Exchange Rates and the Working Capital Channel of Trade Fluctuations

9 Pages Posted: 31 Jan 2018

See all articles by Valentina Bruno

Valentina Bruno

American University - Department of Finance and Real Estate

Se-Jik Kim

Seoul National University - School of Economics

Hyun Song Shin

Bank for International Settlements (BIS)

Date Written: January 2018

Abstract

Focus Our paper provides a fresh take on the way the US dollar exchange rate influences the volume of global trade. We take as our starting point the substantial financing needs of the long supply chains, or global value chains (GVCs), that underpin trade in manufactured goods. These financial needs make GVCs susceptible to fluctuations in the supply of dollar-denominated trade credit. As a stronger dollar goes hand-in-hand with tighter dollar credit supply, the impact of a strong dollar can run counter to the traditional understanding of the impact of exchange rates on trade.

Contribution Our paper is one of a number of new approaches to international trade that tackle the puzzle of why the dollar exchange rate affects global trade volumes. Our paper is distinctive in basing the explanation on the working capital demands of GVCs. We build on previous work showing that, when firms depend more on external financing, their inventories fall more sharply when credit supply dries up. We extend this by taking a global view and considering the prevalence of dollar invoicing in global trade, based on data from more than 2,000 companies. Globally, about 80% of trade finance is denominated in dollars.

Findings We find that a stronger dollar heralds tighter credit conditions and thus dampens GVC activity. As a result, a country's exports may fall when its currency depreciates against the dollar. This runs counter to the conventional view that a weaker currency helps exporters by making their goods comparatively cheaper for overseas consumers. The paradoxical results undermine arguments that tighter trade and investment links can be forged without any need for increased financial openness. Real and financial globalisation go hand in hand.

Keywords: global value chains, dollar invoicing, global liquidity

JEL Classification: F36, F41, G20

Suggested Citation

Bruno, Valentina Giulia and Kim, Se-Jik and Shin, Hyun Song, Exchange Rates and the Working Capital Channel of Trade Fluctuations (January 2018). BIS Working Paper No. 694. Available at SSRN: https://ssrn.com/abstract=3109769

Valentina Giulia Bruno (Contact Author)

American University - Department of Finance and Real Estate ( email )

Kogod School of Business
4400 Massachusetts Ave., N.W.
Washington, DC 20016-8044
United States

HOME PAGE: http://www.american.edu/kogod/faculty/bruno.cfm

Se-Jik Kim

Seoul National University - School of Economics ( email )

San 56-1, Silim-dong, Kwanak-ku
Seoul 151-742

Hyun Song Shin

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://www.bis.org/author/hyun_song_shin.htm

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