Impact of Strong Dollar on Global Trade Recovery

What impact does a strong US dollar have on global exporters? Is it a driving force or a hindrance to the recovery of global trade?

According to the latest readings from the Trade Tracker, which monitors the health of world trade, a strong US dollar may "cast a shadow" over the recovery of global trade. Three key indicators of this trade tracker remain in the "below normal" range, including the contraction of new export orders for US companies.

The only index in the tracker that is above normal is the cargo flow at the Port of Los Angeles, the largest maritime trade gateway in the United States. This port has been very busy this year, with about three-quarters of the total loaded container volume being import containers.

According to the latest forecast from the Organisation for Economic Co-operation and Development (OECD), global trade is expected to grow by 2.3% this year, slower than the overall expected growth of the global economy at 3.1%.

Looking ahead, the Oxford Economics Institute believes in its latest report that "the strength of the US dollar may continue from this year to 2025, and then weaken in 2026. The relatively strong economic growth of the United States, favorable interest rate differentials, and structural improvements in the US balance of payments are all favorable factors for the US dollar."

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Senior economist at the Oxford Economics Institute, Adam Slater, told First Financial Journalists that both short-term cyclical factors and long-term structural factors are beneficial to the US dollar. "The growth differential between the United States and other economies in the G7 has been high recently. The interest rate differential between short-term and long-term rates is favorable to the US dollar, and the transformation of the United States into a net exporter of energy and strong foreign direct investment have also been helpful," he said.

Exporters are also importers

In simple terms, a strong US dollar helps to reduce the prices of imported goods in the United States, while increasing the overseas shipping costs for the United States.

For economies struggling with inflation, the weak local currency has raised import costs against the backdrop of already high global crude oil, food, and logistics prices. Even exporters who would typically rejoice at a strong US dollar are starting to feel the pain.

Several international trade experts interviewed warned that exporters are also importers.Price pressures are permeating factories globally. Jingyi Pan, Deputy Director of Economics at S&P Global Market Intelligence, stated that in places where average input costs have increased, manufacturers often cite unfavorable exchange rates as one of the reasons, such as in Japan. According to surveys of purchasing managers, the global input cost inflation rate in April reached a 14-month high.

As the US dollar continues to strengthen amid diminishing expectations for interest rate cuts in the country, concerns over the weakness of local currencies are deepening in some Asian nations. Exporters have historically welcomed weak currencies, but when rapid, unexpected devaluation leads to increased costs and complicates business planning for all companies, worries arise.

Japanese companies have expressed unusual unease about the weakness of the yen, even though their profits have increased in the short term. The yen, which is at a thirty-year low, may affect other parts of their supply chains in the future.

In South Korea, after the won depreciated by 5% against the US dollar this year, importing raw materials has become more expensive, and South Korean exporters typically benefit from a competitive exchange rate.

As a global exporter and a key participant in the technology supply chain, South Korea's exports largely rely on raw material imports, and with the weakening won, these imports are becoming increasingly expensive. The growing trend of offshore outsourcing means that US dollar earnings are not necessarily all repatriated.

The pain is particularly severe for small and medium-sized enterprises (SMEs) that are unwilling to hedge their currency exposure but still rely on overseas materials. Lee Eui-hyun, CEO of Seoul-based steel company Dae-il Special Steel, is reported to have said that the current weak exchange rate forces companies to pay for more expensive imported products while also facing price-cutting pressures from competitors.

Previously, in mid-April, the won broke through the 1400 mark, a level not seen since the end of 2022.

Cho Gyeong Lyeob, a senior researcher at the Korea Economic Research Institute, stated that conglomerates borrowing abroad to expand facilities, as well as steel, chemical, energy importers, and airlines, are particularly affected. He also said that the negative impacts of the won's weakness outweigh the positive ones.

Although South Korea's exports have maintained growth momentum in recent months, thanks to record demand from the United States, South Korea's exports in April increased by nearly 14% year-on-year. Last month, the finance ministers of the US, Japan, and South Korea issued a joint statement in Washington on the significant decline of the won and yen, with South Korea expressing concern over the won's weakness.

It should also be noted that any competitive advantage South Korea might have due to the won's weakness in markets competing with other Asian countries can be easily undermined, as these countries are continuously climbing the supply chain ladder. This situation is particularly worrying for companies lacking financial hedging tools against currency fluctuations. In a survey conducted by the Korea Federation of Small and Medium Business last August, about 49% of small and medium-sized exporters indicated that they do not have a specific contingency plan.Since 2008, many South Korean small and medium-sized enterprises have been avoiding signing derivative contracts linked to currency, when South Korean exporters suffered about $2.7 billion in losses on contracts sold as a hedge against the depreciation of the won.

The survey also shows that less than half of the exporters believe the depreciation of the won is beneficial to their profitability, while more than a quarter of the exporters believe the depreciation of the won is detrimental to them.

Impact on Service Trade

Another economic factor affected by currency is international tourism, an important part of service trade in international trade.

At present, the yen has fallen to a 30-year low against the US dollar.

Marriott International CEO Tony Capuano said in a recent phone call that 2024 is the US-Japan tourism year, and there is a lot of room for cooperation between the US and Japan. He said that during a meeting with the Japanese ambassador to the US, he talked about the popularity of US tourism in Japan, and he asked how to promote Japanese tourists to travel to the US. The Japanese side's response was: Well, you can weaken the exchange rate of the dollar against the yen.

However, due to the strength of the dollar, it is indeed a good time for Americans to travel abroad. In February of this year, 44-year-old American tourist Cecile Blot was surprised to find that dining out was so cheap while traveling in Argentina. She and her mother had dinner at a restaurant in Buenos Aires, ordering several appetizers, a steak, ribs, dessert, and a bottle of wine, for about $60.

Research from the Oxford Economics Institute shows that since the beginning of 2022, the dollar's real effective exchange rate has risen by 9%, about 10% higher than the long-term trend. However, the current strength of the dollar is by no means unprecedented.

"The previous peaks of the dollar were much higher than they are now, and our framework shows that the current dollar valuation is only moderately overvalued by about 6%. Therefore, the valuation level does not seem to be an obstacle to further appreciation of the dollar," Sarat explained. "Our forecasts have two-way risks, but it can be said that the risks are biased upwards. Wider interest rate differentials and the stronger impact of US artificial intelligence are some of the risks for the dollar to rise, although the impact of artificial intelligence may have been partially priced in."

He said that at the same time, the dollar's share in the world's major international financial transactions remains high and generally stable.