The exchange market mechanism can be pretty confusing for a person who doesn’t have specialised knowledge in this area. The connection between the exchange rate of a currency and its trade deficit may seem like an undecipherable mystery. In order for you to understand the hidden mechanism of the exchange market and the trade deficit, we’ll discuss and explain the American-Canadian Trade and Exchange relationship.
The first thing you should know, in order for you to have an accurate idea of this matter, is that Canada is USA’s largest trading partner with 20% of the US foreign trade.
Whenever you are analysing a trade relationship between 2 countries, you should look at the exchange rate and international trade data. Make sure you are analysing the data concerning at least 2 years of trade, in order to draw the right conclusions. For instance, if you were to analyse the data for 2002 and 2003, you would notice that the CDN DOL column is displaying the number of Canadian Dollars that can be bought in exchange for one US Dollar. A bigger number on this column means that the US Dollar is appreciating; it gets stronger and can buy more Canadian Dollars. On the other hand, whenever the number is decreasing, it means that the US Dollar is depreciating, it gets weaker, and it can buy less Canadian Dollars.
You should also pay attention to the second column, named CDN DEF, which is displaying the amount of the trade balance between the United States of America and Canada. If you find only negative numbers in this column, you should know that this fact means that US is facing a trade deficit when it comes to its Canadian trade relationship. You should also keep in mind that the numbers in this column are usually expressed in millions of US Dollars.
A quick look on the data for 2002 and 2003 will instantly tell you that the US Dollar has depreciated quite fast compared to the Canadian Dollar. For instance, the data for October 2002 shows that 1.58 Canadian Dollars were bought for 1 US Dollars. But the data for October 2003 shows that 1.32 Canadian Dollars were bought for 1 US Dollars, meaning that the US Dollar’s strength has weakened.
Nevertheless you will notice that the trade balance remained the same over that period.
If you wonder about the connection between the exchange rate and the trade balance, well, here it is. The relationship between these two is quite simple: whenever the exchange rate goes up, the trade is going down, and the other way around. A positive number shows that the trade deficit increases when the exchange rate is going down.
In conclusion, whenever you analyse the relationship between the exchange rate and the trade balance, you will come across the numbers for the trade deficit. Always keep in mind that things aren’t as simple as they look, so, in order to reach an accurate conclusion, you have to analyse a lot more numbers than these.
Understanding how exchange rates work and how they affect Forex markets is essential if you're going to last as a Forex market trader. Exchange rates, Euros, dollars, yens, marks, francs,floating exchange rates, pips, points ? the whole concept of the exchange rate can be daunting for a beginner trader What the heck is an exchange rate?
The exchange rate refers to the relative worth of one type of currency against another. To make it simple, let's use an example with a simple exchange rate that everyone is familiar with ? the exchange rate of dollars to dimes. Suppose you have 10 one-dollar bills. You know that each of those dollar bills is worth 10 dimes. You could, if you wanted, go to the bank and exchange your 10-dollar bills for 100 dimes. The exchange rate would be expressed as DOL/DIM=.10 or DIM/DOL=10. In other words, you can exchange one dollar for 10 dimes or 10 dimes for one dollar.
This example can be expanded to include foreign currencies. Instead of dollars and dimes though you're dealing with Euros, yen, pounds and francs. EUR/USD=1.1023 means that each euro is worth $1.1023 (the fourth decimal point is used due to the large volume of trading). In reverse, that would be expressed as USD/EUR=.9071. In other words, if you want to trade US dollars for Euros, it will cost you $1,102.30 to get 1000 Euros.
Exchange rates do however move up and down and here's how that works. The dollars and dimes example can be used to illustrate the point. For example your local store has decided that it will now only accept payment in dimes. If you want to buy a loaf of bread your dollar bills are now worthless. In order to buy that loaf, you're going to have to find 17 dimes for your two dollars. What happens when there becomes a shortage of dimes. You find a source of dimes and you negotiate. You tell the person holding the dimes that you'll give them two dollars for 17 dimes. In doing so you've changed the currency exchange rate from DOL/DIM=.10 to DOL/DIM=.11. That means every dollar is now worth 11 dimes instead of ten ? and if you want to buy $100 worth of dimes, you'll get 90 dimes, not 100.
The same holds true for the international currency market. If you want to buy goods in Japan, you need to trade with Japanese money. If all you have is dollars, then you need to exchange your dollars for yen. If lots of people are trying to buy yen at the same time, then you're going to end up paying (exchanging) more dollars for less yen and the products that you're buying are going to cost you more.
When a country's economy is strong, people know that they'll make more money if they invest in businesses and products in that country. In order to buy products or invest money there, they need to exchange their currency for that country's currency. If there's a rumour that a major industry in that country is about to fail, people will want to get out ? and will start trading in their yen for dollars or Euros or Aussies ? whichever is the best exchange rate you can get.
It's all about supply and demand. There are a couple of other factors that influence exchange rates. One of those is the interest rate. When you hold currency, you earn interest in that country's currency at their prevailing rate. If the interest rate is higher for yen than for dollars, then people will trade in their dollars for yen in order to earn a higher rate. A second factor is the inflation rate. When the inflation rate in a country is high, people don't want to hold that country's currency since the value of the money is going down. Likewise, if the inflation rate is low, people are more likely to want the country's currency because the value isn't expected to go down.
One other important factor in the exchange rate is trade with other countries. If world prices for a country's exports go up in relation to their imports, they'll be making more on what they sell than they are spending for what they buy. You can see this most clearly in the price of oil. The US buys a large percentage of its oil from Canada. As the price of oil on the world market increases, the exchange rate of Canadian dollars to US dollars goes down ? Canadian dollars become more valuable because the Canadian economy is growing stronger.
Floating currency exchange rates are intricate. When you research the subject further you'll be able to better understand more in-depth writings on the subject.
Both Ispas Marin & David Mclauchlan are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
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