2009

Economics Assignment

Ana Segura, Tanja

Factors influencing the value of the dollar

($) or the value of the pound sterling (£)
vis a vis the euro (€) and use them to
predict the exchange rate for early 2009.

Dublin Business School

EC 291 – Business Economics
Ana Segura, 1174538
Xxxx words
INTRODUCTION – BRETTON WOODS

The current exchange rate system doesn’t seem very much likely understandable if we don’t briefly go back
to 1944 when Bretton Woods fixed exchange rates system was set up, though not fully functional till 1958,
basically (Coggan, 1995) it pegged the world’s major currencies at fixed rates to the dollar. The dollar was,
at a set rate, convertible into gold. It was, as mentioned by (Howard Flight, 1989) in some senses, and
adaptation of the old gold standard.

Bear in mind that at that moment the USA was a major world creditor and a good-shape economy and this
is the reason why other currencies were defined in terms of the US dollar, at a fixed exchange rate (Howard
Flight, 1989).

By 1971, the USA brought this Bretton Woods system to an end after having to assume the massive burden
of financing the Vietnam War. Important dollar devaluation followed and it left no other choice rather than
adopting a floating exchange-rate regime, which permitted countries make (Howard Flight, 1989) simple,
speedy economic adjustments to changing circumstances, through exchange rates, without lengthy political
debate against

Now, away from gold convertibility, the price of a currency will be given by its own demand. If the country’s
economy was been deemed prosperous, strong and strengthening, its currency would be in demand so as to
allow buyers afford their commitments and sometimes as a secured value as well, where people would
secure their savings and sometimes even speculate buying at low price and selling at higher ones.

And this was more or less the story; the dollar has been since the end of the World Wars the only gold-
convertible currency, up till 1971. Britain had suspended the sterling gold convertibility by 1931.

At present and after an important research, we couldn’t find uniform agreement on how to predict exchange
rate movements. There are the ones considering exchange rates very much predictable as is the case of
Howard Flight, though the fact that he runs an Asset Management fund and profits with exchange rates
doesn’t make his opinion very independent at all. Philip Cogan mentions different schools and theories at
this respect and (Coggan, 1995) he cites the “economists” and the “ technical analysts”, with methods
radically different. Easier is to enumerate our research findings on reasons behind currency fluctuation.
And here we go.

Factors influencing the value of the currencies

The theoretical framework is e = f (П, Y) + (r, R) + S

This means exchange rate will depend on factors such as Inflation and Income plus return on Investment and
Interst Rates plus Spot Exchage Rate.

Inflation; Let’s imagine the US Federal Reserve decides to print dollar bill notes to pay off the US massive
debt, as a direct consequence inflation would not delay much in coming up. This would be soon eroding the
value of the US currency making it cheaper to get against other stronger currency.

Trade Deficit; If USA imports are far larger than exports, a deficit trade balance is the direct result. We
mentioned before that an economy being deemed strong and strengthening, is immediately followed by its
currency appreciation, and this is what was happening in the US before turning into a major debtor.

GDP; a positive GDP would be linked to a good trade balance, being another good reason behind the
currency appreciation.
Interest Rates; if going back on economic history, there are many examples of economies recurring to high
interest rates to prevent from devaluation, such as Sweden and Turkey (Siebert, 2002) or even Brazil. In
regards to interest rates, it is important to mention the difference made by (Coggan, 1995) between just
levels of interest rates and real interest rate which is the one that the investor expects to receive after
inflation and exchange rates have been taken into account. E.g. money lodged at an interest rate of an annual
200% return does not compensate for an erosion of inflation depreciation at a rate of 500%. 300% of the
currency value has been eroded.

Speculation; besides currency being traded for paying goods (commercial transactions) and foreign
investments, exchange market is used (Carbaugh, 2000) for exchange-rate speculation. This is as defined by
the author the attempt to profit by trading on expectations about prices in the future. And this activity can
either stabilize or destabilize a market depending on the magnitude of the transactions. Latin American
speculators would hold large amounts of the currency they are expecting to rise.

Real Income; (Carbaugh, 2000) defines the general rule relating real income to exchange rates as follows:
Holding other determinants of exchange rates constant, a country experiencing faster economic growth than
the rest of the world tends to find its currency’s exchange value depreciating. This is because the imports
rise faster than its exports, and thus its demand for foreign currency rises more rapidly than its supply of
foreign currency.

Government Intervention; As any other good, currency exchange rate is determined by demand and
supply, as far as monetary authorities don’t intervene to push prices up or down. An example of this is what
happens in Argentina, its everyday’s news that the Central Bank sold or bought a large amount of American
Dollars to maintain the dollar between the ranges of 3.20-3.70 pesos. This is the case of a weak economy
continuously linked to dollar-euro prices. And a big run in the dollar price risks a heavy destabilization for
the local currency.

Mention some other factors.

Performance of the dollar

The USA emerged as a major power after the War, since then and up till they uniterally stopped
convertibility occurred in 1971, its value remained at a constant rate (gold convertible). From 1973 onwards
its price didn’t stop fluctuating, with continuous ups and downs, sometimes very pronounced ones.

Predictions

Bedell: The pound weakened further recently when low inflation data was released because it means we are
likely to get lower interest rates in the future, which will give investors a less attractive return.

Pound is very much likely to rebound strongly in the first quarter of 2009 and US dollar will weaken next
year.

The dollar has been strengthening so much lately, because US is the largest contributor to foreign direct
investment (FDI), as US investors started bailing out of risky assets overseas so there was a wall of money
coming back to the US. Commented [A1]: This colour means I am not sure whether or
not leaving this or replacing it.
Since 2001 the dollar has fallen by 33% against the euro and by 15% against the Japanese yen (source
Economist 9/02/2004).

Nevertheless chaotic predictions around dollar value, our prediction is that for the moment -not existing any
(Soros, 2006) sovereign entity that can replace the United States in the foreseeable future- there won’t be a
dramatic change on what we have been experiencing for the moment.

During the last years the dollar has been experiencing important downs and they say there’s only one way
and it is up. Its trade volume is yet importantly large and though many investors and speculators are running
towards gold as consequence of broad general uncertainty, it would be easier and handier turning back to the
dollar.

Read this and see what can be taken;

http://www.forextv.com/Forex/Commentary/ShowStory.jsp?id=16877&category=1

http://www.forextv.com/Forex/Commentary/ShowStory.jsp?id=16877&category=1

Bibliography

Robert J. Carbaugh, 1999, International Economics, 7th Edition. Cincinnati, Ohio. South-Western College,
Publishing.

Gerard Turley & Maureen Maloney, Principles of Economics an Irish Textbook, 2 nd Edition. 2001. Dublin,
Ireland. Gill & Macmillan.

Paul R. Krugman, Maurice Obstfeld. 2000. International Economics, Theory and Policy, 5 th Edition.
Addison-Wesley Longman.

Christopher Pass, Bryan Lowes & Leslie Davies. 2005. Collins internet-linked dictionary of Economics. 4th
Edition. Collins.

N. Gregory Mankiw. 2004. Principles of Economics. 3rd Edition. Harvard, United States. Thomson South-
Western.

Jeffrey D. Sachs, Felipe Larrain. 1995. Macroeconomía en la Economía Global. Mexico. Prentice Hall Inc.

George Soros. 2006. The age of fallibility, the consequences of the war on terror. 1 st Edition, London, UK.
Orion Books.

George Soros. 2008. The new paradigm of Financial Markets. The credit crisis of 2008 and what it means.
1st Edition. London, UK. Public Affairs Editions.

Horasrd Flight, Bonita Lee-Swan, 1989. All you need to know about exchange rates. 2 nd Edition. London.
Sidgwick & Jackson.

Philip Coggan, 1995. The Money Machine, how the city works. 3rd Edition, London. Penguin.
Francesco Giavazzi and Alberto Giovannini. 1989. Limiting Exchange Rate Flexibility. The European
Monetary System. 1st Edition. Massachusetts Institute of Technology, USA.

Horst Siebert, 2002. The world economy. 2nd Edition, London. Routledge.

Journal article
In this example the volume of the journal (=14), issue number (=2), page numbers (=131-143) and date (=June
2003)
 Caldwell, Raymond. 2003. Models of agency change: a fourfold classification. British Journal of
Management, 14. (2): 131-143, June 2003
Note that the title of the journal is italicised and not the title of the article.

Internet
The important point to remember in this bibliographic note is to enter the date the website was accessed e.g. 4
September 1996
 McKiernan, G. 1996. Project Aristotle(sm): automated categorisation of Web resources. [Online]. Available:
http://www.public.iastate.edu/~CYBERSTACKS/Aristotle.htm [4 September 1996]

Electronic Database
In this example the title of the journal in which the article has been published (Journal of Management Studies) is in
italics. The name of the database and the article reference number (if any) should be given in square brackets.
 Roche, William K. 1999. In search of commitment-oriented human resource management practices and
the conditions that sustain them. Journal of management studies, 36 (5) 653 [Abstract in the InfoTrac
database]