Factors Effecting Currencies - Balance of trade and investment

According to many analysts the balance of trade and investment is acknowledged as the most important influences on the value of the dollar, with good reason. The balance of trade, or also known as a current account, represents the difference between what the US exports and imports in terms of goods and services.

On the contrary, the balance of investment, or financial account, represents the difference in exports and imports, but in terms of the capital. In case of the exports exceeding imports, in either current or financial accounts, it is called a surplus. In many cases, a trade or investment surplus helps to strengthen a country’s currency relative to other currencies, affecting currency exchange rates;

The opposite of a surplus is a deficit, which occurs when a country imports more than it exports. The deficit typically has the opposite effect on currency exchange rates. When imports exceed exports, a country’s currency demand is falling. Lower demand for currency makes it less valuable in the international markets.

The points below elaborate on how the current account and financial account affect the USD:

Balance of trade

As we explained above, the current account balance is equal to the difference between exports and imports in terms of goods and services. Over the past years, the US has been running a trade deficit just like the rest of the world. The trade deficit is making foreign investors increasingly nervous and can affect the dollar substantially.

Falling prices on foreign goods

In case of decreasing prices on foreign goods, they become more attractive to American consumers, creating a larger trade deficit. Conversely, a rise in the prices of foreign goods can make American goods look more appealing and help to reduce the trade deficit.

Balance of investment

When the US imports more that it exports, it prompts foreign investors to buy US assets to keep the dollar from falling. In a simple word, if the US imports more than it exports, foreign investors must buy dollar- denominated assets like bonds or treasury securities in order to counterbalance the difference.

By Adil Maidanov | 9 October 2020

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