The Macro Economy Today 14th Edition Bradley Schiller

CHAPTER 20: INTERNATIONAL FINANCE 437
EXCHANGE RATES: THE GLOBAL LINK
As we saw in Chapter 19, the United States exports and imports a staggering volume of
goods and services. Although we trade with nearly 200 nations around the world, we seldom
give much thought to where imports come from and how we acquire them. Most of
the time, all we want to know is which products are available and at what price.
Suppose you want to buy an Apple iPad. You don’t have to know that iPads are manufactured
in China. And you certainly don’t have to fly to China to pick it up. All you have to
do is drive to the nearest electronics store; or you can just “click and buy” at the Internet’s
virtual mall.
But you may wonder how the purchase of an imported product was so simple. Chinese
companies sell their products in yuan, the currency of China. But you purchase the iPad in
dollars. How is this possible?
There’s a chain of distribution between your dollar purchase in the United States and the
yuan-denominated sale in China. Somewhere along that chain someone has to convert your
dollars into yuan. The critical question for everybody concerned is how many yuan we can
get for our dollars—that is, what the exchange rate is. If we can get eight yuan for every
dollar, the exchange rate is 8 yuan 5 1 dollar. Alternatively, we could note that the price of
a yuan is 12.5 U.S. cents when the exchange rate is 8 to 1. Thus an exchange rate is the
price of one currency in terms of another.
Which currency is most valuable? It
depends on exchange rates.
exchange rate: The price of one
country’s currency expressed in
terms of another’s; the domestic
price of a foreign currency.
FOREIGN EXCHANGE MARKETS
Most exchange rates are determined in foreign exchange markets. Stop thinking of
money as some sort of magical substance, and instead view it as a useful commodity
that facilitates market exchanges. From that perspective, an exchange rate—the price of
money—is subject to the same influences that determine all market prices: demand and
supply.
The Demand for Dollars
When the Japanese Toshiba Corporation bought Westinghouse Electric Co. in 2006, it paid
$5.4 billion. When Belgian beer maker InBev bought Anheuser-Busch (Budweiser, etc.) in
2008, it also needed dollars—more than 50 billion of them. When Fiat acquired control of
Chrysler in 2011, it also needed U.S. dollars. In all three cases, the objective of the foreign
investor was to acquire an American business. To attain their objectives, however, the buyers
first had to buy dollars. The Japanese, Belgian, and Italian buyers had to exchange their
own currency for American dollars.
Canadian tourists also need American dollars. Few American restaurants or hotels accept
Canadian currency as payment for goods and services; they want to be paid in U.S.
dollars. Accordingly, Canadian tourists must buy American dollars if they want to warm up
in Florida.
Some foreign investors also buy U.S. dollars for speculative purposes. When Argentina’s
peso started losing value in 2012–2013, many Argentinians feared that its value would
drop further and preferred to hold U.S. dollars; they demanded U.S. dollars. Ukrainians
clamored for U.S. dollars when Russia invaded its territory in 2014.
All these motivations give rise to a demand for U.S. dollars. Specifically, the market
demand for U.S. dollars originates in
• Foreign demand for American exports (including tourism).
• Foreign demand for American investments.
• Speculation.
Governments also create a demand for dollars when they operate embassies, undertake
cultural exchanges, or engage in intergovernment financial transactions.