Question

1. Look up the current U.S. dollar exchange rate for the five major trade partners of the United States and list them.

2. Where is the dollar strongest? Explain why you think this is the case.

3. Where is the dollar weakest? Explain why you think this is the case.

4. Describe how these exchange rates are determined, using the concept of derived demand.

5. Have you had any experience with exchange rates and traveling to foreign countries? Explain.

Answer 1

1)

                                    The five major trading partners in terms of volume of trade carried out with the USA are China, Canada, Mexico, Japan and Germany. The exchange rate of each of these nations are given below

            1 USD = 7.07 Chinese yuan

            1 USD = 1.36 Canadian dollar

            1 USD = 23.01 Mexican piso

            1 USD = 108.10 Japanese yen

            1 USD = 0.89 German Euro

2)

                                    From the above figures, it can be seen that the US dollar is strongest against the Japanese yen as it needs around 108 Japanese yen to buy a good that is costing a dollar in USA. The major reasons for the fall in value of Japanese yen compared to the USD are as follows

· The massive quantitative easing program has resulted in debasing the currency of japan

· Most of the funding mechanism of Japan providing funds to the pensions like GPIF are buying significant dollars as a part of overseas asset diversification program

· The USD-Japanese yen pair is the one among the most liquid pairs of currency as the yen is also issued as a reserve currency like the USD

3)

                                    From the above statistics, it can be seen that the dollar is the weakest when compared to the German Euro. It takes only 0.89 German Euro to buy goods that can be bought with a USD. The following can be seen as the major reasons for the same

· The economy of Germany has a more strong base than that of USA and hence the fluctuations in the domestic and international exchanges are lower in Germany which leads to a more stable currency

· The supply of Euro is relatively smaller in the international market compared to the USD. Lesser supply in the market means that each individual Euro is more worth of buying than the USD

· Euro represents the currency of the Eurozone of many nations and hence is relatively more stable than the USD

4)

                                    Derived demand represents the demand for a commodity or service that is caused as a consequence of the demand for some other commodity. Currency exchange rates are fixed by two major ways, either floating exchange rate or a fixed exchange rate. In a floating rate, the currency values are fixed by the demand and supply patterns in the international trade between the nations. Thus, when the demand is higher, the value would increase and this would fall with a fall in the demand in the international market. The fixed exchange rate refers to a process of fixing the currency with respect to a major world currency in circulation and the government would buy or sell its currency in order to maintain the exchange rate in the market. The demand in the international market are always derived from the status of the current international economy. For example, if the demand for a particular product in the international market is lower, it tends to move itself to the country having trade relations with the former which is expected to create changes in the demand of the latter which explains the concept of derived demand.

5)

                                    Yes. While travelling from India to USA, we can feel that difference where the American dollar is much stronger than the Indian rupee [almost 65 rupees at that time]. Thus, we have to spend more of Indian rupee to buy commodities in the American market. Thus, an exchange of Indian rupee with the American dollar meant that we require more Indian rupee so that we could live as we are in India. The cost of living is higher and hence the USD is seen much stronger.