Sunday, November 25, 2012

How Does A Current Account Deficit Affect The Host Countries Currency

A reader asks, "How does the trade deficit affect the value of the country's currency?"

When a country has a trade deficit, the country imports more than it exports. that means that foreign countries hold American dollars. the foreign country can buy use exports or us bonds. Whatever the foreign country buys will appreciate the dollar. 

There are many factors that influence the value of a country's currency.  AP Economics suggest that income and interest rates are a couple of factors that influence the value of a country's currency.  I would like to add that technical analysis by traders is another factor.  Traders often get a feel for the trend and trade on their gut feeling rather than on supply and demand fundamentals.  

The interested reader should review the relationship between the Current Account and the Financial account to see how imports and capital inflows recorded to make sense of my explanation.

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