The U.S. dollar has fluctuated in value against other currencies since the early

Question

The U.S. dollar has fluctuated in value against other currencies since the early 1970s. The value of a currency is determined by the supply and demand for the respective currency in a particular country. Discuss the factors that influence supply and demand for the U.S. dollar in foreign exchange markets. How do these changes affect consumers and businesses that operate only in the U.S.? In addition, consider recent events (those from the last two years or less) that may have affected the U.S. dollar’s strength or weakness. Examples include recent elections or government activity, U.S. debt and rating, interest rates, and the like.

Explanation / Answer

Factors influencing demand and supply for the U.S. Dollar

When we export products or services, we create a demand for dollars because our customers need to pay for our goods and services in dollars. Therefore they will have to convert their local currency into dollars, so they sell their currency to buy dollars so that they can make the payment. In addition, when the U.S. government or large American corporations issue bonds to raise capital, and if these bonds are bought by foreigners then again the bonds have to be paid for in dollars and the customer will have to sell their local currency to buy dollars so they can effect payment. Also, if there is strong growth in the U.S. and companies are expanding their earnings then the desire by foreigners to own corporate stocks in the U.S. also requires that they sell their currency to buy dollars to pay for the purchase of stocks.

These situations create more demand for dollars, and that in turn puts pressure on the supply of dollars, increasing the value of the dollar relative to the currencies being sold to buy dollars. On top of this, the U.S. dollar acts as a safe haven during times of economic uncertainty, so demand for dollars can often persist despite the performance of the U.S. economy.

Impact on consumers and businesses

a change in the exchange rate can, in the short run, affect the demand for and supply of commodities, and the competitiveness of US agriculture. When the US dollar strengthens or gains in value, it causes importers to pay more for the US dollar to buy US commodities. While a stronger US dollar increases prices for importing (foreign) countries, it decreases the demand for US commodities abroad. It also decreases US domestic prices and increases the number of domestic commodities. This could seriously affect the profitability of an enterprise, especially in cases where profit margins are already thin. However, when the US dollar is strong, US businesses and consumers can purchase foreign goods and services at cheaper exchange rates (e.g., US$1 = 104 yen). This encourages foreign imports because US importers can pass on some of the cost savings to US consumers in the form of lower prices. By and large, US consumers benefit from a strong US dollar. In general, while a strong US currency makes our goods less competitive abroad and at home, which could negatively influence a farm's profitability, it also makes imported goods from abroad cheaper, and our commodities (locally produced) less competitive in the domestic market. This encourages imports and discourages exports.

Events that affected dollars

Bernie Madoff and the $50 billion Ponzi Scheme

Fluctuation of the dollar triggered by consumer confidence, regulatory missteps,

The deception was the stuff of movies. The losses totaled more than the GDP of Monaco. The criminal behavior began decades before the collapse of Bernard Madoff’s investment firm. In the end, it is estimated that Madoff misappropriated more than $65 billion in investor’s money over the course of a storied career as an investment chief and one-time chairman of NASDAQ. Victims ranged from humble husband and wife investors to high-profile celebrities like Steven Spielberg.

The impact on the stock market was drastic, and not just here in the United States. With investors around the world seeking Madoff’s historically unbelievable returns of 10-12% annually, foreign losses were staggering. Some firms lost nearly half of their invested assets, while others simply closed up shop and failed altogether. The lack of confidence in the stock market created stock value drops and a commensurate devaluation in the dollar.

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