Trade and Capital Flows
Before you make your final prediction about the trend of a country's currency, you should take a moment to categorize the country
as dependent on either trade flow or capital flow. Trade flow refers to
how much income a country earns through trade. Capital flow refers to
how much investment a country attracts from abroad. Some countries are
sensitive to trade flows, while others are far more dependent on capital
flows.
Countries whose currency strength depends on their trade flows include:
- Canada
- Australia
- New Zealand
- Japan
- Germany
These
countries achieve a large portion of their growth through the export of
various commodities. In the case of Canada, oil is the primary source
of revenue. For Australia, industrial and precious metals dominate
trade, and in New Zealand, agricultural goods are a crucial source of
income. Trade flows are also important for other export-dependent
countries such as Japan and Germany.
For countries such as the US and UK, which have large liquid investment markets, capital flows
are of far greater importance. In these countries, financial services
are paramount. In fact, in the US, financial services represented 40% of
the total profits of the S&P 500.
The
United States also serves as a perfect example of why it is crucial to
understand which flows affect which country in order to effectively
analyze the direction of currencies. On the surface, the US currency,
with its record multi-billion dollar trade deficit and near $1 trillion
current account deficit should depreciate significantly. However, that
has not been the case. As the chart below illustrates, the US has been
able to attract more than enough surplus capital from the rest of the
world to offset the negative effects of its massive trade deficits.
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