Currency Strength and Exchange Rates
On the international market, currency values are set by central banks according to estimates of supply and demand. Changes in the value of currency have a direct effect on international trade. When people in country A demand goods from firms in country B, they must purchase the country B's currency in order to buy the goods.
Just as supply and demand for goods and products can move and shift the the product prices, constant movements in supply and demand for foreign exchange currencies issue price changes in currencies. The effect of this is that the price of money changes as demand for foreign currency changes. This is termsed the foreign exchange rate, or the price of foreign currency expressed in terms of U.S. currency (or expressed relative to the subject's domestic currency).(Casey 2011) The foreign exchange rate expresses the quantity of United States dollars it will require to purchase a unit of foreign currency. The foreign exchange rate is commonly described as “floating” because its value shifts daily according to international levels of supply and demand for currency. (Gomes 2014)
Several factors can increase the demand that exists for a currency. If country B sells their products at a lower price than equivalent substitutes sold domestically in country A, consumers in country A will increase demand for imports from country B. If incomes in country A rise or if the inflation rates in country A are higher or exceed those in comparable countries, import demand will rise also. This is similar to the fact that in capital markets, if country B's interest rate is higher than domestic interest rates in country A, some people in country A will choose to buy securities in country B. (Gomes 2014) When activity by persons in country A increases in country (such as when imports increase, or foreign investments increase), country A's demand for the domestic currency of country B necessarily rises. An increase in demand has an affect on the price of the currency by pushing it higher, and the currency appreciates.
When consumers in country A use their domestic currency to buy the currency of country B, when the demand for foreign currency increases then the international supply of domestic currency from country A also increases by proportion. As supply of country A's currency increaes, then its price thereby falls, and this results in currency depreciation.
In today's international markets, the suppy and demand for currency and the values exchange for currency bears effect on the demand for imports and exports. In the case of the United States for example, if domestic USD are strong relative to worlwide currencies, USD are considered to be comparatively valuable and from the domestic US citizen's point of view, foreign currencies are by comparison less expensive. The inexpensive price of foreign currencies means we can purchase foreign currencies for cheaper rates, and in this context the prices of products in foreign countries appear much lower than we may expect. When prices are lower, the quantity demand thus rises. This means that when USD are strong, citizens tend to buy a greater amount of imports on world markets. US importers like those running grocery store retail chains, gas stations, and big box electronics stores are able to buy goods at a cost difference to what they are able to sell domestically. The cost margin allows retailers leeway are to sell those goods to US domestic customers using various cost strategies as a way to increase demand and thus increase profits. (Gomes 2014)
On the converse, however, there is a flip side. For when a domestic currency (such as our case of the USD) is strong, buyers in foreign countries consider our currency expensive, effectively making our domestic products more expensive than avilable alternatives. In this position, US exporters are forced to lower prices in order to attract demand and as a result the receive lower porfits. give up more of their currency to buy dollars. As a result, the prices of our products appear more expensive to them. In this way quantity demanded lowerr, which may be damaging to some US exporters whose profitability model relies on the cost surplus they glean from importing and reselling at a cost premium. (Gomes 2014) The consequence of strong currency is a trade deficit. Imports rise, while exports fall. A consequence of this idea, however, is that the flow can be self correcting over some time. As a country's exports increase, its currency value may appreciate over time. (Godley et al. 2007) Likewise, as a country's exports decrease, its currency value may depreciate.
References
Cassey, Andrew J & Dhanireddy, Davan (2011). A primer on exchange rates and exporting. Washington State University – Economics Series. Retrieved from http://cru.cahe.wsu.edu/CEPublications/EM041E/EM041E.pdf
Gomes, Joao (2014). What a robust dollar does for US business and the global economy. Knowledge at Whartom. Retrieved from http://knowledge.wharton.upenn.edu/article/what-a-robust-dollar-means-for-u-s-business-and-the-global-economy/
Godley, W., & Lavoie, M. (2007). A simple model of three economies with two currencies: the eurozone and the USA. Cambridge Journal of Economics, 31(1), 1-23.
