How International Trade affects Currencies

Now that we’ve sprinted through two fundamental analysis concepts for the foreign exchange markets, let’s seek to understand another important concept: international trade.

International trade is any economic activity that occurs between individuals, companies, and even governments, between borders. Every day, you probably buy items that were made in one country, assembled in another; market tested in yet another country, and then shipped by a company from one more country.

Along the way, money changes hands in each step. Naturally, international trade, which can be conducted in many different currencies, affects the currency markets.

A Simple Example

Electronics make for a great example in international trade. You’re accessing this website either on a PC, mobile phone, or some kind of electronic device. We’ll use a specific company, Apple, and its product, the Mac computer.

Apple is based out of Cupertino, California. There, business people, engineers, and technicians work to create concepts for the new products. Apple also raises money in the American capital markets.

But the product isn’t manufactured in the United States. Instead, Apple’s products are manufactured in China, where all the parts are thrown together to make a computer. Later, the finished product might be sold in any one of six different continents, and in different currencies.

Applying this Concept

Apple’s key people are in the United States. These key people don’t actually make the product itself, but they design the code for the software, and the business model to promote it. They also raise money in the United States, which is in dollars.

When Apple goes to manufacture the product, they have to convert their US dollars to Chinese Renminbi to pay the workers. Each time Apple pays a worker, they’re essentially selling the USD/RMB pair, pushing down the price of dollars, and pushing up the price of Renminbi.

Then the computer is sold to the consumer, who may be in any place around the world, but we’ll use Europe for this example. Apple exports the finished computers to Europe, which uses Euros. When Apple sells a computer to a European shopper, Apple receives Euros, which it then trades back into US Dollars. The result is effectively a sell order for EUR/USD. The Euros are sold, so that they can be converted into US Dollars.

We now have a core understanding of what international trade is, and how it necessarily affects the currency markets. International companies have to buy and sell currencies to conduct their basic business operations.

In the next section, we’ll explain balance of trade, and how international trade can be measured with the balance of trade calculation.