- Basics of Exchange Rates
(a). Visit the website of the Board of Governors of the Federal Reserve System at https://www.federalreserve.gov/ Click on the tab “Data” and then under the center column “Exchange Rates and International Data”, click “Foreign Exchange Rates – H.10/G.5”. Click on the tab “Country Data”, you can find major daily exchange. What has happened to the value of the U.S. dollar relative to the Canadian dollar, Japanese yen, and Danish krone since 2000 (Earlier data are also available, the default is 2000-present)?
Using the information above, what has happened to the value of U.S. dollar relative to the British pound and the euro? Note: The H.10 release quotes these two exchange rates as U.S. dollars per unit of foreign currency in line with long-standing market convention.
(b). Go to the website for Federal Reserve Economic Data (FRED): http://research.stlouisfed.org/fred2/. Locate the monthly exchange rate data for the following:
(1) Canada (dollar), 1980-present
(2) China (yuan), 1999-2004, 2005-2009, 2009-2010, and 2010-present
(3) Mexico (peso), 1993-1995 and 1995-present
(4) Thailand (baht), 1986-1997 and 1997-present
(5) Venezuela (bolivar), 2003-present
Look at the graphs and make your own judgement as to whether each currency was fixed (peg or band), crawling (peg or band), or float relative to the U.S. dollar during each time frame given.
- The U.S. Current Deficits
Note: To answer the following questions, you may find that it would be helpful (although it’s not required) to read articles provided in the reading list, such as Bernanke (2005), Yang (2012), Roubini and Setser (2004), and Mann (2002).
(a). Make a chart of the U.S. current account deficit, both in absolute $ value and as a share of GDP from 1990 to present. Find the most recent estimate of the U.S. current account deficit for the next two quarters (Note: depending on the availability of actual data. If actual data is available up to the third quarter of 2019, you should look for the estimate for 2019Q4 and 2020Q1).
(b). For the same sample period (1990-present), chart the evolution of the net foreign assets of the U.S. (NIIP) and decompose the total NIIP in the part that is the net stock of foreign direct investment from the part that is the rest (portfolio, banks, other forms of debt).
(c). Discuss the evolution of the U.S current account deficit and net foreign assets: how much of the evolution of the deficit (as a share of GDP) is due to changes in private savings, public savings (fiscal deficits) and investment rate (all as a share of GDP) and how much has the role of different factors changed over time?
(d). Based on this analysis, are the U.S. current account and external debt sustainable? Does the U.S. differ or not from emerging markets or not and why?
(e). How likely are the risks of a crash of the U.S. dollar triggered by foreign investors reduced willingness to lend to the U.S. and accumulate U.S. assets?
(f). Will the U.S. dollar strengthen or weaken in the next 2 years and relative to which currencies and why?
Data are available from the Bureau of Economic Analysis: https://apps.bea.gov/iTable/index_nipa.cfm Click “Beginning using the data”, you can find
- Section 1: Table 1.1.5 Nominal GDP. Make sure you modify the time span to set the starting year is 1990, similar for downloading other tables.To do that, when you are on the table page, click “Modify”, then select the years desired.
- Section 4: Table 4.1. You can find current account balance at Row 35.
Data on the net foreign assets of the United States can be obtained from the table on the (Net) International Investment Position (NIIP) of the United States published in the Survey of Current Business, Bureau of Economic Analysis, U.S. Department of Commerce:
Click “Beginning using the data”, choose “International Transactions (ITA)” (Note: Do not use “International Investment Position (IIP)” as this one does not provide quarterly data before 2006). Row 38 of Table 1.1 is the net foreign assets of the U.S. (NIIP). The net stock of foreign direct investment is given by Row 20 minus Row 25.
Branching Paths: The Basics of Exchange Rates.
- Over the last 20 years the Canadian Dollar value has appreciated compared to the US dollar. From the graph, in 2000, the value of the Canadian dollar was 1.35714 against the US dollar but currently stands at 1.20276. On other hand since 2000 the value of the Japanese yen J.P.Y. has greatly declined. This shows a major fall in its purchasing power of 101.48. Currently, the Japanese Yen exchange rate is 109.59 against the U.S. dollar. As a result, one can purchase more J.P.Y. compared to back then. This depicts the loss of value of the J.P.Y.
The value of the Danish Krone has appreciated; this is illustrated by the steady rise of the Danish Krone from 7.3421 to 6.1088 in 2000. Technically one can exchange less Danish Krone for a dollar as the USD gained more value. This shows that Danish Krone has greatly appreciated.
Between 2002 and 2007, the U.S dollar value declined by 40% following the enormous debt the country had accrued. As a result the Euro value increased to $1.46 compared to $0.87 in 2002. This increment was characterized by the paradigm shift in market forces given the innate relationship between the two strong currencies. In the wake of 2008, the Dollar regained it is worth following influx of global investors into the U.S. market due to the favourable investment policies. Consequently, in 2008, the dollar exchange rate declined by 20% while the Euro remained stagnant at $1.46. In 2010, the Euro’s value greatly fell while the Dollar strengthened due to the emergence of the Greek debt crisis that destabilized the European economy(Marthinsen,2020). At the same time the value of the British pound rose from 0.6194 to about 0.7068986, which shows that its value has depleted since a single USD would earlier purchase less GBP than is currently purchasing. The EURO value increased from 1.0316 to 0.821483, thus triggering hefty interest rates, inflation that weakens the US dollar. Towards the end of 2012, the Dollar fell by 10% but later regained itsworh at the end of the year. At the same time, the Euro appreciated by $1.32.
Similarly, the British pound was experiencing a staggering fall, and the Euro was still hovering around $1.32. During the heightened Eurozone crisis in 2013, the Dollar lost against the Euro. By the end of the year, the Euro was worth approximately $1.37, a 5% increment from the previous year. Toward the end of 2014 and early 2015, the Euro to dollar exchange rate dropped to $1.23 and $1.12, respectively, following the mass exodus of investors from the Eurozone as well as the Paris attacks in November. However, on February 11, 2016, there was a sudden economic recovery that triggered the Euro’s rise to $1.13 and the fell to$1.11 on June 25 two days after U.K annexed the UK. Although there were fears of a continuous decline in the exchange due to the ongoing Brexit politics, immediately the United Kingdom voted to leave the European union the market stabilized. In this regard, the British pound rose against the U.S. dollar. However, towards the end of 2016, the Euro fell to $1.04.
The following year the Euro rose to $1.10, and the investors stopped using the Dollar for the Euro amidst the highly controversial political relationship between U.S. and Russia during President Trump’s administration (Marthinsen,2020). In 2018 the Euro continued gaining value against the Dollar but slowly started weakening due to the trade wars in America. The decline spiraled to September 2019, when it then suddenly rose in December. However, in 2020, with the influx of the COVID-19 pandemic, the Euro accented against the Dollar for the rest of the year, reaching a $1.22 high by December. Since then, the U.S. dollar has maintained a competitive lead against the two popular exchange rate currencies and are interchangeably used in the long-standing marketing conventions.
- Currency movement are classified into three distinct movements against the U.S. dollar.According to the Federal Reserve Economic DATA the Canadian Dollar (1980- present) is float relative. Secondly, China (Yuan) 1999-2004 is fixed peg, 2005-2009 is crawling peg, 2009-2010 is fixed Band and 2010-2021, floating relative. Thirdly Mexico (Peso), 1993-1995 ia fixed peg till December 19, 1994, then floating bands to late 1995. 1995-present, floating relative. Next, Thailand (Baht), 1986-1997 is fixed peg, 1997-present is floating band. Finally, Venezuela (bolivar), 2003- present is crawling band.
- Since 1990, the U.S. has been running a persistent account deficit. This is primarily due to advent of the private savings trend among the young people. An increase in consumer consumption lowers savings, which is mostly affected by the interest rates. When there is a decrease in private direct investment, the current account deficit will increase over time. On the other hand, public savings triggers the amount the country can invest across its borders; an increase in public savings will increase the current account deficit due to a lower amount of the overall G.D.P.An increase in the public investment will increase the overall G.D.P. hence helping achieve a proper deficit account balance.
- The U.S. current account deficit greatly differs from other emerging countries’ account deficit since, despite its growth, there is an increase in the overall G.D.P. over time which tends to cushion the U.S. debt over time. The U.S. has not yet accumulated its foreign liabilities above the maximum level, showing that its account deficit is greatly maintained.
- The crash of the U.S. dollar weakened the investors’ willingness to invest in them by lending to them. This greatly contributed to the decline in the overall assets due to the decrease in the amount they could borrow and invest.
- The U.S. dollar is likely to strengthen in the next two years due to a general increase in the overall G.D.P. from time to time. This increase will increase its direct investments and improve its investors’ confidence to invest in its stock, increasing its real value.
Marthinsen, J. E. (2020). Foreign Exchange Basics. In Demystifying Global Macroeconomics (pp. 425-450). De Gruyter.