International TradeInternational Trade

Mechanics of Foreign Mechanics of Foreign Exchange (FOREX)Exchange (FOREX)

Foreign Exchange (FOREX)Foreign Exchange (FOREX)The buying and selling of currencyThe buying and selling of currency

Ex. In order to purchase souvenirs in France, it Ex. In order to purchase souvenirs in France, it is first necessary for Americans to sell their is first necessary for Americans to sell their Dollars and buy Euros.Dollars and buy Euros.

Any transaction that occurs in the Balance Any transaction that occurs in the Balance of Payments necessitates foreign exchangeof Payments necessitates foreign exchange

The exchange rate (e) is determined in the The exchange rate (e) is determined in the foreign currency markets. foreign currency markets. Ex. The current exchange rate is approximately Ex. The current exchange rate is approximately

8 Yuan to 1 dollar8 Yuan to 1 dollarSimply put: The exchange rate is the price Simply put: The exchange rate is the price

of a currency.of a currency.

Appreciation and DepreciationAppreciation and Depreciation

Appreciation of a currency occurs when Appreciation of a currency occurs when the exchange rate of that currency the exchange rate of that currency increases (e↑)increases (e↑)

Depreciation of a currency occurs when Depreciation of a currency occurs when the exchange rate of that currency the exchange rate of that currency decreases (e↓)decreases (e↓)Ex. If German tourists flock to America to go Ex. If German tourists flock to America to go

shopping, then the supply of Euros will shopping, then the supply of Euros will increase and the demand for Dollars will increase and the demand for Dollars will increase. This will cause the Euro to increase. This will cause the Euro to depreciate and the dollar to appreciate.depreciate and the dollar to appreciate.

Q$

S$

D$

e

q

S$ .: e (ex. rate) ↓ & Q$ ↑

.: $ depreciates relative to €

S$ 2

e1

q1

Increase in the Supply of U.S. Dollars relative to the Euro

€ / $

€/¥

Q¥

S¥

D¥

e

q

S¥ .: e ↑ & Q¥ ↓

.: ¥ appreciates relative to €

S¥2

e1

q1

Decrease in the Supply of Yen relative to the Euro

$/£

Q£

S£

D£

e

q

D£ 2

e1

q1

D£ .: e ↑ & Q£ ↑

.: £ appreciates relative to the $

Increase in the Demand for the British Pound relative to the

U.S. Dollar

£/¥

Q¥

S¥

D¥ 2

e1

q1

D¥

e

qD¥ .: e ↓ & Q¥ ↓

.: ¥ depreciates relative to the £

Decrease in the Demand for Yen relative to the British Pound

Exchange Rate DeterminantsExchange Rate Determinants

Consumer TastesConsumer Tastes Ex. a preference for Japanese goods creates an Ex. a preference for Japanese goods creates an

increase in the supply of dollars in the currency increase in the supply of dollars in the currency exchange market which leads to depreciation exchange market which leads to depreciation of the Dollar and an appreciation of Yenof the Dollar and an appreciation of Yen

Relative IncomeRelative Income Ex. If Mexico’s economy is strong and the U.S. Ex. If Mexico’s economy is strong and the U.S.

economy is in recession, then Mexico will buy economy is in recession, then Mexico will buy more American goods, increasing the demand more American goods, increasing the demand for the Dollar, causing the Dollar to appreciate for the Dollar, causing the Dollar to appreciate and the Peso to depreciateand the Peso to depreciate

Exchange Rate DeterminantsExchange Rate Determinants Relative Price Level/InflationRelative Price Level/Inflation

Ex. If the price level is higher in Canada than in the Ex. If the price level is higher in Canada than in the United States, then American goods are relatively United States, then American goods are relatively cheaper than Canadian goods, thus Canadians will cheaper than Canadian goods, thus Canadians will import more American goods causing the U.S. Dollar import more American goods causing the U.S. Dollar to appreciate and the Canadian Dollar to depreciate.to appreciate and the Canadian Dollar to depreciate.

Speculation/Interest RatesSpeculation/Interest Rates Ex. If U.S. investors expect that Swiss interest rates Ex. If U.S. investors expect that Swiss interest rates

will climb in the future, then Americans will demand will climb in the future, then Americans will demand Swiss Francs in order to earn the higher rates of Swiss Francs in order to earn the higher rates of return in Switzerland. This will cause the Dollar to return in Switzerland. This will cause the Dollar to depreciate and the Swiss Franc to appreciate.depreciate and the Swiss Franc to appreciate.

Exports and ImportsExports and Imports

The exchange rate is a determinant of The exchange rate is a determinant of both exports and importsboth exports and imports

Appreciation of the dollar Appreciation of the dollar causes American causes American goods to be relatively more expensive and goods to be relatively more expensive and foreign goods to be relatively cheaper thus foreign goods to be relatively cheaper thus reducing exports reducing exports and increasing importsand increasing imports

Depreciation of the dollar Depreciation of the dollar causes American causes American goods to be relatively cheaper and foreign goods to be relatively cheaper and foreign goods to be relatively more expensive goods to be relatively more expensive thus thus increasing exportsincreasing exports and reducing and reducing importsimports

Big Graphs 15 and 16!!

Foreign Exchange

Graph for both countries

1. The interest rate in the United States is increasing. Graph for the US and Japan.

Graph for both countries

2. Inflation is high in England. Graph for England and the US.

Graph for both countries

3. Americans are buying more and more Hyundai cars. Graph for Korea and the US.

Graph for both countries

4. Mexico’s economy is doing very well. Graph for Mexico and the US.

Expansionary Monetary PolicyExpansionary Monetary Policyto Counteract a Recession w/ reinforcing to Counteract a Recession w/ reinforcing

effect on Net Exports effect on Net Exports

Res. Ratio Disc. Rate Buy Bonds

ER , therefore MS causing nir which leads to IG

so AD , resulting in PL and GDPR , making u%

AD = Aggregate DemandPL = Price LevelGDPR = Real Gross Domestic Productu% = Unemployment RateS$ = Supply of Dollars in FOREXM = Imports, XN = Net Exports

ER = Excess ReservesMS = Money Supplynir = Nominal Interest RateIG = Gross Private InvestmentD$= Demand for dollars in FOREXX = Exports

=

And now! Because nir either D$ or S$ which causes $ making U.S. goods

relatively and foreign goods relatively causing X and

M which means XN thereby reinforcing the increase in AD already caused by

the increase in IG.

cheaper more expensive

Contractionary Monetary PolicyContractionary Monetary Policyto Counteract Inflation w/ reinforcing to Counteract Inflation w/ reinforcing

effect on Net Exports effect on Net Exports

Res. Ratio Disc. Rate Sell Bonds

ER , therefore MS causing nir which leads to IG

so AD , resulting in PL and GDPR ,making u%

AD = Aggregate DemandPL = Price LevelGDPR = Real Gross Domestic Productu% = Unemployment RateS$ = Supply of Dollars in FOREXM = Imports, XN = Net Exports

ER = Excess ReservesMS = Money Supplynir = Nominal Interest RateIG = Gross Private InvestmentD$= Demand for dollars in FOREXX = Exports

=

And now! Because nir either D$ or S$ which causes $ making U.S. goods

relatively and foreign goods relatively causing X and

M which means XN thereby reinforcing the decrease in AD already caused by

the decrease in IG.

more expensive cheaper