Business concepts and applications

Business

The first graph shows the evolution of the USD/JPY exchange rate over a period of two years, from 1st of January 2003 to 1st of January 2005. The graph shows us a significant volatility of the exchange rate, but with a constant descending trend. One may conclude upon the analysis of the graph that the U.S. dollars gradually devalued against the Japanese Yen over the period of time analyzes here. At the beginning of the period, the value was somewhere around 120 Japanese Yen for a dollar, while two years later, it ranked only around, which represents a 13.3% drop in overall value.

If we look closer on the graph, we will see brief periods of appreciation for the U.S. dollar in March and June 2004. These may correspond to the periods when the Federal Reserve decided to raise interest rates in the U.S. In order to fight rising inflation. Indeed, in order to encourage economic growth, the level of interest rates in the U.S. had reached some of the lowest levels in history, 1%, before gradually rising (they presently stand at 3%). Each 0.25% increase in the interest rate boosted confidence in the U.S. dollar.

On the other hand, in terms of bilateral trade and direct foreign investments, we may judge that that there was a higher demand for Japanese Yen (hence a gradually increasing exchange rate), which means that imports from Japan into the U.S. grew during this period. This is of course correlated to the actual evidence we have seen in the period analyzed. Indeed, during this time, the U.S. trade deficit grew to some of the highest value in history, reaching close to 60 billion U.S. dollars at the beginning of the year. This helped decrease confidence in the American currency, due to speculations it will not be able to cover this enormous deficit.

In terms of investment, it is a fact that demand for a certain currency will boost up the exchange rate on the respective currency. In this sense, direct investments in a country will mean that foreign investors will need local currency in order to buy their investments. As such, as the demand for the local currency rises, the currency exchange rate increases as well. In this case, it may be less that the American investors increased their holdings in Japanese companies, but more that the Japanese businessmen and investors began to lose confidence in buying U.S. assets, due to the enormous U.S. budgetary and trade deficits. In this sense, Japanese investors were less determined, from the point-of-view of the opportunity cost, to give up investing in Japan and buy American assets and stock. Demand for the U.S. dollars decreased and had a significant impact on the evolution of the exchange rate.

The Indian Rupee-U.S. Dollar exchange rate had the same descending trend, but was less volatile in its evolution than the Japanese-U.S. Dollar rate. Indeed, in two years time, the exchange rate barely varied from 48 Rupees for a Dollar to 44. As such, we may state that the exchange rate remained significantly stable over the period of time we have been analyzing so far.

On the other hand, it is much simpler to explain this decreasing exchange rate from an investment point-of-view. The American companies have found India to be one of the best resources of human potentials in the world. At incredibly low wages, ranging from 2-300 dollars to less than 1,000, one can hire extremely well-prepared scientists, programmers, researchers, etc.

As such, a cheap, but very qualified workforce has determined many American companies to choose India as an excellent place to outsource part or its entire production capabilities. The American investors in India drove demand for the Indian Rupee upwards and increased the rate from 48 to around 44 Rupees for a Dollar.

Explanations for the Mexican Peso-U.S. Dollar exchange rate need to be traced in the particularities of the Mexican-American bilateral partnership. The most important thing that needs to be mentioned is Mexico's extreme economic dependency on the United States. No less than 85% of all exports are to the U.S., with Canada covering most of what is left. Imports, on the other hand, are high as well, almost reaching 90% in many cases. Bilateral trade, as I have previously discussed, affects the exchange rate because it increases or decreases demand for a certain currency. When one's imports surpass the exports, we may assume that the exports need to be paid for in the partner's currency, which means that it will need to be acquired, thus impacting demand. This is the case here as well: a commercial balance with a deficit will devaluate the Mexican Peso.