1. Mechanics of Foreign Exchange (FOREX)
International Trade
Mechanics of Foreign Exchange (FOREX)

2. Foreign Exchange (FOREX)
The buying and selling of currency
Ex. In order to purchase souvenirs in France, it is first necessary for Americans to sell their Dollars and buy Euros.
Any transaction that occurs in the Balance of Payments necessitates foreign exchange
The exchange rate (e) is determined in the foreign currency markets.
Ex. The current exchange rate is approximately 8 Yuan to 1 dollar
Simply put: The exchange rate is the price of a currency.

3. Appreciation and Depreciation
Appreciation of a currency occurs when the exchange rate of that currency increases (e↑)
Depreciation of a currency occurs when the exchange rate of that currency decreases (e↓)
Ex. If German tourists flock to America to go shopping, then the supply of Euros will increase and the demand for Dollars will increase. This will cause the Euro to depreciate and the dollar to appreciate.

4. Exports and Imports
The exchange rate is a determinant of both exports and imports
Appreciation of the dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper thus reducing X and increasing M
Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively more expensive thus increasing X and reducing M

5. of U.S. Dollars relative to the Euro .: $ depreciates relative to €
Increase in the Supply
of U.S. Dollars relative to the Euro
€ / $ S$
S$ 2 e e1 D$ Q$ q q1
S$ → .: e (ex. rate) ↓ & Q$ ↑
.: $ depreciates relative to €

6. of Yen relative to the Euro .: ¥ appreciates relative to €
Decrease in the Supply
of Yen relative to the Euro
€/¥
S¥2 S¥ e1 e D¥ Q¥ q1 q
S¥ ← .: e ↑ & Q¥ ↓
.: ¥ appreciates relative to €

7. for the British Pound relative to the U.S. Dollar
Increase in the Demand
for the British Pound relative to the U.S. Dollar
$/£ S£ e1 e
D£ 2 D£ Q£ q q1
D£ → .: e ↑ & Q£ ↑
.: £ appreciates relative to the $

8. for Yen relative to the British Pound
Decrease in the Demand
for Yen relative to the British Pound
£/¥ S¥ e e1 D¥
D¥ 2 Q¥ q1 q
D¥ ← .: e ↓ & Q¥ ↓
.: ¥ depreciates relative to the £

9. Exchange Rate Determinants
Consumer Tastes
Ex. a preference for Japanese goods creates an increase in the supply of dollars in the currency exchange market which leads to depreciation of the Dollar and an appreciation of Yen
Relative Income
Ex. If Mexico’s economy is strong and the U.S. economy is in recession, then Mexico will buy more American goods, increasing the demand for the Dollar, causing the Dollar to appreciate and the Peso to depreciate. The stronger economy does the buying.

10. Exchange Rate Determinants
Relative Price Level/Inflation
Ex. If the price level is higher in Canada than in the United States, then American’s will not buy from Canada. The supply of American dollars decreases and the demand for the Canadian dollar decreases. Countries do not buy from countries with high inflation.
Interest Rates
Ex. If U.S. investors expect that Swiss interest rates will climb in the future, then Americans will demand Swiss Francs in order to earn the higher rates of return in Switzerland. This will cause the Dollar to depreciate and the Swiss Franc to appreciate. Countries will invest their money in the countries with high interest rates.

11. Big Graphs 15 and 16!!
Foreign Exchange

12. Graph for both countries and list the determinant
1. The interest rate in the United States is decreasing to very low levels. Graph for the US and Japan.

13. Graph for both countries and list the determinant
2. Inflation is high in England. Graph for England and the US.

14. Graph for both countries and list the determinant
3. Americans are buying more and more Hyundai cars. Graph for Korea and the US.

15. Graph for both countries and list the determinant
4. Mexico’s economy is doing very well. Graph for Mexico and the US.

16. Expansionary Monetary Policy to Counteract a Recession w/ reinforcing effect on Net Exports
Res. Ratio
Disc. Rate
Buy Bonds →
ER , therefore MS causing nir which leads to IG → → → → → =
so AD , resulting in PL and GDPR , making u% → → → →
And now! Because nir either D$ or S$ which causes $ making U.S. goods
relatively and foreign goods relatively causing X &
M which means XN thereby reinforcing the increase in AD already caused by
the increase in IG. → → ← ←
cheaper
more expensive → → →
AD = Aggregate Demand
PL = Price Level
GDPR = Real Gross Domestic Product
u% = Unemployment Rate
S$ = Supply of Dollars in FOREX
M = Imports, XN = Net Exports
ER = Excess Reserves
MS = Money Supply
nir = Nominal Interest Rate
IG = Gross Private Investment
D$= Demand for dollars in FOREX
X = Exports

17. Contractionary Monetary Policy to Counteract Inflation w/ reinforcing effect on Net Exports
Res. Ratio
Disc. Rate
Sell Bonds →
ER , therefore MS causing nir which leads to IG → → → → = →
so AD , resulting in PL and GDPR ,making u% → → → →
And now! Because nir either D$ or S$ which causes $ making U.S. goods
relatively and foreign goods relatively causing X &
M which means XN thereby reinforcing the decrease in AD already caused by
the decrease in IG. ← ← → →
more expensive
cheaper → → →
AD = Aggregate Demand
PL = Price Level
GDPR = Real Gross Domestic Product
u% = Unemployment Rate
S$ = Supply of Dollars in FOREX
M = Imports, XN = Net Exports
ER = Excess Reserves
MS = Money Supply
nir = Nominal Interest Rate
IG = Gross Private Investment
D$= Demand for dollars in FOREX
X = Exports