Ok I have a feeling I’m missing something and my brain does not feel at it’s peak performance at the moment so forgive me if this is an obvious oversight.
So, let’s use a common example of trade flow between US and Canada… And for the sake of simplicity, let’s say the US and Canada are the only two countries in existence. If the US has a trade deficit, it is buying more goods from Canada than selling to it. Everything I’ve learned says that, in this situation, in order to buy goods from Canada, the US has to sell USD and buy CAD. This leads to an increased supply of USD and increased demand for CAD… Which in turn leads to a the value of CAD rising and the value of USD falling.
My question is simply, if the US is selling USD, where is the USD going? I was under the impression that for every seller, there is a buyer. So if the US is selling USD, someone should be buying it, which means there should be no change in supply because it is balanced by the demand of the buyers. Likewise, the US is buying CAD off of someone or someplace that must be selling it, right? Otherwise where does it come from?
Maybe it doesn’t work like the in the bigger scheme of things, in which case… How does it work?
Either way, I still feel like I’m missing some fundamental understanding of something or other so I feel kind of silly asking. But any help is much appreciated. Thankyou
Not silly in asking, think not in terms of countries ( I know this may sound contradictory) think instead in terms of commercial companies within countries.
So when you say ‘US selling USD’, think Toyota selling the USD’s that they have accumulated from sales within the US to buy Yen to pay their taxes and costs in Japan.
Then think of a recent incident of a UK company being faced with huge law suits, those suits having to be settled in USD, their money being in GBP.
This is where the difference in a ‘commercial’ and a ‘speculator’ is defined, the commercial needs to settle,- he sells to … someone who will take on the risk of potential gain or loss, i.e. the speculator.
The commercial doesn’t care that the speculator made a subsequent profit/loss from the transaction.
I know I’ve told this horribly, will try again later
The concept is complex but don’t over-complicate this in your mind. Don’t think about supply as in aggregate money supply, think of it like trading a stock. While total shares outstanding may remain the same, the price will fluctuate as there is higher and lower interest to buy and sell the security.
The same it true for foreign exchange. When large quantities of one currency are being sold, there may always be a buyer…but not always at the price that the seller wants. If there is more sell relative sell interest than buy side interest, the sellers will have to take lower and lower prices as the price buyers are willing to pay decreases, or as buyers at higher prices get orders filled and only lower priced buyers are left. If there is relatively higher sell side quantity in a currency, it will pressure prices downward.
