In Reading 20, the text says that “about one-third of the projected BRIC GDP growth should come from rising exchange rates”. Can someone conceptualize this for me - I think i’m starting to confuse all of these relationships.
How will rising exchange rates increase GDP? And more broadly, can someone summarize the relationship between a country’s exchange rate and its growth & expansion / recession ??
I tend to think that a currency will increase in value with growth and or rising real interest rates. However, at some point this can reverse if the current account deficit causes deflation. Also, maybe if things get too hot that rates are raised so high to control inflation and ultimately slow the economy down enough to cause rates to decrease.
The problem is that it’s all cyclical so of course the relationship never really ends. Does my description above generally capture the relationship btw exchange rates and economic conditions?
Thanks in advance!
I think there is a key term missed in the statement:
“about one-third of the projected BRIC GDP growth should come from rising exchange rates”.
it reads in the book as
“about one-third of the projected BRIC USD GDP growth should come from rising exchange rates”.
The GDP is being measured in USD. So I am thinking actually the currency is appreciating against the USDollar - - which means USD is depreciating - so more USD is available for each Rupee(I)/Yuan©/Real(B)/Ruble®.
Does this make sense?
That does. But how does currency appreciation contribute to economic growth? Is there a general relationship btw a currency’s value and the strength of the economy?
i think cpk’s answer is really what you are looking for in terms of the context you gave above.
To ask the general relationship betw a currency’s value and the strength of the ecnomy is asking something different i think. generally a stronger currency hurts exporters (and so GDP) but too weak a currency may lead to currency flight and a crisis in the capital account…
The text, particularly the BRICs reading, makes it seem like strong, growing economies coincide with and are partly the result of appreciating currencies (or maybe that’s my interpretation).
I’m wondering generally how currency appreciation contributes to economic growth. Is there a positive correlation between the two (ie a strong currency and a strong economy)?
I always seemed to think that a weaker currency value was almost preferred bc it led to increased exports, increased domestic aggregate demand, and a current account surplus.
capital inflows and investment
There is a new paper in the CFA Research Foundation series titled “Currency Investing” that I’m looking at right now. It mentioned on page 30
“An economic principle known as the Balassa–Samuelson hypothesis predicts that the countries that have experienced high productivity gains and higher real income growth are likely to have appreciating curren- cies.” It then goes on to produce 4 charts on East European countries as empirical evidence. I tend to think that BRIC would fit in this category of countries experiencing econemic liberalization. The paper is available for free if you want to take a look at. The effect on the return in USD is as cpk stated.
Thanks, all. It doesn’t seem like there is some major underlying relationship or principle. Appreciating currency can be good and bad. I guess I was wondering if I was missing some larger underpinning, for example: like how interest rates are used to quell inflation and are negatively correlated.
To CPKs point, can I offer an an example and y’all tell me if I’m interpreting rcorrectly.
Say the Pound / Dollar is 10 / $1. Through its growing economy and rising incomes, the pound has appreciated to 5 / $1. If you started with 100 pounds, that equaled $10. Now that same 100 pounds equals $20. So the pound has increased, in USD terms, from $10 to $20. So the total Pound market cap has grown - is that the gist?
How do rising incomes increase currency values – through increased spending and demand?
Thank you everyone for your input.
I think you got it BMiller12…
to CPK’s point - they are measuring GDP growth in USD terms.
So lets say China has a GDP in yuan of 600 and the exchange rate to USD is 6:1, so in USD terms, Chinese GDP is $100
Now lets say nothing else changes in china (no gdp growth), but the yuan appreciates against the dollar to an exchange rate of 5:1
Chinese GDP is still 600 yuan, but now Chinese GDP in USD terms is 600/5 = $120 - a 20% appreciation of GDP in USD terms.
I believe this is what the text and CPK is getting at.
Essentially when the Yuan Appreciates - USD depreciates. So the figure in the USD terms will be BIGGER and hence look higher.
earlier you were getting 6 Yuan to the . Now you are getting only 5 Yuan to the .
There is nice and short formula for the return in Domestic Currency on unhedged foreign investment( appeared in Level 2, 2012, Reading 62).
where E(s) is the expected percentage currency movement, ignoring the second-order effect.
The assertion in the reading seems to require us to accept Balassa–Samuelson theory as true.
It may be reasonable since it’s a long-run equilibrium relation.
Sounds good. Thank you.
It just seems a little gimmicky to conclude that the economy grew (GDP increased) when it was actually the result of currency appreciation relative to another currency - not necessarily that the home economy actually grew organically (ie by greater productivity or employment growth). If the US currency depreciated as the result of its own actions irrespective of china and the yuan, it appears like the Chinese economy grew when in fact it may not have changed at all. Y’all see my thinking/concern with looking at economic growth through the straight context of currency appreciation?
That’s true. Maybe the text phrased it as “the share of world GDP” or something.