Effects of Exchange Rates on Crude Oil Trade Between China and the United States

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Table of Contents Introduction.................................................................................................................................... 2 Factors Affecting Changes in US dollar Exchange Rate..................................................................... 2 Economic Performance............................................................................................................... 2 The Outlook for Inflation............................................................................................................. 3 Interest Rates Differences........................................................................................................... 5 Current Account Deficit............................................................................................................... 5 Terms of Trade............................................................................................................................ 6 Public Debt................................................................................................................................. 6 The Effects of Exchange Rates on Crude Oil Trade Between China and the United States......... 8 Conclusion..................................................................................................................................... 16 Works Cited................................................................................................................................... 17
To what extent the changes in the US dollar exchange rate will affect the crude oil between China and the United States?
Introduction
The US dollar is the steadiest currency globally. Other currencies get their values through the exchange of the dollar. For a long time, the value of the global currency has steadily gained worth. When the dollar's value is stable, other currencies and economies are also steady. The world economy mainly depends on the stability of the US dollar to determine how the prices of critical items are determined. One such product that relies on the dollar's stability is crude oil, whose change in the price extensively affects the cost of other products. This change implies that the cost of importing oil increases, resulting in a rise in gas prices. The dollar's value is mainly determined by three main factors; exchange rates, treasury earnings, and foreign currency assets. When the three determinants are stable, the dollar's worth remains stable. It's worth noting that China has experienced tremendous economic growth in the past two decades. As part of the global economy, crude oil is an essential commodity for the Asian country. Thus, understanding the US dollar exchange rate changes is vital in comprehending its effects on the crude oil trade between China and the United States.
Factors Affecting Changes in US dollar Exchange Rate
Economic Performance
The economic growth rate indirectly affects the exchange rate of the US dollar. No direct links result in a change without considering other variables to precisely determine the exchange rate. A strong exchange rate is an indication of a strong economy. The stability of the US economy has enabled the country to attain stability in the exchange rate, making it the global currency. Recently, the conversion rate immensely changed due to speculations. The stability of the dollar nearly eradicates the possibility of its drastic collapse. However, short-term variations could sometimes be misleading. A country's exchange rate is predominantly measured by its performance in the market over a long period. Also, changes in conversion rates indicate economic growth as the prices keep swaying. For instance, most European countries have an uncompetitive economy because of the rigidity of the pound. Their exports become more expensive, and the imports are cheaper. This price implies that they will experience a reduction in the demand for exported goods while the value of the imports will rise.
The short-term variation in the exchange rate of the dollar does not majorly imply that the economy of the US is falling. Devaluation in the price causes the price of the imports to increase while the exports value upsurge. However, the inflation of imports may implicate the rise of another country's economy. Therefore, economic performance vastly impacts the exchange rate of the US dollar through the long-term economic performance.
The Outlook for Inflation
Inflation is narrowly interrelated to interest degrees that impact exchange rates. A balance between the two is a challenging approach because of the intricacy of their relationship. Low-interest rates have a resultant positive effect on the economy of a nation. Besides an increase in consumer expenditure to the mark that demand surpasses the available supply, inflation may arise, which may not be inevitably fatal. During the lockdown, US citizens had minimum chances of spending their funds to acquire their basic needs. Also, the government constantly provided relief funds to every family, improving the income of most homes (Liulov, 228). Other citizens continued to work from home while not spending their salaries effectively. The lifting of the nationwide curfew meant that people were back with more cash than before. However, this became detrimental as many people started spending lavishly on the limited resources available in the market. As a result, the demand attracts foreign investors to satisfy the market. The presence of foreign investors implies that the US dollar is enlarged. Therefore, the desirability of the dollar improves as every investor wants to trade using the dollar. However, some investors are not secure in withholding the dollar as a cash asset, for they perceive that the economy is unstable. As investors shy away from holding the dollar in massive amounts, the exchange rate is adversely affected.
Figure one below, illustrates this phenomenon better.
Figure One
Source: Corporate Finance Institute (https://corporatefinanceinstitute.com/resources/knowledge/economics/floating-exchange-rate/)
As indicated above, an increase supply of currency from S1 to S2, leads to a depreciation of the dollar value. Similarly, an increase in demand of the currency from D1 to D2, leads to an appreciation of the dollar.
Interest Rates Differences
Interest rates have a close relationship with inflation and the exchange rate. The three aspects determine the valuation of a nation's currency in the world market. First, the Federal Bank directly influences the interest rates of loans sold in the US. A change in the interest rates directly impacts inflation and the dollars’ worth (Plakandaras, 112). The high rates offer the economy an immense return when they lend money to other countries. The government also raises capital through the sale of treasury bonds. Recently, the government advertised vast amounts of bonds to the public. The acquisition of the treasury bonds improved the government’s incomes, which were used to fund the capsizing companies. Also, the government lowered interest rates to enable companies recover from the COVID-19 pandemic. Huge amounts of cash were in circulation as cash was easily obtained from the government. Prices had to increase since consumers were more than the suppliers (Salisu et al., 210). As a result, the supply-demand caused inflation of prices and a rise in the exchange rate.
Current Account Deficit
The dollar's exchange rate directly influences the stability of trade through the foreign exchange stream and demand. A resultant positive figure of the US trade account indicates that there is a more supply of the dollar. In turn, the market influences the price of the US currency. Recently, the US has experienced a turnaround in demand for the dollar. This turnover is due to the increased imports than the overall export. An increased supply of cash resulted in an upsurge of demand for goods in the country. Therefore, the country had to import more than it supplies to other nations.
Generally, the demand for the dollar decreased before steadily increasing after lockdown. The resumption changed the export rate vastly as production vastly increased. Similarly, the exchange rate stabilized, though not according to the anticipated pace. The rates may still be high, but as soon as the trading account is beyond zero, the demand for the dollar would rise.
Terms of Trade
Comparing export cost to import cost is linked to present accounts and the steadiness of expenditures. A balance between the two prices majorly affects the position of the country's currency in the world market. A rise in the rate of exports implies that the trade terms have immensely developed. Each government strives to ensure that their respective nations indicate higher export rates. However, the US export rates have resulted in an imbalance in trade. Moreover, the ongoing economic crisis destabilized some primary shipment sources.
Otherwise, a rise in the demand for exports indicates enhanced terms of trade. The short-term decline in demand for the US dollar resulted in continuous criticism of the currency and its stability (Liulov, 228). Thus, the rise in the dollar's value is inevitable when the terms of trade are improved with time.
Public Debt
Nations incur huge debts financing to pay civic sector schemes and administrative funding. The measure has two possible outcomes according to the extent of the deficit incurred. First, domestic operations are stimulated since it revives the economy. Lastly, investors may be repelled due to the high operational debts. The leading cause of repulsion is the inevitable inflation of prices, decreasing the dollar value. Likewise, the US government primarily sustains its projects and funding through debts. America has the highest debt in the world yet the most stable economy. In 2020, the total debt accounted for 895.4% of the country’s GDP compared with the ratio of 870.7% in the previous quarter (Ceicdata.com). The paradox of the statement is that high debts result in the destabilization of an economy, but the US is still stable with the debt.
Figure 2
Figure 3
Source: Karfakis, Costas. (2008). Does the US international debt affect the euro/dollar exchange rate?
Figure 3 above illustrates the impact of growth in foreign debt against the exchange rate of the euro/dollar. Evidently, as the foreign debt increased throughout the years 1999 to 2006, the exchange rate also increased.
The Effects of Exchange Rates on Crude Oil Trade Between China and the United States
The US dollar is fiat money that does not require any backing to determine its value. However, it is still widely accepted as a global currency. Currently, one US dollar is equivalent to 6.37 Chinese Yuan. The Yuan has progressively appreciated against the US dollar, which jeopardizes the Chinese manufacturers. The main fear is the anticipated losses during the export of their products. Therefore, many investors opt to convert the US dollar back to Yuan since the competitiveness of their exports is vastly reduced. Furthermore, changes in exchange rates are negatively impacting crude oil prices. As the rate increases, the price of crude oil upsurges. This rise will increase the prices of importing oil and buying gas. The oil price has been gradually increasing over the months but has gradually cooled in recent weeks. An attack on the dollar's stability has prompted the consideration of dropping the US dollar for exchange. Thus, it is essential to discourse on the effects of the US dollar exchange rate on crude oil between China and the United States.
Figure 4
Source: Hui, Cho-Hoi, Chi-Fai Lo, and Po-Hon Chau (2018).
Currently, China is the biggest importer of crude oil globally, followed closely by the US. America has been esteemed for its prowess in controlling the oil ...