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Factors Influencing Exchange Rate Between the US Dollar and Euro - Essay Example


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Factors Influencing Exchange Rate Between the US Dollar and Euro

The various factors that are considered as influencing factors on dollar-euro exchange rate are the international real interest rate differential, relative prices in the traded and non-traded goods sectors, the real oil price, and the relative fiscal position (Dollar-euro currency exchange). A look into the various analytical works prove that the main reason behind the present fall in dollar value is the large trade deficit, which, in turn, was created by the flow of foreign investment dollars into the US economy. One can say undoubtedly that the world countries will not let the dollar go down as such a fall will adversely affect their own national interests. To illustrate, the US economy offers more return on capital than its European counterparts. As a result, foreign governments, especially the Asian giants like China, Japan and India, have purchased considerable amounts of US dollars as reserve backing for their own currencies. So, a significant fall in the dollar will have an adverse impact on these investor economies. Admittedly, the present day fall in dollar value is primarily as a result of the decline in private foreign investment and is in no way connected with foreign governments. Before its fall, dollar witnessed a sharp rise against the euro, and because of this growth, there arose a belief among private investors that dollar has become too expensive to afford. So, there was a natural shift towards euro as the only other option. As a result, dollar came down the way it went

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up. Now, experts point out that as far as America manages to offer a higher return on investment, it will remain as the primary destination of investment for foreign banks and private investors. As the demand for dollar will grow again, the current deficit will be overcome. However, there are certain governmental initiatives that have already tarnished the image of America as an investor-friendly nation. Some examples are the Patriot Act and the Sarbanes-Oxley Act. As a result of such provisions (as reported by The Economist ) that require extensive paperwork and offer the threat of privacy intrusion, foreign investors have lost interest in the America economy. In the opinion of Gene Epstein, in order for dollar to further collapse, there conditions should exist at the same time. First of all, there should be an existing weakness for dollar that makes investors look for other options. Secondly, there should be another more beneficial option, and thirdly, there is the need for a triggering event. It is pointed out by the scholar that the first option is already in place. This is so because dollar has already fallen by more than 30% in a period of one year. However, the problem is that there is no viable alternative at present for dollar. According to Epstein (2011), this is so because while 61% of the foreign currency reserves are in dollars, the nearest rival euro only has 30% of the reserves. In addition, there is the debt crisis faced by the euro-zone. As a result of all these, one cannot consider euro as a viable alternative to dollar. The third point is the occurrence of a triggering event. In the case of dollar, a possible triggering event is the dumping of treasury notes on the secondary market by foreign governments. If such a measure is taken by countries like China or Japan, there will be panic in the market leading to dollar collapse. However, a look into the business tactics of these nations proves that such a step is unlikely


Factors Influencing Exchange Rate between the U.S. Dollar and Euro Factors Influencing Exchange Rate between the U.S. Dollar and Euro A look into the performance of dollar shows that it fell by 30% against euro in the year 2010…
Author : barryfriesen
Factors Influencing Exchange Rate Between the US Dollar and Euro
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