Botnst - 2/8/2005 2:11 PM
Hmmm. Nice graph. Looks like shifts in value vary considerably over the short period that the Euro has existed. Kind of difficult to pick-out long term trends. In fact, I don't think there is a long-term trend, do you? Unless a long sweeping down and up is a trend.
Educate me some more. Money is a medium of exchange. It's value is dependent upon...what? I assume it's value is dependent upon what people will pay for it. If folks suddenly thought that squirrel pelts were almighty valuable then everybody would go buy them until they became over-valued (as compared to other currencies) and then everybody would dump squirrel pelts and buy hen's teeth.
So what affects the market valuation of currency? In some measure, I guess that it's the issuer's ability to pay debts using that currency, right? So if a country's economy is strong and its government is strong, then it is likely that it will repay. In contrast, if the economy is weak and the government is weak, then it's ability to repay debt in its own currency is weakened. Is that right?
Too bad I didn't pay attention in Econ 101. It's always nice to have people unhesitatingly willing to point-out my shortcomings.
Thanks for the vote of confidence, but I'm probably not the best spot to educate you on this, sclerosis has attacked my brain cells about as much as alcohol, so bear with me...
Kirk has touched on broad factors that directly and indirectly affect the value of a currency relative to another.
GermanStar has described how it can affect businesses, and tourism. A cheap dollar allows us to export (although as you have noted, we are not producing much any more, we are service oriented...) more, also allows more tourists in (this is also consider an export btw). Small companies dealing in foreign goods take a hit when the USD depreciates, the Daimler Chrysler example is pointless in that the Balance Sheet movements in asset valuation can be somewhat misleading. Consider that the real estate valuation of some of DCs US assets seemed to have dropped because of the exchange rates only because the financial statements are stated in Euros. It could be monkey money, as in USD terms on their US assets might have appreciated (or not :))
Fiscal and Monetary policies affect it greatly. Within monetary policy, the monetary mass (volume of money that is in circulation affecting supply, demand) and interest rates are the two biggest factors affecting the foreign exchange markets (ForEx).
If you have billions of dollars, you can make a bunch by playing the arbitration game. Market efficiency and the use of computers curtail your ability to be an arbitrator, but in theory, you could make a living, in fact, some do, with minimal or zero risk. Unfortunately, you can only make a fortune when you already start with a fortune.
Basically, if you look at two countries, say the US and the UK, you can write an equation that will put in balance exchange rates between the USD and the GBP, and the interest rates offered in the two countries. The interest rates will give you an expected appreciation. You can then use the current exchange rates and futures on currency exchange rates to determine if your appreciation would be greater if you dealt in T-bills, the British equivalent, or in futures. You decide if the current exchange rates are appropriate or if there is an opportunity for you to make $ by buying or selling USD or GBP. If you and others do that as long as there is money to be made, then equation is back in balance, and the arbitrage opportunity disappears.
This is hard to do for you and me, but the big institutions do it constantly, in addition, you can complicate the matter by using more than two countries. Use Canada in the mix and now you have a triangular relationship to consider when comparing the exchange rates and interest rates between Canada, the US, and the UK.
The ability to control and set interest rates is very important in that context. Mix in that this is a tool of choice to mock with the economy, you now understand why the UK is not part of the Euro zone. They do not want to relinquish the interest setting policies that the Bank of England to control and help the British economy. For the Euro to work, the member countries had to relinquish that right to the Central European Bank. It limits the control that each local government has over its economy, at least insofar as not being able to set an interest policy.
Fiscal policy will also direct flow of capital. For instance, would you rather have your money be taxed in your French investment at 40%, or would you rather take stakes in a British Company where you'd be taxed at 30%. That will influence exchange rates as well.
In the 80s, one third of the USD monetary mass was outside our borders. Central banks all over the world uyse their euro dollars to modify (through supply and demand) the rate of their respective currencies vs the USD.
PS. I apologize in advance for not checking my posts for typos, it's not a mark of disrespect, just a consequence of being in a hurry.