Tuesday, March 10, 2009

Econ 101: Exchange Rates

What determines the exchange rate? The simplest answer is supply and demand. Suppose you are sitting in England and have some savings in pounds and want to buy an asset in the US. To do so, you must sell your pounds for dollars because US based assets are priced in US dollars. This raises the demand for dollars and increases the supply of pounds - leading to an increase in the exchange rate between dollars and pounds. It now takes more pounds to buy dollars than it did before.

The New York Times has a nice article on the rising dollar. In it the author stresses the flight to safety - foreigners are snapping up US Treasuries. This is good for the government, because it keeps the cost of borrowing money low. But the rising dollar is bad for US exporters (and Oregon is one of the states most dependant on exports) because it raises the price of US goods abroad. So people and businesses from all over the world that are worried about loaning money to just about anyone, will still loan to the US government because it has the lowest risk of default of any entity out there. Since it takes dollars to buy treasuries, this raises the demand for dollars and increases the supply of just about every other currency. Voila, a rising dollar.

But it is not just the demand for US treasuries that is causing an appreciation in the dollar (though surely it explains most of the rise), there are also some other anecdotal snippets, like this story about foreigners snapping up houses in Detroit. If Australians and Brits are coming over here to but property, they are bringing with them their own currencies and will have to convert them to actually make a purchase which reinforces the appreciation of the dollar against those currencies. 

1 comment:

OregonGuy said...

But, the beautiful thing for Americans buying American goods is, we should be indifferent to changes in the value of the dollar when making those purchases. It's only when we look to imports that exchange rates become important, and only serve to underscore the benefits of trade.

If Oregon exports are of real concern, perhaps our efforts are best led by a desire to increase our competitive advantage. But, in the current political environment, how could that occur?