buy their own currency or sell foreign currency. Modifying interest rates is another key tool.
Interest Rates and Currency Value
Interest rates represent the price of money, often reflected in the yield of bonds. Increasing interest rates makes bonds more attractive, drawing capital into these investments and reducing the amount of money circulating in the broader economy.
While primarily used to control inflation, higher interest rates also have external consequences. They attract foreign investors seeking higher returns, increasing demand for the domestic currency and thus appreciating it. Conversely, lower interest rates can lead to currency depreciation.
Public Spending and Currency Appreciation
An increase in public spending can stimulate the economy, leading to higher demand and a greater need for money. If the central bank does not increase the money supply to match this demand, the price of money (the exchange rate) increases, leading to currency appreciation.
The Impact of Oil Prices
Oil and World Trade
Oil prices significantly affect world trade and the global economy, particularly through transportation costs. Rising oil prices increase these costs, impacting businesses and consumers.
Falling oil prices can boost real household incomes, leading to increased consumer spending. This occurs because overall consumer prices may fall, and real wages can rise as demand for labor increases in expanding sectors. Government tax revenues also tend to rise due to increased economic activity, often offsetting declines in revenue from the oil and gas sector. A drop in oil prices can also help narrow a country’s trade deficit.
Reasons for Falling Oil Prices
- Fracking becoming profitable at lower price points ($70-$100).
- Advancements in electric vehicles and energy-efficient technologies.
- Producers lowering barrel prices to discourage the above factors.
Geopolitical Factors in Oil Markets
Saudi Arabia, a major oil exporter and historical ally of the US, has benefited from American protection. Shifts in US foreign policy could alter this dynamic. Saudi Arabia’s interests in maintaining oil prices may not align with countries like Venezuela or Ecuador, and geopolitical tensions with nations like Iran add further complexity to the global oil market.