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The Impact of Currency Fluctuation on International Trade

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THE IMPACT OF CURRENCY
FLUCTUATION ON
INTERNATIONAL TRADE
Prof. John Huber
Zhejiang Normal University
December 9, 2019
 INTRODUCTION

The date is… December 9, 2019

You are living and working in China and planning a vacation to the United States one
year from now. You have already saved 10,000 CNY. Would you be better to keep
the money in CNY or convert it now to USD? How would you know which is
better?

(Ignore any conversion charges and interest rates)

1 US Dollar = 7.030 Chinese Yuan

1 Chinese Yuan = 0.142 US Dollar

2
USD TO CNY FOREC AST 2020, 2021, 2022, 2023

7.7

7.6

7.5

7.4

7.3

7.2

7.1

6.9

6.8

6.7
Dec 2019 Dec 2020 Dec 2021 Dec 2022 Dec 2023
3
USD TO CNY FOREC AST 2020, 2021, 2022, 2023

4
 CURRENCY FUTURE

December 9, 2019
10,000 CNY = 1,422.47 USD

If you converted the money today to USD, it would be worth 1,422.47 in one years
time; no change.

December 31, 2020

1 US Dollar = 7.125 Chinese Yuan
1 Chinese Yuan = 0.1403 US Dollar

If you kept the money as CNY, it would be worth less. 10,000 CNY would only be
worth $1,403.50 USD. A loss of $19.46 USD.

The change and impact in this example is minimal, however what if the scenario had
bigger shifts and much more money?
5
 IMPORT / EXPORT EXAMPLE

Let’s assume the following…

An importer of USA products into China. Demand for wine is high and they have
found enough buyers to justify importing a 20ft container. It’s June 2016 and they
have procured the wine at an average cost of $8.00 USD per bottle. The buyers are
willing to purchase each bottle for ¥72 CNY.

At the time of the deal with the American distributor, June 13, 2016, 1 US Dollar =
6.57129 CNY.

6
 IMPORT / EXPORT EXAMPLE

A 28% gross margin becomes the sales baseline.

7
 IMPORT / EXPORT EXAMPLE

It’s several months later and demand has once again returned for wine. The
importer contacts the seller and he maintains his average selling price of $8.00 per
bottle and the buyers also maintain their average buying price of ¥72 CNY. All
seems good.
It’s December 27, 2016 and the importer secures his deals. All seems good;
however, the exchange rate has changed. 1 US Dollar = 6.9457 CNY.
What impact will this have on the importer?

8
 IMPORT / EXPORT EXAMPLE

The depreciation in the USD results in a lower gross margin, 28% down to 23%.
9
 IMPORT / EXPORT EXAMPLE

It’s now 13 months later and demand. Within the first twelve months a total of
three shipments went out (6/6/2016, 12/27/16 & 5/13/17) went out. Currency has
been been depreciating and customers have refused to accept a price increase.

It’s time for the fourth shipment and the importer once again pushes for an increase
in prices but to no luck; maybe next time.

Not only have his margin eroded in the last two shipments, but the wine distributor
has now increased his price 5% or to $8.40).
It’s January 26, 2018 and the importer secures his deals, not wanting to lose the
business. He looks at the exchange rate and once again it has fluctuated, 1 US
Dollar = 6.3200 CNY.
What impact will this have on the importer?

10
 IMPORT / EXPORT EXAMPLE

Despite a fixed sales price and an increased purchase price of the wine, margins are
higher than on the first shipment. 11
 IMPORT / EXPORT EXAMPLE

Look at the historical data. This likely happened to many importers.

The distributers/retailers in China didn’t experience any changes in market,
therefore, in the short-term they would refuse to adjust their buying price.
Therefore, the importer had to absorb the currency change and decrease their
margin by 5% which equated

USD to CNY: December 2010 – December 2019

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 OVERVIEW ON CURRENCY FLUCTUATION

OVERVIEW
Most of the world's currencies are bought and sold based on flexible exchange
rates; their prices fluctuate based on the supply and demand in the foreign
exchange market.
A high demand for a currency or a shortage in its supply will cause an increase in
price.
A currency's supply and demand are tied to several intertwined factors including
the country's monetary policy, the rate of inflation, and political and economic
conditions.

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 OVERVIEW ON CURRENCY FLUCTUATION

MONETARY POLICY

Many central banks attempt to control the demand for currency by increasing or
decreasing the money supply and/or benchmark interest rates. With a low interest
rate, people and businesses are more willing and able to borrow money. As a
country's money supply increases and the currency becomes more available, the
price of borrowing the currency goes down. With a low interest rate, people and
businesses are more willing and able to borrow money. As they continually spend
this borrowed money, the economy grows. However, if there is too much money in
the economy and the supply of goods and services does not increase accordingly,
prices may begin to inflate
↑ LoansCountry = ↓ Interest RateCentral Bank = ↑ BorrowingPeople and Businesses =
↑ SpendingBorrowed Money = if ↑ Money Supply & → Goods and Services =
↑ Inflation = ↓ Currency Valuation
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 OVERVIEW ON CURRENCY FLUCTUATION

INFLATION

Inflation in the currency’s home country is a determining factor, as countries with

low inflation generally have money with greater purchasing power, and therefore a
rising value relative to other currencies. The inflation rate is the rate at which the
general price of goods and services are increasing. While a small amount of
inflation indicates a healthy economy, too much of an increase can cause economic
instability, which may ultimately lead to the currency's depreciation.

↓ Low InflationCountry = ↑ Purchasing PowerCountry = ↑ Currency Exchange Rate

↑ High inflationCountry = ↓ Purchasing PowerCountry = ↓ Currency Exchange Rate

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 OVERVIEW ON CURRENCY FLUCTUATION

COUNTRY’S BUDGET
Countries that borrow to fund infrastructure projects, military spending and other
expensive efforts must also contend with a lower value for their currency. Currency
from these countries is in less demand because of the greater chance for default,
higher inflation from adding to the money supply, and more. Firms must be vigilant of
the economic sentiment in the countries that they’re headquartered in, but also
those with which they conduct business.

↑ Infrastructure Projects ↑ Risk of Default

= ↑ BorrowingCountry =
↑ Military Spending ↑ InflationMoney Supply

= ↓ Currency Valuation

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 OVERVIEW ON CURRENCY FLUCTUATION

THE ECONOMIC AND POLITICAL CONDITIONS OF A COUNTRY

↑ Interest Rates Predictability

↑ Political Stability = of = ↑ Currency Valuation
↑ Economic Soundness Investment

↑ GDP
Strong and
↓ Unemployment Rate = = ↑ Currency Valuation
Growing
↑ Housing Starts
Economy
↑ Trade Balance

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 CURRENCY FLUCTUATION IMPACT ON TRADE

FLUCTUATIONS IN CURRENCY HAVE A BROAD IMPACT

Consumers
Market Competition
Investments
Businesses
Interest Rates
The Economy

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 THE IMPACT ON CONSUMERS

CONSUMERS
When a currency starts losing value and becomes weaker, imports become more expensive,
and basically, everything sees a surge in prices.
That extra cost is paid for by the consumer, and that always has a seriously bad effect on
international trade. When your morning coffee is a dollar more expensive overnight, you’ll
start drinking it fewer times throughout the week, and the coffee shop will begin importing
less because they are not selling as much.
So, when there are currency fluctuations, they will become more expensive, and the supply-
demand balance is distorted because people simply will buy less. Nobody wants to pay extra
money for a service they got cheaper not too long ago, and this jeopardizes international
trade on several fronts.

↓ Currency Valuation = ↑ Raw MaterialsImports = ↑PricesConsumer

↑ Currency Valuation = ↓ Raw MaterialsImports = ↑ProfitsBusinesses = → PricesConsumer
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 THE IMPACT ON MARKET COMPETITION

MARKET COMPETITION

If your country’s currency becomes stronger for quite a while, a state of saturation starts to
spread. The markets become dormant, and people aren’t as competitive, and this damages
international trade and internal economies alike because trade just slows down.
On the other hand, if the currency goes the other way and is weakened, investors start
showing up –– because it’d be cheaper for them to invest at this very moment –– and they
start pumping money into the economy. While that is a good thing, leaving the economy in the
hands of big investors is never a good idea and rarely ends well for international trade.

↑ Currency Valuation = ↑ SaturationMarket = ↓ Competition

↓ Currency Valuation = ↑ Foreign Investment = ↑ PowerInvestors

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 THE IMPACT ON INVESTMENTS

INVESTMENTS
Another huge hiccup associated with currency fluctuations is related to investments. It is a
rule of thumb that having a stable currency is a key factor for any investor wanting to invest
in a place. Countries that don’t have that are at risk and no investor would invest in a place
where the conversion from British pounds to said currency is different today than it was
throughout the entire week before.
They need to see that that country provides a safe environment for investment, and if they
don’t find that, they simply won’t invest. No investors want to pay a lot of money only to find
their investment is short-lived because the country’s currency is volatile, which could cause
them enormous losses. When you consider that factor, international trade is suddenly halted
by such fluctuations, and buyers and sellers alike are incredibly cautious.

→ Currency Valuation = ↑ InvestmentsForeign

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 THE IMPACT ON BUSINESSES

BUSINESSES
It’s a safe assumption that any big company has global ties, and they often import and export
products from all over the world, no matter how big or small. This is naturally severely
damaged by currency fluctuations because it becomes more expensive for a company to buy
the things it needs from abroad, and the same applies to whichever companies importing
from them.
It’s a chain reaction that has a domino effect on all involved in international relations. It is not
just about imports and exports, though. A business’s profits decrease because of a currency
weakening, and it even pays more money for its domestic expenses.
A company that uses trucks to move its products will have to pay more gas money because
the cost of fuel went up. Smaller businesses even have it worse because they don’t have the
necessary resources to deal with such complications.

↑ ↓ Currency Valuation = ↑ ↓ Importsraw materials / ExportsFinished Goods =

↑ ↓ Profit / Loss
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 THE IMPACT ON INTEREST RATES

INTEREST RATES
The central banks of a country enforce their financial policies based on the condition of the
local currency. This can lead to increased or decreased interest rates depending on the
condition of the currency in international markets.
It goes without saying that an increased interest rate slows down international trade because
it affects lending policies. An investor won’t come to a country and borrow money from
banks at an increased interest rate because they’d be losing money instead of making it.

↑ Interest Rates = ↓ International Trade = ↓ Foreign Investment

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 THE IMPACT ON THE ECONOMY

THE ECONOMY
Sometimes, currency fluctuations can actually have a good impact on a country’s economy.
When a currency is weak, it means imports become more expensive, and countries don’t buy
as many products from abroad as they usually do, because they can’t afford it. This might seem
like a bad thing, but it actually isn’t.
Think of it this way; if the country’s currency is strong, it will import a lot more than it
exports. This halts its own economy and creates a trade deficit, and damages a nation’s
economy in the long run.
When the currency is weak, local markets become active and more competitive, though there
is the problem of inflation on the other hand and the complications that arise with it, which
will make it extremely difficult to import even the basic necessities you can’t produce.

↓ Currency Valuation = ↓ Imports = ↑ Exports

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 SOURCES

Slides 12-13
Why Do Currencies Fluctuate?
xe.com, Accessed December 9, 2019
https://www.xe.com/moneytransfertips/why-do-currencies-fluctuate.php

Slides 14
Why Currencies Fluctuate and How It Affects Businesses
currencytransfer.com, May 1, 2018
https://www.currencytransfer.com/blog/expert-analysis/why-currencies-fluctuate

Slides 18 - 23
Currency Fluctuations And Its Impact On International Trade
Russell Campbell, November 2019
https://bitrebels.com/business/currency-fluctuations-impact-international-trade/

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