International Finance

Topics: United States dollar, Dollar, Foreign exchange market Pages: 5 (1854 words) Published: May 6, 2011
Question 1
a. The dollar is presently weak and is expected to strengthen over time. These expectations affect the tendency of U.S investors to invest in foreign securities because the value of U.S dollar decrease will lead to the U.S company get less profit and earn less money. Consequently, U.S companies will pay fewer dividends for investors who invest in these companies. So, investors will tend to invest in foreign securities where they can get higher dividend. On the other hand, a weak currency can reduce unemployment but maybe it can lead to high inflation, and simultaneously it may reduce U.S imports and boost U.S exports or buy more goods than it sells abroad (imports exceed exports). Another thing, in the long run, trade deficits may be expected to contribute to a weaker dollar, as the economy adjusts to create the surpluses needed to repay foreign investors. However, in the short run, the relationship between the trade deficit and the dollar is weak, and the value of the dollar is determined largely by investor preferences for U.S. dollar assets. On the other hand, when U.S dollar is strong again, it will make the value of U.S dollar increase. A strong dollar will make exports more expensive to foreign consumers and also make imports cheaper. Hence, it encourages imports and reduces exports, and maybe increasing the balance of trade deficit. However, when the U.S dollar has stronger than other dollars such Singapore dollar, Yen, Euro or Canadian dollar, the value of the U.S dollar is a dependant variable by which it is determined by supply and demand. The consumptions will reduce and exports are the same, and against imports will increase. So it will make to enlarge the U.S balance of trade deficit. For instant, in 2006, U.S exports to China were about $55 billion, but imports from China were about $255 billion, which result in a balance of trade deficit of $200 billion with China (Jeff Madura, 2008, p.26). b. A current account deficit in the U.S will explain that the use demands of U.S dollar to buy U.S exports is lower than other currency countries to buy imports. When the value of U.S dollar decreases, making imports will be cheap and exports will be more expensive. And then, U.S consumers will change their purchases from imports to domestic produced goods, and consumer’s other countries will purchase export goods more than home produced goods. Another thing, a floating exchange in a country’s trade suggests that the country needs to spend more fund on foreign products than it needs to receive from exports to foreign countries. Because when it sell its currency in better volume than the foreign demand for its currency, at that same time, the value of its currency should reduce and encourage more foreign demand for its goods in the future. On the other hand, this is to cut expenditure policies of any government to reduce demand in the economy and to reduce consumer spending in the economy such as increasing taxes and interest rate. In addition, if consumer spending will fall in the economy, spending all goods and services will fall. And this will reduce a current account deficit. Otherwise, a recession or inflation also is big problem on adjustment to reduce a currency account deficit. c. It is true that U.S current account deficit could not have increased without any financing support from countries with current account surplus. A country’s international trade flows are affected by inflation, national income, government restrictions, and so on. But they will not always be determined by exchange rate in an economy. For example in an economy where wages and price are flexible, the GDP will settle at the level of full employment, and then it determines the size of savings and investment. Likewise, when a local currency is strong, foreign investors will be willing to invest in the country’s securities to benefit. On the other hand, when investors feel that investment is not secure if the local currency is...
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