Say goodbye to the days when domestic monetary policy was dictated by isolated elected officials within a country’s borders. Increasing globalization and international transactions have made domestic monetary policy a global issue now, and the impact on trade can send ripples through local communities, influencing current and future policy decisions.
Two economic topics at the forefront of every business story today involve currency strength and domestic inflation. While countries are currently struggling to generate a healthy range of price appreciation, trade can in turn impact domestic inflation rates. The concept of “trading inflation” has been around for decades and is becoming increasingly relevant as domestic monetary policy decisions are influenced by companies that engage in trade around the world.
When comparing the underlying economic fundamentals between two countries, exchange rates are a key benchmark in understanding the strength and the story behind each country’s underlying economic conditions. For instance, the real broad trade-weighted exchange rate of the US dollar has advanced nearly 11.5% since June 2014 against its trading peers.
Improvements in the US economy have propelled the dollar exchange rate higher in recent months. As the economy of a country strengthens, so will its underlying currency and vice versa. In addition, the prospect of a future interest rate hike, or a movement toward a less accommodating monetary policy by the Federal Reserve, also signals to the market that the US economy is in a better position today compared to its peers.
As a result of the strong dollar, imports are less expensive to US companies and consumers. Tradable inflation also is low-to-negative as long as the US dollar remains strong against its peers.
It may be helpful to think about trading inflation like this: The same product that US Firm A bought from a Eurozone firm six months ago is today significantly less expensive due to the US dollar’s appreciation against the euro. In turn, the consumer is spending less on the same product and deflation has occurred.
The concept of trading inflation works both ways. While the US will record deflationary pressures from the above transaction, the Eurozone actually records imported inflation, providing a much-needed boost to declining consumer prices. As a Eurozone business or consumer imports a product from the US, that product is now more expensive than it was six months prior and, as a result, inflation has occurred within the Eurozone.
Tradable Inflation May Provide Benefits to the Eurozone and Asia This Year
As the Eurozone embarks on its version of quantitative easing this year to spur the economy, imported inflation could go a long way towards helping the Eurozone meet its goal of stable price appreciation close to 2%. A depreciating currency, should create tradable inflation, boosting the negative consumer price appreciation. Japan stands to reap the same benefits.
The exact impact of US businesses on inflation tradables will vary according to how global a company is and how much trade a company engages in. But the next time you discount what’s happening in Europe or Asia as having little to do with your business today, you could actually be highly influencing economic conditions and policy in another country.