How is the significance of a country's economy assessed to draw such conclusions
To evaluate a country's economy, economists usually use the measure known as the current account. The current account is "the combined balances on trade in goods and services, income, and net unilateral current transfers" (Weinberg 2006). The worsening current account deficit must cause permanent depreciation of a national currency. To economists' surprise, in case of the US, the growing current account deficit produces periods of appreciation of the US currency. Such were the periods from 1995 to 2002 and 2005 (Roubini 2005).
Roubini claims that the current account deficits may be related to the appreciation or depreciation of a currency (2005). A national currency weakens when the inflow of capital in the country cannot fully finance a current account deficit, that is, the supply of financing from the capital account is low (Roubini 2005). As it is seen, capital inflows and outflows play an important role in this relation. Short-term and long-term interest rates, political risk factors, the GDP growth rate and other economic factors determine the capital flows and are the direct causes to the currency fluctuations. Roubini calls all these "the law of gravity" for a currency (2005).
Still, as it was mentioned above, sometimes the laws of gravity are defied (Roubini 2005). ...Show more