Exchange rates and the working capital channel of trade fluctuations

BIS Working Papers  |  No 694  | 
25 January 2018



Our paper provides a fresh take on the way the US dollar exchange rate influences the volume of global trade. We take as our starting point the substantial financing needs of the long supply chains, or global value chains (GVCs), that underpin trade in manufactured goods. These financial needs make GVCs susceptible to fluctuations in the supply of dollar-denominated trade credit. As a stronger dollar goes hand-in-hand with tighter dollar credit supply, the impact of a strong dollar can run counter to the traditional understanding of the impact of exchange rates on trade.


Our paper is one of a number of new approaches to international trade that tackle the puzzle of why the dollar exchange rate affects global trade volumes. Our paper is distinctive in basing the explanation on the working capital demands of GVCs. We build on previous work showing that, when firms depend more on external financing, their inventories fall more sharply when credit supply dries up. We extend this by taking a global view and considering the prevalence of dollar invoicing in global trade, based on data from more than 2,000 companies. Globally, about 80% of trade finance is denominated in dollars.


We find that a stronger dollar heralds tighter credit conditions and thus dampens GVC activity. As a result, a country's exports may fall when its currency depreciates against the dollar. This runs counter to the conventional view that a weaker currency helps exporters by making their goods comparatively cheaper for overseas consumers. The paradoxical results undermine arguments that tighter trade and investment links can be forged without any need for increased financial openness. Real and financial globalisation go hand in hand.


JEL classification: F36, F41, G20

Keywords: global value chains, dollar invoicing, global liquidity