The U.S. Economy and Foreign Exchange

The foreign exchange market establishes global commerce. In the United States, citizens monitor the value of the dollar, as it relates to the domestic economy and political environment. Beyond these domestic issues, the strength of the U.S. dollar is a leading indicator for the overall global economy. Recognize the factors that influence foreign exchange market performance in America, before planning your own financial strategy.

Foreign Exchange Market

The foreign exchange market describes the vast network of private individuals, corporations and financial exchanges that trade dollars for international currencies. In the United States, smaller savers may exchange dollars for foreign currencies at branches of larger banks, such as Bank of America and Wells Fargo. Meanwhile, investors may set up accounts to trade currencies through financial exchanges, such as the Chicago Mercantile Exchange. Currency values are identified with foreign exchange rates, which describe the amount of one currency that must be presented to receive one unit of another international banknote.

Beyond banknotes, the U.S. foreign exchange market also includes currency derivates, such as options, futures, and forwards. Currency derivatives manage risk, by locking in set foreign exchange valuations for particular time frames.

The Value of A Dollar

The value of the dollar fluctuates according to America’s economic climate. In general, strong dollar values emerge as an endorsement of U.S. business strength. At that point, foreigners covet American stocks, bonds, and real estate, and must trade for dollars to purchase these investments. The additional demand for dollars supports higher domestic currency values.

Alternatively, weak exchange rates for the dollar are often associated with domestic recession. In recession, foreigners liquidate their American holdings for cash, and convert these dollars back into their respective home currencies. Further, the Federal Reserve Board reacts to recession with debt monetization, where it purchases outstanding U.S. treasuries with cash. Debt monetization effectively increases the supply of dollars in circulation, which causes dollar values to depreciate.

Imports and Exports

Developments within foreign exchange markets carry major implications for U.S. imports and exports. High values for the dollar translate into relatively cheaper prices for imported goods. Beyond imports, Americans often take advantage of strong dollars to plan overseas vacations. Strong dollar values, however, adversely affect the export economy. At that point, American goods become more expensive on the international marketplace. Conversely, lower dollar values benefit U.S. exports, because American goods then become relatively cheaper, overseas.

U.S. Treasuries

Strong dollar values are not always associated with a growing domestic economy. Dollar values often appreciate amidst global financial panic, where investors covet the safety of U.S. Treasuries. Treasuries are actually government debt securities, and are acknowledged as the world’s safest investments. The Federal government carries powers to tax and create money to repay its debt. Therefore, U.S. Treasury investors are never concerned about default risks.

Inflation Risks

Low exchange rates are inflationary, because they increase the costs of imported goods. Further, low exchange rates carry political risks, as angry citizens will point to weak dollar values as evidence that government officials are mismanaging the economy. Meanwhile, foreign investment may decline further, as international investors become wary of foreign exchange losses.