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What Is the Relationship between Exchange Rate and International Trade?

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  • Written By: Esther Ejim
  • Edited By: Kaci Lane Hindman
  • Last Modified Date: 29 August 2016
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The main relationship between exchange rate and international trade is the manner in which fluctuations in exchange rates affect the value of imports and exports. When it comes to exchange rate and international trade, a weak currency may affect the type of goods as well as the quantity of goods that one country may be able to purchase. Such a disparity in exchange rate and international trade may also lead to a condition where there is a trade imbalance between two trading partners.

An analysis of the relationship between exchange rate and international trade can be done on the national or governmental level, or it may be seen from an individual perspective. On the national level, a country with a weaker currency is at a disadvantage when trading with a country with a much stronger currency. This is due to the fact that the country with the weaker currency will not be able to attach the same value and satisfaction to the goods that it is able to purchase based on the exchange rate.

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When a country is exporting a product, it may find out that a weaker currency will be to its advantage. Selling its goods on the international market will net more money in terms of local currency due to the fact that the local currency is weaker than the foreign one. This also works for individuals. For instance, if a businessman’s currency sells for 100 to a dollar as opposed to a previous 50 to a dollar, this means that he can sell the goods for the usual dollar amount and make twice as much money in terms of the local currency based on the change in the exchange rate.

The problem would be that when the businessman tries to import products he would have to spend twice as much to buy the stronger foreign currency in order to facilitate the trade. This means that there is trade imbalance between the two countries in which the country with the stronger currency has the monetary advantage. The imbalance is due to a disproportionate variation in the exchange rates of the currencies of both countries.

In economic terms, any form of depreciation or appreciation that occurs in the exchange rate of a country directly affects the trade balance between that country and its trade balance. Thus, depending on whether the exchange rate depreciates or appreciates, the trade balance may change to the detriment or to the gain of the country in relation to trading with other countries. Such factors also affect the competitiveness of a country in international trade. Some countries purposefully devalue their currency so as to improve the benefits of trading with countries that have stronger currencies. Devaluation increases the value of exports by making them cheaper while making imports expensive.

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ddljohn
Post 3

@SarahGen-- I'm not an economist but I think that a company would like to do business in a country that has a currency that is less valuable and also stable.

But stability in exchange rates really isn't possible. Exchange rates will always be volatile and unpredictable. It's true that if exchange rates go up, the company's transaction costs will go up too. But it's possible for exchange rates to decrease and profit the company. So it's like a gamble that companies who trade internationally engage in often.

SarahGen
Post 2

@literally45-- So is it better to trade with a country whose currency is less valuable than ours? Or is it better to trade with a country whose currency is valuable but very stable?

literally45
Post 1

Fluctuating exchange rates is one of the major reasons why companies are reluctant to do international trade. Only the well established companies are able to take this risk. If a smaller company starts trading with another country and the value of that country's currency suddenly goes up, the company will lose a lot of money. So it's a big risk and an important factor to consider.

If exchange rates were equal and stable across the globe, people would be trading non-stop.

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