Foreign Exchange

For businesses or governments that trade billions of dollars, even small changes in the exchange rate become significant.

When the United States dollar (symbol: USD) becomes stronger, then foreign goods and services become cheaper, and goods and services from the United States will become more expensive. Consequently, imports to the United States will increase and exports will decrease.

When the dollar becomes weaker with respect to other currencies, then the opposite happens: goods and services from the United States become cheaper, thereby increasing exports, and foreign goods and services will become more expensive, thereby lessening imports.

Thus, the trade balance of any country is largely determined by the value of the domestic currency in relation to other currencies.

It would seem logical that if the dollar, for instance, weakens, the U.S. trade balance will improve, as exports would rise and imports would decrease. However, the U.S. trade balance usually worsens for a few months.

Most import/export orders are taken months in advance. Immediately after a currency’s value drops, the volume of imports remains about the same, but the prices in terms of the home currency rise. On the other hand, the value of the domestic exports remains the same, and the difference in values worsens the trade balance until the imports and exports adjust to the new exchange rates. This can be represented graphically by the J-Curve: