A broad appreciation of the dollar dampens international trade by weighing on the operation of credit-intensive global value chains (GVCs).
We are accustomed to drawing an automatic link between exchange rates and export performance through the textbook trade competitiveness channel according to which a strong US dollar boosts exports of non-US economies. Paradoxically, a strong dollar may actually serve to dampen trade volumes, rather than stimulate them.
A detailed empirical analysis using 4.6 million observations of export shipments by product category shows that when dollar credit conditions tighten, firms that rely more on wholesale dollar-funded banks suffer a greater contraction in exports. This is due to greater stringency in access to working capital to sustain GVCs.
First, following an appreciation of the dollar, banks with high reliance on dollar wholesale funding reduce supply of dollar credit more relative to banks with low wholesale dollar funding exposures.
Second, firms that are more exposed to wholesale dollar-funded banks (and hence suffer a decline in credit supply), experience a slowdown in exports, controlling for non-credit factors.
Third, the exports of firms that have higher working capital needs and are part of longer production chains are hit more by the dollar appreciation.
Taken together, the findings point to the trade suppressing effect of dollar appreciation working through the global bank credit channel. Our findings are consistent with the conventional trade competitiveness channel in that we also observe the positive effect on exports deriving from the trade competitiveness channel, but only in those firms that borrow from banks that are less exposed to dollar wholesale funding, or are not exposed at all.
The dollar exchange rate affects real outcomes not only through competitiveness, but also through fluctuations in credit supply. Using detailed export data at the firm-level, we find that the dollar exchange rate affects exports and, conditional on the firms' and banks' financing structure, operates in the opposite direction to the competitiveness channel. Other things equal, firms that are more reliant on banks with higher dollar funding suffer a larger negative effect on exports following an appreciation of the dollar. The effect is particularly pronounced for firms with long production chains. We identify a financial channel of the dollar exchange rate operating through bank credit supply to the exporting firm.
JEL codes: F34, F42
Keywords: global factors, risk taking channel, non-core bank funding, working capital, global value chains
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