Foreign Exchange

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Foreign Exchange Paper

A country's currency is a gauge of how well that country's economy is doing. "Currently the United States has a 3% real rate of return. The short-term interest rate is 5.25% and the inflation rate is 2.25% based on the core-rate from the GDP numbers" (Kordell, 2008).

If one compares our real rate of return with other countries; Canada +2.50, Britain +2.50, Euro FX +0.25, and Japan +1.15 one can see that money tended to flow towards the U.S. over the past several years ever since the monetary policy was changed and interest rates in the U.S. started to rise. (Kordell, 2008)

The American dollar has been the world's principal currency since the end of World War II (Wong & Khan, 2006). "Following the breakdown of the Bretton Woods system in 1970, the US dollar has been the benchmark for other national currencies. No other currencies, the deutsche mark, yen or the pound sterling, have come to being a close contender for the dollar's international role" (Wong & Khan, 2006).

"An international currency can be defined as a currency that is used by residents outside the country of issue. It performs the same functions as that of any other national currency- as a medium of exchange, store of value, and unit of account" (Wong &Khan, 2006). Hartmann and Issing (2002) cite the following factors as key to determining the choice of international currency: (1) the size and strength of the domestic economy (2) the depth, breadth, liquidity and degree of openness of the domestic financial markets (3) the convertibility of the currency (4) historical bias. The euro has made considerable developments as an global financing currency. "Recent years have seen an increase in the net issuance of euro-denominated bonds over that of the dollar" (Wong & Khan, 2006).

Table 1 compares the relative economic size and strength of the US, Euroland, and Japanese economy.

United States Euro Japan

Population (million) 270 291 126

Employment (million) 131 114 65

GDP ($bn) 8510 6471 3780

Financial Assets 33828 16648 12414

% of GDP 11.9 16.1 10.5

Share of world exports (%) 16.5 19.0 8.5

Macroeconomic performance

CPI Inflation (%) 2.2 1.1 -0.3

GDP Growth (%) 4.0 2.0 0.5

Unemployment Rate (%) 4.1 10.0 4.6

TABLE 1: THE EURO AREA COMPARED WITH US AND JAPAN

It can be clearly seen that the euro compares positively to the US in most aspects. Population size, employment levels and the value of GDP are fairly close for the Euro area and US and the euro area outperforms the US in terms of the percent of GDP.

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