The U.S. dollar turned higher this week after the U.S. Federal Reserve cut interest rates and surprised markets by not signaling its intentions for future rate reductions. We have been talking about how the U.S. dollar's strength is becoming a factor both good and ill in company earnings, capital flows, and so forth. Earlier this year, Hyun Song Shin, economic adviser and research head at the Bank of International Settlements, owned by 60 central banks, offered an interesting take on U.S. dollar strength and how it affects international trade in a speech to European finance experts.
Shin's research includes looking at exports as a percentage of gross domestic product to create a proxy of global trade activity. Cross referencing this to the value of the dollar reveals a stark inverse relationship – the stronger the U.S. dollar, the less global trade in the world and vice-versa. This is an interesting observation in many ways. It is easy for U.S. exporters to blame their performance problems on a strong dollar and the rest of the world trying to take advantage with their relatively weak currencies to gain international market share.
But why does the strength of the U.S. dollar affect global trading as a whole? It speaks to the central role of the dollar in international transactions. Yes, the dollar is the world's reserve currency, but it is also the currency of a lot of trading relationships. China is the most prevalent example of how this works. Invoicing of intermediate goods in China, and Asia as a whole, still tends to be in U.S. dollars. This is partly due to convenience with past practice and that intermediate goods producers crave U.S. dollars to buy raw materials.
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