Yes, I do believe that once appreciated dollar may or may not go further appreciating because although the exchange rates are determined by the free demand and supply of currencies in forex market there are always various impacting factors that create uncertainty.
My first assertion goes like, an appreciated dollar definitely helps to make a dollar stronger and weaker Swiss franc, ultimately making the imports for the USA cheaper and expensive for the Swiss franc. The Purchasing Power Parity (PPP) of the US currency increases but other the other hand due to the oversupply of the US currency in the foreign exchange market, the exchange rate diminishes. So here the US dollar may not remain appreciated, as we should not forget that in times internal exchange rates and interest rate converges to maintain their normalcy.
But, I would further like to add that, if we examine the Real Exchange Rate(RER) between the US and Swiss franc, we can find that RER=e Sf/$(Price index US/Price index Sf), so from the above equation also we can see that the strength of currency not only depends on the exchange rate(e) but also in their relative prices which are defined by the price indices in respective economy. To take an example even if the US dollar appreciates, i.e., from $1=1.5Sf to $1=1.75Sf, if the price level is higher in Swiss in compare to the US the result would be different, in reality, the exchange rate is inverse to the inflation.
The similar inference could be generated from the concept of Purchasing Power Parity (ppp $/Sf)=e$/Sf * (PIUS/PI$/Sf), the higher inflation leads to the decrease in the exchange rate of the USA. Except for these factors like current spot market rate, forward market rate, domestic interest rate, foreign country interest rate, availability of the loanable funds also impacts the exchange rate of the dollar.
Further another school of thought may also happen if we assume the transactional cost and government intervention to be null. The high appreciated US currency could be arbitrage in the market with the lower exchange, ultimately leading to depreciate its value. But the chances of happening are null. Similarly, the availability of the derivative markets, i.e., forward market, future markets, options, and swaps will also impact the consistency of the dollar exchange rate.
In this case, if the US importers initially if plans to hedge the risk of Swiss franc appreciation he can contractually bind into the forward contract, the importer for the USA supply the currency in the foreign exchange spot market to be exchanged for Swiss franc, this creates upward pressure in the domestic interest rate of USA(due to low availability of domestic currency), now as this fund enters into the foreign exchange market ,the supply of the US dollar creates a downward pressure depreciating the USA dollar and appreciates the Swiss franc(condition where the dollar depreciates). Now here if the importer form the USA plans to hedge his risk of dollar depreciation, he goes into the forward contract demanding the USA for defined transaction which puts the upward pressure in the forward rates and ultimately when the transaction is made by the USA, there will be enough supply of fund in Swiss franc and downward pressure in the home interest rate of Swiss. So here we saw that the foreign exchange market was adjusted automatically.
So from the above assertions we could support the statement that once appreciated dollar while making a Swiss purchase may not maintain its consistency as factors like inflation, real and nominal interest rate, investors motives towards hedging, home country foreign exchange rate regime(floating or fixed exchanged), currency war(devaluation and revaluation as in the case of China and USA), status of balance of payment , trade deficit et cetera comes into the action which may lead to appreciate, depreciate or even maintain the same rate.
Bibliography
Appleyard, D. R., & Field, A. J. (2014). International Economics. Irwin: McGraw-Hill.
No comments:
Post a Comment