US Dollar vs.

Euro
Research project
Denis Moiseev

Research objective
Figure out which currency is better to invest in short term and long term. U.S. Dollar vs. Euro.

Background
Dollar

The United States dollar (sign: $; code: USD) is the official currency of the United States. The
U.S. dollar is normally abbreviated as the dollar sign, $, or as USD or US$ to distinguish it from
other dollar-denominated currencies and from others that use the $ symbol. Was founded in the
6th of July in 1786. At that day dollar became official currency of United States of America. The
U.S. dollar is the currency most used in international transactions. US Dollar is first reserved
currency. Some countries using it, as their official currency. And many countries using dollar as
de facto currency and also it used as the sole currency in some British Overseas Territories.
Bimetallism persisted until March 14, 1900, with the passage of the Gold Standard Act, which
provided that:

"...the dollar consisting of twenty-five and eight-tenths grains (1.67 g) of gold nine-tenths fine, as
established by section thirty-five hundred and eleven of the Revised Statutes of the United
States, shall be the standard unit of value, and all forms of money issued or coined by the United
States shall be maintained at a parity of value with this standard..."

Euro

The euro (sign: €; code: EUR) is the official currency of the European Union (EU), the euro was
founded in the 1st of January 1999, moreover it has been a goal of the European Union since
1960s. After negotiations between countries, particularly due to opposition from the United
Kingdom, the Maastricht Treaty entered into force in 1993 with the goal of creating economic
and monetary union by 1999 for all EU states except UK. In 1999 the currency was born
virtually and in 2002 notes and coins started to circulating. It rapidly took over from the former
national currencies and slowly expanded behind the rest of the European Union. The euro is the
second largest reserve currency (a status it inherited from the German mark) as well as the
second most traded currency in the world after the U.S. dollar. As of October 2009, with more
than €790 billion in circulation, the euro is the currency with the highest combined value of
banknotes and coins in circulation in the world, having surpassed the U.S. dollar. Based on IMF
estimates of 2008 GDP and purchasing power parity among the various currencies, the Eurozone
is the second largest economy in the world.
Factors that influence exchange rates
Inflation

A high rate of inflation, relative to other countries, implies that prices of goods or services in one
country are increasing at a comparatively fast pace. These goods and services look expensive in
terms of foreign investors. Percentage of inflation shows how fast price of goods and services are
increasing in country. If the law of purchasing power parity holds, the nation’s currency should
appreciate to offset the relative decrease in prices.

Interest Rates

The correlation between a nation’s interest rate and its exchange rate is easy to find out. Every
investor thinks only about profitability of investments, hence they will invest money in
operations where, for a given level of risk, the returns are higher. Thus, when a disparity interest
rates exists between countries whose risk of default is equal, investors would likely lend to the
country that was offering the higher interest rate. Higher interest rates increase demand for
nations currency, and causes it to appreciate in value.

Speculation

Speculators play not last role in exchange rates. If speculators believe that nations currency will
rise, they will demand more now to be able to make a profit. This increase in demand will cause
the value to rise. Therefore movements in the exchange rate do not always reflect economic
fundamentals, but are often driven by the sentiments of the financial markets.

Change in competitiveness

If nation goods become more attractive to foreign countries, foreign countries start inflow money
in nation currency, which lead to appreciate nation currency.

Relative strength of other currencies

Some investors are afraid to invest money in new and risky currencies, for example between
1999 and 2001 the £ appreciated because the Euro was seen as a weak currency.

Current-Account / Trade Balance

When a country runs a current account deficit, it typically means that the nation imports more
than it exports. This tends to depreciating currency of country who basically consume more than
produce. In due course, the exchange rate may adjust so as to make the first nation’s products
affordable to foreigners, and bridge the gap between imports and exports.

Public (government) debt

The relationship between government debt obligations and its exchange rate is not having cut.
Basically, government borrowing to finance deficit spending increases inflation, which literally
eats into the value of that nation’s currency. In addition, if lenders believe there is any risk of
default, they may sell the debt (in the United States, this debt takes the form of treasury
securities) on the open market, exerting downward pressure on the exchange rate.

Political and Economic Factors

Most investors are risk-averse; accordingly, investors will invest their capital where there is a
certain degree of stability. They tend to avoid investing in countries that are typified by
governmental instability and/or economic recession. Moreover, they will invest capital in stable
countries that shows strong signs of economic growth. A nation whose government and economy
are more or less stable will attract the most investment. This, in turn, creates demand for that
nation’s currency and causes its currency to appreciate in value.

Attractiveness for investors

Dollar
Inflation

The Consumer Price Index, the government’s most closely watched reading for inflation at the
consumer level, rose 0.1% in March. February’s CPI was flat and marked the first time prices
had not advanced since March 2009. "Inflation as a concern is relegated to the distant future,"
Guy Lebas, chief fixed income strategist at Janney Montgomery Scott LLC in Philadelphia, said
on Bloomberg. "It gives the Fed the flexibility to keep rates low for a while." Inflation rate in
april 2010 is 2.3%. Graph below shows inflation rates of dollar from last decade.

Interest rate

The current Federal Reserve interest rate is between zero and .25%. It was lowered by 1/2 point
on December 17, 2008, the 10th rate cut in a little over a year. In the beginning of 2007 the
interest rate was 4.75%, for the three years federal reserve decreased interest by 4.5%.

Oct 31 07: A 1/4 point cut to 4.5%.

Dec 11 07: A 1/4 point cut to 4.25%.

Jan 22 08: A 3/4 point cut to 3.5%.

Jan 30 08: A 1/2 point cut to 3%.

Mar 18 08: A 3/4 point cut to 2.25%.

Apr 30 08: A 1/4 point cut to 2%.

Oct 8 08: A 1/2 point cut to 1.5%.

Oct 29 08: A 1/2 point cut to 1%.

Trade balance

Since 1989, the current account deficit of the United States has been increasing, in 2006 reaching
around 7% of GDP. BEA (Bureau of Economic Analysis) published data from fourth quarter
and year 2009: “The U.S. current-account deficit--the combined balances on trade in goods and
services, income, and net unilateral current transfers--increased to $115.6 billion (preliminary) in
the fourth quarter of 2009 from $102.3 billion (revised) in the third quarter. The increase was
more than accounted for by an increase in the deficit on goods and, to a lesser extent, a decrease
in the surplus on income.”

Government debt

Total economic output of United States, or GDP, is $14.4 trillion. The debt is now 83% of GDP,
up from 51% in 1989. (Bureau of Economic Analysis) The most recent budget forecast from the
Office of Management and Budget (OMB) showed the budget deficit rising $1.7 trillion in fiscal
year 2009 and $1.17 trillion in fiscal year 2010. This will easily increase the debt to over $13
trillion by 2013.

Euro
Inflation

The introduction of the euro has led to extensive discussion about its possible effect on inflation.
In the short term, there was a widespread impression in the population of the Eurozone that the
introduction of the euro had led to an increase in prices. Paradoxically, this impression has not
been supported by general indices of inflation, showing no major effect of the introduction of the
euro ( www.interscience.wiley.com). According to Eurostat, the statistical office of the European
Union, inflation rate in February 2010 was 0.9% By 1 per cent lower than in January.

Interest rate

According to ECB (European Central Bank) interest rate on euro in April 2010 is 1%. It was cut
in January 2009 from 2,5% to 2% more than a half since euro exist, 4.75%.

Trade balance

Eurostat (TradingEconomics.com) shows that:” The first estimate for the euro area (EA16) trade
balance with the rest of the world in February 2010 gave a 2.6 bil euro surplus, compared with
-1.2 bil in February 2009. The January 2010 balance was -9.0 bil, compared with -12.0 bil in
January 2009. In February 2010 compared with January 2010, seasonally adjusted exports rose
by 2.7% and imports by 1.5%. The first estimate for the February 2010 extra-EU27 trade balance
was a 6.0 bil euro deficit, compared with -10.7 bil in February 2009. In January 20102 the
balance was -22.3 bil, compared with -27.8 bil in January 2009. In February 2010 compared with
January 2010, seasonally adjusted exports rose by 3.9% and imports by 2.0%.”

Government debt

In the Eurozone the government deficit to GDP ratio increased from 2.0% in 2008 to 6.3% in
2009, and in the EU27 from 2.3% to 6.8%. In the Eurozone the government debt to GDP ratio
increased from 69.4% at the end of 2008 to 78.7% at the end of 2009, and in the EU27 from
61.6% to 73.6%. The Minister for Finance, Brian Lenihan, noted the publication of the
Maastricht returns and said: “While the headline deficit for 2009 is 14.3% of Gross Domestic
Product, as a result of a technical reclassification associated with Government support provided
to the banking sector, it is important to note that the underlying 2009 General Government
deficit for Ireland is 11.8% of GDP, which is broadly similar to that projected in December’s
Budget. There is no additional borrowing associated with this technical reclassification. This is a
once-off impact, and will not affect the Government’s stated budgetary aim of reducing the
deficit to below 3% of GDP by 2014.”

Jürgen Stark (member of the Executive Board and the Governing Council of the ECB says in the
research paper “Euro Area Fiscal Policies and the Crisis”) that the financial and economic crisis
has had a very profound impact on public finances in the Eurozone. Projections suggest that the
government deficit will climb to almost 7% of GDP in 2010 and that all Eurozone countries will
then exceed the 3% of GDP limit. Stark says the Eurozone government debt-to-GDP ratio could
increase to 100% in the next few years:"These fiscal developments are all the more worrying in
view of the projected ageing-related spending increases, which constitute a medium to long-term
fiscal burden," he warns.

Conclusion
This research shows that Euro doing better than US Dollar and more attractive for investors, but
Dollar has been in circulation more than 2 centuries and Euro has been only 10 years. From one
hand it is necessary give respect to Euro because only for 10 years, Euro became second reserve
currency in the world. From the other hand it was not tested by time as US Dollar, also appear
problem with Greece debt, this situation with Greece brought Euro Dollar exchange rate to 5
years record. Now Euro is in the test and how it will survive, we will see.

References
Newspapers

Wall Street Journal, Financial Times

Internet

BBC news www.bbcnews.com

Bureau of Economic Analysis www.bea.gov

Bloomberg www.bloomberg.com

European Central Bank www.ecb.int

Federal Reserve www.federalreserve.gov

Standart&Poors www.standardandpoors.com

International Monetary Fund www.imf.com

FOReign EXchange tradewww.forex.com

Investopedia www.investopedia.com

EUbusiness www.eubusiness.com

www.InterScience.Wiley.com

www.tradingeconomics.com