Question

Suppose an economy is an export based one where a US Multi National Corporation conducts business with the economy, what are the implications if the currency of the export based economy depreciates significantly against the dollar? What if this depreciation leads to a deficit on the current account, what are the implications for the supply/demand in the foreign exchange market, holding all else constant?

Answer 1

If the currency of the export based economy depreciates significantly against the dollar then the export based economy will start earning more money in terms of its home currency. Thus the export economy will gain from the depreciation of its currency against the dollar. On the other side of this coin the imports for this economy will become more expensive and if the economy imports more than what it exports then a current account deficit will occur. It should be noted that current account deficit occurs when the value of imports exceeds exports and the exporting nation thus becomes a new borrower. In such a case the demand for US dollars will increase for the exporting nation and this will lead to a higher demand of US dollars in the foreign exchange market. So holding all else constant when there is a deficit on the current account the local currency will further weaken and the dollar will gain additional strength against the local currency.