How Currency Exchange Rates Affect Import and Export

How Currency Exchange Rates Affect Import and Export

Currency exchange rate changes have far greater implications than remittence. I came to know about this fact recently while reading Naked Economics. Based on whether currency is weak or strong, country may gain more profits with either exports or imports.

To get started, let's consider very trivial example from this book. Suppose you went to USA from India 10 years ago when the exchange rate was 45 Rupees for $1. The room in dollars cost $100 and you paid 4500Rs. for a room. Now you visit the same hotel with same room and same cost in dollars, Rupee-Dollar exchange rate has climbed to 75 Rupees for $1 and you had to pay 7500Rs. So what got changed that forced you to pay 3000Rs. more? It's the exchange rate. Rupee was weakened against dollar in last 10 years and buying (Or importing) foreign goods became expensive. Due to this, Indian goods also become less expensive for rest of the world since they can buy more rupees for their unit currency which promotes export.

Now consider the case when exchange rate went in reverse direction and it became 15 Rupees for $1. Then people traveling to USA from India would just need to pay 1500Rs. If we apply this logic to importing goods, then we get more goods for far fewer rupees which makes importing or buying foreign good less lossy. But imports become more expensive for the rest of the world since they need to pay more in their unit currency since rupee has appreciated in value thus reducing export volumes.

How Ford and other American companies benefit from weak US Dollar?

Now let's take another practical example (Taken from the same book Naked Economics). Ford makes cars in USA and sells them here or to the rest of the world. Let's consider the scenario when Dollar becomes cheap compared to Euro. If the car made in USA takes $25,000 to manufacture and earlier selling for €19,230 for the exchange rate of 1.3. Now say, exchange rate becomes 1.5 and the same car that cost $25,000 in USA now costs €16,666.67 in Europe boosting the demand thereby increasing revenue and profits.

At the same time, due to weak dollar, imports becomes more expensive. So the €25,000 European manufactured car that used to cost $32,500 in USA for the exchange rate of 1.3, now costs $37,500 thus reducing demand. At the same time, Ford's USA manufactured car still costs $25,000 in USA thus gaining advantage in terms of cost comparison.

Now, given this example, you can understand how strong dollar negatively impacts American companies. With dollar appreciating, American made cars become more expensive in European market while European imported cars become less expensive in American market and the cost of American made cars remain the same in American market thus hurting US carmakers.

Do countries artificially adjust their currencies?

The weak Chinese Yuan has always been source of contention between USA and China. This is because as we saw earlier, weak currencies benefit exporters and punish importers. This is what China wants to do - To promote exports and reduce imports.

The currency appreciates when there is a demand. For example, when oil prices increase, the value of Dollar appreciates since International oil is traded in dollars. At the same time, when economy is fledgling and investors have no longer confidence in currency, they try to sell as much and as soon as possible depreciating currency value

I would like to add a note from my personal experience. When I went to USA 11 years ago, Rupee was relatively stronger compared to Dollar (1 Dollar could buy 45 Rupees). When I purchased USA college education (Import), that was cheaper for me compared to what students have to deal with now (1 Dollar buys 74 Rupees).

Now, when I send money back home (Export), it's much more beneficial to me with weak rupee now that I can send more Rupee for the same amount of US dollars.


Naked Economics by Charles Wheelan