Exchange Rates and Agricultural Trade

1. Exchange Rates and Agricultural Trade Chapter 17

2. Discussion Topics • Exchange rates and the foreign exchange market • Exchange rate determination • Exchange rates and U.S. agricultural trade

3. Exchange Rate Defined • Exchange rate: The no. of units of foreign currency (i.e., Mexican peso) required to obtain 1 unit of domestic currency (i.e. U.S. $) • Reciprocal of this rate: No. of units of domestic currency required to obtain 1 unit of foreign currency • Value of domestic currency relative to foreign currency (i.e., value of the $ relative to the £ or ¥) Page 335

4. Exchange Rate Defined • When the value of the dollar appreciates in value, the exchange rate index increases • A depreciation of the value of a dollar causes the index to decline Page 337

5. Canadian dollar (per U.S. dollar) of 1.305 → 1.31 Canadian dollar exchanges for 1 U.S. dollar • British Pound (in U.S. dollars) of 1.82 → a British pound exchanges for almost $1.82 in U.S. currency Page 337

6. Exchange Rate Determination • Only 25 countries, including the U.S., Japan and Canada allow their currencies to float independently • Determined by supply and demand for these currencies • Most countries peg or “fix” their currency relative to another currency or basket of currencies Page 345

7. Exchange Rate Determination Demand for U.S. $ • Foreign demand for U.S. $ neg. sloped • Lower exchange rate → cheaper for EU to import U.S. goods/services • ↑ demand for U.S. $ to pay for imports • Supply of U.S. $ positively sloped • Higher exchange rate → Imports to U.S. relatively cheap • Convert $ to foreign currency, more $ available to market Supply of U.S. $ 5 4 3 Euros/$ Exchange Rate 2 1 10 30 40 20 50 Quantity of $ Traded (Mil./Day) Page 348

8. Exchange Rate Impacts An increase in the value of the dollar (relative to the Yen) makes U.S. exports more expensive Page 352

9. Exchange Rate Determination • Interest rate differentials across countries are a major factor affecting demand for currency • ↑ in U.S. interest rates relative to other countries • Foreign investors would transfer funds to the U.S. to generate higher returns → ↑ in demand for U.S. $ Page 348

10. Exchange Rate Determination Supply of U.S. $ 1.5 1.4 1.3 U.S. $ Demand w/ ↑ in IR Euros/$ Exchange Rate 1.2 1.1 U.S. $ Demand 10 30 40 20 50 Quantity of $ Traded (Mil./Day) • An ↑ in demand for U.S. $ as U.S. interest rates ↑ • Exchange rate goes from 1.30 to 1.433 Euros/$ Page 348

11. Exchange Rate Determination • Balance of Trade has an impact on exchange rates • U.S. trade deficit (U.S. imports > U.S. exports)→ exchange rate ↓ • U.S. exports become relatively cheap for other countries • U.S. imports of other countries goods become more expensive • U.S. exports will ↑ & U.S. imports will ↓ • →Approach balanced trade levels Page 348

12. Exchange Rate Determination Supply of U.S. $ Supply of U.S. $ resulting from trade deficit 5 4 3 Euros/$ Exchange Rate 2 1 U.S. $ Demand 10 30 40 20 50 Quantity of $ Traded (Mil./Day) • Trade deficit → an ↑ in supply of U.S. $ on currency markets • → weakening of the U.S. $ • →↓ in exchange rate from 3 to 2 Euros/$ Page 348

13. Exchange rate ↑→ exports tend to ↓ • Exchange rate ↓→ exports tend to ↑ Page 351

14. Summary • Exchange rates have an impact on U.S. agricultural trade • The value of foreign currencies is determined in the foreign exchange market. • Exchange rates have a significant impact on our trade balance

15. Chapter 18 discusses the reasons why nations trade….