Question:
Hello. First of all, this idea about answering economic questions is just wonderful and very helpful to simple citizens, but to people like me, too, who are studying economics and want to ask some things. My question has to do with the rate between two currencies. I know the basics but I would like a deeper answer on what it means for the countries the two currencies represent. For example, how can we understand which country is more powerful when we know the rate between their currencies. A few examples, such as with the euro and dollar, would be appreciated in order to understand it better. Thank you in advance!!Answer:
The rates don’t reflect relative power. For example, 1 UK pound equals about 1.56 USD. That does not at all mean that UK is more powerful. Similarly, a US dollar approximately exchange for 122 Japanese yen currently. By no imagination, it means that the US is multiple times more powerful than Japan.
What matters is the percentage change in the rates over a span of time. For example, euro in last one year has depreciated against US dollar, that is, one euro now buys less USD and vice versa. At its root lies the relative demand for currencies: the demand for US dollar vis-à-vis euro has increased. It is both due to increased demand for US goods as well as US assets, bonds and equities, relative to their European counterpart. Why the demand has increased in turn has do with their relative macroeconomic situations. US economy has picked up growth recently while most European countries are undergoing deep to moderate recession. This has led to a capital outflow from European countries towards the US thus raising the relative demand for USD.
