Becomes imbalanced at times as part of the natural

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becomes imbalanced at times as part of the natural development of the globaleconomy.During 2003-2007, the euro was overvalued versus the US dollarusing the purchasing power of FX value, yet the United States continued tohave a trade deficit with the Eurozone, the opposite direction of tradeimbalance that the ILOP theory would suggest. Moreover, the extent of theeuro’s overvaluation grew throughout this time period. Warren Buffett said inMarch 2008 that the euro would continue to appreciate as long as the UnitedStates continues to import more from the Eurozone than it exports.Another reason that concern over trade imbalances has subsidedsomewhat is the global use of hard currencies. For example, US dollars sentto countries outside the United States for imports are not always returned forgold or official FX reserves. Instead, US dollars often serve more or less as aninternational currency. If US officials were to try to create a depreciation of theUS dollar to correct a trade deficit, confidence in the US dollar as internationalcurrency would drop.22Several views on the trade deficit are in Kenichi Ohmae, “Lies, DamnedLies, and Statistics: Why the Trade Deficit Doesn’t Matter in a BorderlessWorld,”Journal of Applied Corporate Finance, Winter 1991, 98-106, and M.Pakko, “The U.S. Trade Deficit and the ‘New Economy’,”Review of the FederalReserve Bank of St. Louis, September/October 1999, 11-19.
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Chapter 5 / Exercise 5
International Financial Management
Madura
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11Figure 2.2. How the iPhone Widens the US Trade Deficit with China.Source: ADBI working paper 257, Tokyo: Asian Development Bank Institute, Y. Xing; N. Detert, 2010
12February 2004The euro rose by 50% against the US dollar since its low in July 2001. SinceJanuary 2002 the euro rose against the greenback by roughly twice as much as theyen, sterling or the Canadian dollar. When the US dollar first started to drop, America'seconomy was weak, but in February 2004, it was growing far faster than theeconomies of the euro area and Japan. So why was the US dollar still dropping? Giventhat stronger growth in America than elsewhere could cause the high US trade deficitto swell still more, a fall in the US dollar is both inevitable and necessary to reduce thedeficit by making imports dearer and exports cheaper.In the past, the US supported a strong dollar, yet today is thriving on a weakerdollar. The lower FX price is boosting exports and profits. As yet, the weaker dollar hasnot pushed up import prices. Foreign exporters tend to fix their prices in dollars, andhave held prices down. Instead, they have trimmed their profit margins. One bizarreresult is that some German cars are now almost 30% cheaper in America than theyare in Europe. But there is a limit to how much firms can squeeze profits; eventually afalling dollar will push up prices, reducing imports.The current "strength" of the euro is often exaggerated. As recently as 1995the currency (as calculated from a basket of the national currencies that preceded it)was trading much higher, at the equivalent of $1.37. The euro's trade-weighted value

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Term
Spring
Professor
Krapl,A
Tags
Exchange Rate, Purchasing Power Parity, United States dollar, FX rate
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International Financial Management
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