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How Does The Exchange Rate Exactly Works?
By: Ispas Marin
The exchange market mechanism can be pretty confusing for a person who doesn’t
have specialised knowledge in this area. The connection between the exchange
rate of a currency and its trade deficit may seem like an undecipherable
mystery. In order for you to understand the hidden mechanism of the exchange
market and the trade deficit, we’ll discuss and explain the American-Canadian
Trade and Exchange relationship.
The first thing you should know, in order for you to have an accurate idea of
this matter, is that Canada is USA’s largest trading partner with 20% of the US
foreign trade.
Whenever you are analysing a trade relationship between 2 countries, you should
look at the exchange rate and international trade data. Make sure you are
analysing the data concerning at least 2 years of trade, in order to draw the
right conclusions. For instance, if you were to analyse the data for 2002 and
2003, you would notice that the CDN DOL column is displaying the number of
Canadian Dollars that can be bought in exchange for one US Dollar. A bigger
number on this column means that the US Dollar is appreciating; it gets stronger
and can buy more Canadian Dollars. On the other hand, whenever the number is
decreasing, it means that the US Dollar is depreciating, it gets weaker, and it
can buy less Canadian Dollars.
You should also pay attention to the second column, named CDN DEF, which is
displaying the amount of the trade balance between the United States of America
and Canada. If you find only negative numbers in this column, you should know
that this fact means that US is facing a trade deficit when it comes to its
Canadian trade relationship. You should also keep in mind that the numbers in
this column are usually expressed in millions of US Dollars.
A quick look on the data for 2002 and 2003 will instantly tell you that the US
Dollar has depreciated quite fast compared to the Canadian Dollar. For instance,
the data for October 2002 shows that 1.58 Canadian Dollars were bought for 1 US
Dollars. But the data for October 2003 shows that 1.32 Canadian Dollars were
bought for 1 US Dollars, meaning that the US Dollar’s strength has weakened.
Nevertheless you will notice that the trade balance remained the same over that
period.
If you wonder about the connection between the exchange rate and the trade
balance, well, here it is. The relationship between these two is quite simple:
whenever the exchange rate goes up, the trade is going down, and the other way
around. A positive number shows that the trade deficit increases when the
exchange rate is going down.
In conclusion, whenever you analyse the relationship between the exchange rate
and the trade balance, you will come across the numbers for the trade deficit.
Always keep in mind that things aren’t as simple as they look, so, in order to
reach an accurate conclusion, you have to analyse a lot more numbers than these.
About the Author:
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