Academy of Economic Studies

Faculty of Business Administration – English Section, 3rd year of study.

The relation euro –

dollar
and its impact on other
currencies

Coordinator: Team:
Professor Laura Elly Novac
Gavrila Cristiana (gr.136)
Selaru Alexandra (gr. 137)
Varsatila Anca(gr. 137)
 Table of contents

1. U.S. dollar
1.1 History
1.2 The Gold Standard
1.3 Bretton Woods System

2. U.S. dollar decline and rise of Euro

2.1 U.S. dollar’s decay
2.2 Rethinking the Global Money Supply

3. Euro – history

4. Euro – U.S. dollar relationship

4.1The volatility of the euro – U.S. dollar exchange
rate
4.11 Short run
4.12 Long run
4.2 The factors influencing the exchange rate
4.21 The theories underlying the U.S. dollar – euro
exchange rate

5. Impact on other currencies

5.1 U.S. dollar – Japanese Yen
5.2 U.S. dollar – British Sterling Pound
5.3 U.S. dollar – Swiss Franc
5.4 Euro – Romanian Leu

6. Conclusions

7. References

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1. US Dollar

1.1 US dollar’s history

The currency of the United States can be traced back to 1690 before the birth of the country
when the region was still a patchwork of colonies. The Massachusetts Bay Colony used paper
notes to finance military expeditions. After the introduction of paper currency in Massachusetts,
the other colonies quickly followed.

Various British imposed restrictions on the colonial paper currencies were in place until being
outlawed. In 1775, when the colonists were preparing to go to war with the British, the
Continental Congress introduced the Continental currency. However, the currency did not last
long as there was insufficient financial backing and the notes were easily counterfeited.

Congress then chartered the first national bank in Philadelphia - the Bank of North America - to
help with the government's finances. The dollar was chosen to become the monetary unit for the
USA in 1785. The Coinage Act of 1792 helped put together an organised monetary system that
introduced coinage in gold, silver, and copper. Paper notes or greenbacks were introduced into
the system in 1861 to help finance the Civil War. The paper notes used several different
techniques including a Treasury seal and engraved signatures to help diminish counterfeiting. In
1863, Congress put together the national banking system that granted the US Treasury
permission to oversee the issuance of National Bank notes. This gave national banks the power
to distribute money and to purchase US bonds more easily whilst still being regulated.

The Federal Reserve Act of 1913 created one central bank and organised a national banking
system that could keep up with the changing financial needs of the country. The Federal Reserve
Board created a new currency called the Federal Reserve Note. The first federal note was issued
in the form of a ten dollar bill in 1914. Finally, a decision by the Federal Reserve board was
made to lower the manufacturing costs of the currency by reducing the actual size of the notes by
30%. The same designs were also printed on all dominations instead of individual designs.

The designs of the notes would not be changed again until 1996 when a series of improvements
were carried out over a ten-year period to prevent counterfeiting.

Participating Members

The United States Dollar has been adopted, and in some cases used as the official currency, in
many different territories and countries. This process of incorporating the currency of one
country into a different economic market is called 'dollarization'. Dollarization of the US Dollar
has occurred in the British Virgin Islands, East Timor, Ecuador, El Salvador, Marshall Islands,
Federated States of Micronesia, Palau, Panama, Pitcairn Islands, and Turks and Caicos Islands.

1.2. The Gold Standard

As global trade has grown, so has the need for international institutions to maintain stable, or at
least predictable, exchange rates. But the nature of that challenge and the strategies required to

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meet it evolved considerably since the end of the World War II -- and they were continuing to
change even as the 20th century drew to a close.

Before World War I, the world economy operated on a gold standard, meaning that each nation's
currency was convertible into gold at a specified rate. This system resulted in fixed exchange
rates -- that is, each nation's currency could be exchanged for each other nation's currency at
specified, unchanging rates. Fixed exchange rates encouraged world trade by eliminating
uncertainties associated with fluctuating rates, but the system had at least two disadvantages.
First, under the gold standard, countries could not control their own money supplies; rather, each
country's money supply was determined by the flow of gold used to settle its accounts with other
countries. Second, monetary policy in all countries was strongly influenced by the pace of gold
production. In the 1870s and 1880s, when gold production was low, the money supply
throughout the world expanded too slowly to keep pace with economic growth; the result was
deflation, or falling prices. Later, gold discoveries in Alaska and South Africa in the 1890s
caused money supplies to increase rapidly; this set off inflation, or rising prices.

The gold standard collapsed in the wake of World War I. Wartime financing with un backed
paper currency led to widespread inflation. European nations tried to resume the gold standard in
the 1920s, but the gold supply was insufficient and inelastic. A ferocious monetary squeeze and
competition across countries for limited gold reserves followed and contributed to the Great
Depression. After World War II, nations adopted the dollar-exchange standard. The U.S. dollar
was backed by gold at $35 per ounce, while the rest of the world’s currencies were backed by
dollars. The global money stock could expand through dollar reserves.

1.3 Bretton Woods System

Nations attempted to revive the gold standard following World War I, but it collapsed entirely
during the Great Depression of the 1930s. Some economists said adherence to the gold standard
had prevented monetary authorities from expanding the money supply rapidly enough to revive
economic activity. In any event, representatives of most of the world's leading nations met at
Bretton Woods, New Hampshire, in 1944 to create a new international monetary system.
Because the United States at the time accounted for over half of the world's manufacturing
capacity and held most of the world's gold, the leaders decided to tie world currencies to the
dollar, which, in turn, they agreed should be convertible into gold at $35 per ounce.

Under the Bretton Woods system, central banks of countries other than the United States were
given the task of maintaining fixed exchange rates between their currencies and the dollar. They
did this by intervening in foreign exchange markets. If a country's currency was too high relative
to the dollar, its central bank would sell its currency in exchange for dollars, driving down the
value of its currency. Conversely, if the value of a country's money was too low, the country
would buy its own currency, thereby driving up the price.

The Bretton Woods system lasted until 1971. By that time, inflation in the United States and a
growing American trade deficit were undermining the value of the dollar. Americans urged
Germany and Japan, both of which had favorable payments balances, to appreciate their
currencies. But those nations were reluctant to take that step, since raising the value of their
currencies would increases prices for their goods and hurt their exports. Finally, the United
States abandoned the fixed value of the dollar and allowed it to "float" -- that is, to fluctuate
against other currencies. The dollar promptly fell. World leaders sought to revive the Bretton
Woods system with the so-called Smithsonian Agreement in 1971, but the effort failed. By 1973,
the United States and other nations agreed to allow exchange rates to float.

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Economists call the resulting system a "managed float regime," meaning that even though
exchange rates for most currencies float, central banks still intervene to prevent sharp changes.
As in 1971, countries with large trade surpluses often sell their own currencies in an effort to
prevent them from appreciating (and thereby hurting exports). By the same token, countries with
large deficits often buy their own currencies in order to prevent depreciation, which raises
domestic prices. But there are limits to what can be accomplished through intervention,
especially for countries with large trade deficits. Eventually, a country that intervenes to support
its currency may deplete its international reserves, making it unable to continue buttressing the
currency and potentially leaving it unable to meet its international obligations.

2. U.S. dollar decline and rise of Euro

2.1 U.S. dollar’s decline

In 2008, the current account deficit was $700 billion. Over half of the current account deficit is
owed to foreign countries and hedge funds. (Source: U.S. Treasury Dept.)

Partly as a result of this deficit, the dollar declined 40% between 2002-2008. The dollar
strengthened during the recession, as investors sought a relatively safe haven. Since March 2009,
however, the dollar has resumed its decline. This is a result of the $11 trillion U.S. debt. Creditor
nations believe that the U.S. government is not supporting the value of dollar. A weaker dollar
means that the deficit will not cost the government as much to pay back. As creditor nations
realize this, they have been gradually changing their assets to other currencies to stem their
losses. Many fear that this could turn into a run on the dollar. This would quickly erode the value
of U.S. investments, while increasing inflation.

The euro could replace the dollar as an international currency. Between Q1 2008 and Q2 2009
(most recent report), the value of euros held in foreign government reserves increased from $393
billion to $1.17 trillion. During this same time period, dollar holdings decreased from $2.77 to
$2.68 trillion in reserves. (Source: IMF, COFER Table)

China is the largest investor in dollars. As of September 2009, it held nearly $800 billion in U.S.
Treasury Securities. It has hinted it will reduce its holdings if the U.S. continues to spend on the
stimulus package, and increase its debt.

Japan is the second largest investor, with $752 billion in holdings. It buys Treasuries to keep the
value of the yen low, so it can export more cheaply. However, its debt is now 200% of its GDP.
It is facing pressure to lower its debt burden, causing it to sell dollars.

Oil-exporting countries (and the Caribbean banking centers that often serve as their front) hold
$356 billion. If they decide to trade oil in euros instead of dollars, they would have less of a need
to hold dollars to keep its value relatively higher. For example, Iran and Venezuela have both
proposed oil-trading markets denominated in euros instead of dollars.

In the most profound financial change in recent Middle East history, Gulf Arabs are planning –
along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a
basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new,
unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia,
Abu Dhabi, Kuwait and Qatar. Secret meetings have already been held by finance ministers and
central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will
mean that oil will no longer be priced in dollars.

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The decline of American economic power linked to the current global recession was implicitly
acknowledged by the World Bank president Robert Zoellick. "One of the legacies of this crisis
may be a recognition of changed economic power relations," he said in Istanbul ahead of
meetings of the IMF and World Bank. But it is China's extraordinary new financial power –
along with past anger among oil-producing and oil-consuming nations at America's power to
interfere in the international financial system – which has prompted the latest discussions
involving the Gulf states.

Ever since the Bretton Woods agreements – the accords after the Second World War which
bequeathed the architecture for the modern international financial system – America's trading
partners have been left to cope with the impact of Washington's control and, in more recent
years, the hegemony of the dollar as the dominant global reserve currency.

The Chinese believe, for example, that the Americans persuaded Britain to stay out of the euro in
order to prevent an earlier move away from the dollar. But Chinese banking sources say their
discussions have gone too far to be blocked now. The Russians will eventually bring in the
rouble to the basket of currencies. The Britains are stuck in the middle and will come into the
euro. They have no choice because they won't be able to use the US dollar.

1) The blue line shows how much less foreign currency the dollar can buy now. The currency
basket is the US Dollar Index, and the dollar buys only 75 units compared to 100 at the start of
the decade.
2) The red line is the key. The dollar could purchase 100 units of gold at the start of the decade,
but today only purchases 27, a 73% decline in the dollar’s purchasing power.
3) The black line shows the dollar’s purchasing power in terms of crude oil, which trends pretty
much in the same direction as gold, but obviously with considerable volatility. Compared to 100
units at the start of the decade, the dollar now purchases only 32, though this is an improvement
from the only 18 units the dollar purchased during the spike in crude oil prices in mid-2008.

2.2.Rethinking the Global Money Supply

The People’s Bank of China jolted the financial world in March with a proposal for a new global
monetary arrangement. The proposal initially attracted attention mostly for its signal of China’s
rising global economic power, but its content also has much to commend it.

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A century ago almost all the world’s currencies were linked to gold and most of the rest to silver.
Currencies were readily interchangeable, gold anchored exchange rates and the physical supply
of gold stabilized the money supply over the long term.

President Richard Nixon delinked the dollar from gold in 1971 (to offset the U.S.’s expansionary
monetary policies in the Vietnam era), and major currencies began to float against one another in
value. But most global trade and financial transactions remained dollar-denominated, as did most
foreign exchange reserves held by the world’s central banks. The exchange rates of many
currencies also remained tightly tied to the dollar.

This special role of the dollar in the international monetary system has contributed to the global
scale of the financial crisis, which is rooted in a combination of overly expansionary monetary
policies by the Federal Reserve and lax financial regulations. Easy money fed an unprecedented
surge in bank credits, first in the U.S. and then elsewhere, as international banks funded
themselves in the U.S. money markets. As bank loans flowed into other economies, many
foreign central banks intervened to maintain currency stability with the dollar. The surge in the
U.S. money supply was thus matched by a surge in the money supplies of countries linked to the
U.S. dollar. The result was a temporary worldwide credit bubble, followed by a wave of loan
defaults, falling housing prices, banking losses and a dramatic tightening of bank lending.

China has now proposed that the world move to a more symmetrical monetary system, in which
nations peg their currencies to a representative basket of others rather than to the dollar alone.
The “special drawing rights” of the International Monetary Fund is such a basket of four
currencies (the dollar, pound, yen and euro), although the Chinese rightly suggest that it should
be rebased to reflect a broader range of them, including China’s yuan. U.S. monetary policy
would accordingly lose its excessive global influence over money supplies and credit conditions.
On average, the dollar should depreciate against Asian currencies to encourage more U.S. net
exports to Asia. The euro should probably strengthen against the dollar but weaken against Asian
currencies.

The U.S. response to the Chinese proposal was revealing. Treasury Secretary Timothy Geithner
initially described himself as open to exploring the idea; his candor quickly caused the dollar to
weaken in value—which it needs to do for the good of the U.S. economy. That weakening,
however, led Geithner to reverse himself within minutes by underscoring that the U.S. dollar
would remain the world’s reserve currency for the foreseeable future.

Geithner’s first reaction was right. The Chinese proposal requires study but seems consistent
with the long-term shift to a more balanced world economy in which the U.S. plays a monetary
role more coequal with Europe and Asia. No change of global monetary system will happen
abruptly, but the changes ahead are not under the sole control of the U.S. We will probably move
over time to a world of greater monetary cooperation within Asia, a rising role for the Chinese
yuan, and greater symmetry in overall world monetary and financial relations.

3. Euro – history

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The European Economic and Monetary Union is an agreement between participating European
nations to share a single currency, the euro and a single economic policy with set conditions of
fiscal responsibility. There are currently 27 member-states of varying degrees of integration with
the European Economic and Monetary Union. Sixteen member states have adopted the euro:
Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the
Netherlands, Portugal, Slovenia, Spain, from 1 January 2008, Cyprus and Malta, and, from 1
January 2009, Slovakia. Three other member states, the United Kingdom, Denmark and Sweden,
have no immediate plans to adopt the euro. Other member states are in various stages of euro
adoption and are expected to join the Eurozone within the next ten years.
Currently, participating European countries can be integrated into three different economic
stages, which correspond to the historical stages of European Economic and Monetary Union
development.

Stage I

In 1979, the European Monetary System was established to link European currencies and prevent
large fluctuations between their respective values. It created the Exchange Rate Mechanism
under which the exchange rates of each member state’s currency was to be restricted to narrow
fluctuations (+/-2.25%) on either side of a reference value. This reference value was established
in an aggregated basket of all the participating currencies called the European Currency Unit,
which was weighted according to the size of the member states’ economies.
In the late 1980s, the market of each member state grew closer to its neighbours, shaping what
would eventually be called the European Single Market. International trade in the Single Market
could be hindered by exchange-rate risk – despite the relative stability introduced by Exchange
Rate Mechanism – and the increased transaction costs that this brought. The creation of a single
currency for the single market seemed a logical solution, and thus the idea of a single currency
was brought back to the fore.
It aimed to remove institutional and economic barriers between European Community member
states and established the goal of a common European market.

The first stage of European Economic and Monetary Union development can be correlated to a
current candidate country first meeting the Copenhagen Criteria and then joining the European
Union.

Stage II

At the December 1995 summit in Madrid, Germany successfully argued to change the name of
the European Currency Unit to the “euro”. The so called “Madrid scenario” also set out a
transition period between the introduction of the euro in accounting and later as a cash currency.
In the second stage of the European Economic and Monetary Union, the European
Monetary Institute was established as a forerunner of the European Central Bank. In June
of 1997, the European Council in Amsterdam agreed to the Stability and Growth Pact and
set up the Exchange Rate Mechanism II, which would succeed the European Monetary
System and the Exchange Rate Mechanism after the launch of the euro.

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The second stage of European Economic and Monetary Union development can be correlated to
a recently acceded member state entering the Exchange Rate Mechanism II, where it must stay
for at least two years before adopting the euro.

Stage III

For each state to adopt the new currency on 1 January 2002, they had to meet the “Convergence
Criteria“ set out by the Maastricht Treaty. The criteria include four requirements.
• Currencies has to stay within the bands set by the Exchange Rate Mechanism for at least
two years
• Long-term interest rates could not be more than two percentage points higher than those
of the three, best-performing member states
• Inflation had to be below a reference value (within 3 years prices may not be higher than
1,5% of best performer)
• Government debt had to be below 60% of GDP (or moving towards this objective) and
budget deficits below 3%

The third stage of European Economic and Monetary Union development can be correlated to a
member state that, having joined the Exchange Rate Mechanism II and maintaining the
Convergence Criteria for at least two years, joins the Eurozone.

4. Euro – U.S. dollar relationship

It is a known fact that the euro and the U.S. dollar share the role of the world’s key international
money. Due to this fact, the relationship between them is particularly important, not only for
these two large economic areas, but also for the world economy as the whole. Next, we will
analyze the evolution of the exchange euro/dollar.

4.1The volatility of the euro – U.S. dollar exchange rate

Firstly, we must distinguish between a shorter-run exchange rate volatility which is

associated with moderate negative effects on trade volumes and large longer-term exchange rate
movements which may have more serious macroeconomic consequences. As a basis for assesing
the effect of the advent of the euro on both shorter and longer-term exchange rate volatility, we
will compare the experience since the introduction of the euro with the 25 preceding years when
individual euro area currencies were floating against the U.S. dollar.

4.11. Short run

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The short-run volatility of the (dollar exchange rate of the) synthetic euro varies somewhat
across the five sub-periods of the pre-euro era. This suggests that, whatever are the factors
underlying short-run exchange rate volatility, they are not completely constant over time. The
average short-run volatility of the synthetic euro across the entire pre-euro era is 3.0%.

This is almost exactly the same as the 3.1% short-term volatility of the actual euro during the
five years from the beginning of 1999 up to 2003. To conclude, the short term volatility of the
euro exchange rate has not significantly changed from the pre-euro era.

4.12. Long run

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 There is a plausible explanation for at least an important part of the down and up swing in the
euro/dollar exchange rate during the past 6 years. On the other hand, it can also be argued that
downswing (below $1.00 or $0.95) was overdone and was unhelpful from a broader
macroeconomic perspective.

When the euro was introduced at the start of 1999 there was widespread (although not universal)
sentiment among economic analysts that the euro would appreciate moderately against the dollar
—reflecting the status of the new currency as a credible rival to the dollar.

The majority of specialists believed that on a multilateral basis the new euro appeared to be
neither significantly undervalued nor significantly overvalued. Specifically, with the euro area
economy operating reasonably close to potential, the multilateral real exchange rate of the euro
appeared to be broadly consistent with a modest current account surplus for the euro area. That
current account surplus, in turn, reflected the medium-term equilibrium excess of saving over
investment for the euro area.
The medium-term equilibrium level of the euro/dollar exchange rate was in the range $1.25–
$1.35.

The euro/dollar exchange rate is nowin that range. Because inflation rates in the euro area and
the United States have been quite similar over the first 6 years after the introduction of euro,
differential movements in national price levels do not imply that the medium-term equilibrium
exchange rate between the euro and the dollar should have changed very much. Other
considerations point in opposite directions. On an absolute purchasing power parity basis, the
euro looks expensive and the dollar looks cheap. In particular, tourists find that
Europe is expensive and that America is cheap. On the other hand, the U.S. current account
deficit has continued to widen despite significant dollar depreciation over the past 2 years; and
some (not unreasonable) estimates suggest that this deficit is likely to continue to widen at
presently prevailing exchange rates. The implication is that substantial further dollar depreciation
will be needed to help reduce the U.S. current account deficit to sustainable proportions. Much
of this further dollar depreciation should presumably come against those currencies where there
has so far been little or no real exchange rate adjustment.

There is not a firm basis at this stage to conclude with confidence either that the euro has now
appreciated sufficiently against the dollar to make the requisite contribution to restoring a
sustainable pattern of international payments positions or that substantially greater appreciation
of the euro against the dollar is still needed for this purpose. The euro has already appreciated a
great deal from what was clearly a substantially undervalued rate; and there is evidence that the
bilateral trade balance of the United States vis-a-vis the euro area has begun to improve, despite
significantly stronger demand growth in the United States than in the euro area. But there is no
credible reason to believe that the euro has meaningfully overshot a reasonable long-term
equilibrium value versus the dollar.

4.2. The factors influencing the exchange rate

Four factors are identified as fundamental determinants of the real euro to dollar exchange rate:
The international real interest rate differential
Relative prices in the traded and non-traded goods sectors
The real oil price
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The relative fiscal position

The nominal bilateral dollar to euro exchange is the exchange rate that attracts the most
attention. The dollar and the euro have a strong predisposition to run together in the very short
run, but sometimes there can be significant discrepancies. The very strong appreciation of the
dollar against the euro in 2003 is one example of these discrepancies.
As inflation is at very similar levels in the US and the Euro area, there is no need to adjust the
dollar to euro rate for inflation differentials, but because the Euro zone also trades intensively
with countries that have relatively high inflation rates (e.g. some countries in Central and Eastern
Europe, Turkey, etc.), it is more important to downplay nominal exchange rate measures by
looking at relative price and cost developments.

4.21 The theories underlying the U.S. dollar – euro exchange rate

The basic theories underlying the dollar to euro exchange rate are:
Law of One Price: In competitive markets free of transportation cost barriers to trade, identical
products sold in different countries must sell at the same price when the prices are stated in terms
of the same currency.
Interest rate effects: If capital is allowed to flow freely, exchange rates become stable at a point
where equality of interest is established.

The dual forces of supply and demand determine euro vs. dollar exchange rates. Various factors
affect these two forces, which in turn affect the exchange rates:
-The business environment: Positive indications (in terms of government policy, competitive
advantages, market size, etc.) increase the demand for the currency, as more and more
enterprises want to invest there.
-Stock market: The major stock indices also have a correlation with the currency rates.

-Political factors: All exchange rates are susceptible to political instability and anticipations
about the new government. For example, political or financial instability in Russia is also a flag
for the euro to U.S. dollar exchange because of the substantial amount of German investments
directed to Russia.
-Economic data: Economic data such as labor reports (payrolls, unemployment rate and average
hourly earnings), consumer price indices (CPI), producer price indices (PPI), gross domestic
product (GDP), international trade, productivity, industrial production, consumer confidence etc.,
also affect fluctuations in currency exchange rates.

5. Impact on other currencies

The currency markets are the largest financial markets in the world. Banks, multinational
corporations, hedge funds and central banks are the main actors on this markets. Each transaction
on this type of market includes two different trades: the sale of one currency and the purchase of
another currency. The two currencies involved in this transaction are known as a pair. The
majority of transactions occur among popular currency pairs.

Since the U.S. dollar is the world’s reserve currency, the U.S. dollar is the most traded currency
of all. This is why, next, we will analyse the trading relationships between the U.S. dollar and

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some of the most knows and powerful currencies, such as the Japanese yen, the British sterling
pound and the Swiss franc. In the end, we will also analyse the relationship between euro and the
Romanian national currency, the Romanian leu.

5.1 U.S. dollar – Japanese yen

The Japanese economy is one of the largest economies in the entire world. Japan is one of the
most significant exporter and due to this quality, multinational corporations need to convert
regularly local currency into yen and vice versa. Because of the low interest rates in Japan, the
yen has become a popular currency and the pair U.S. dollar – Japanese yen is heavily traded on
international currency markets.

Being a small country with limited resources, Japan has relied on innovative manufacturing
techniques, new technologies, a high national savings rate and cooperation between the
government and the private sector to overcome its disadvantages. Since the Second World War,
the economy has grown continuously.

The Japanese yen is the most traded currency in Asia and among the most traded currencies in
the entire world. Due to the period of slow economic growth of Japan, its central bank has been
forced to maintain interest rates at a low level. These rates have increased the popularity of the
Japanese yen. However, the popularity of the Japanese yen depends on the state of the global
financial markets. When volatility is low and there are many opportunities available in global
financial markets, traders choose the yen to make money. When volatility increases and the
number of opportunities declines, the yen is not that much preffered.

Another aspect that should be closely observed is the dependence that Japan has upon imports
and exports. Because Japan is dependent on imported oil and other natural resources, rising
commodity prices can hurt the economy and cause the yen to weaken. Japan’s export
dependency can also prompt central bank intervention when the yen begins to strengthen.
Traders should pay careful attention to the future course of Japanese economic growth. An
eventual economic recovery might bring with it higher interest rates, an end to the popularity of
the yen carry trade, and systemically stronger levels for the Japanese yen.

5.2. U.S. dollar – British sterling pound

In contrast with the small dimensions of the country, the economy of the United Kingdom is
developed. Since the British sterling pound is an important currency in the international financial
markets, investors consider trading the pair U.S. dollar – British sterling pound.

Before the World War I, the United Kingdom was the powerful nation in the world, and
consequently, the British pound was very important. After the two world wars, the United
Kingdom entered a period of decline whereas the United States of America developed
continuously.

However, since the 1980s, the country has regained its economic vitality. It has become a center
for global finance. Hence, the financial sector has become the most important part of the British
economy.
As we have seen in the above chapters, the United Kingdom has not adopted the euro,
maintaining its own currency, the British sterling pound.

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The British pound/U.S. dollar pair is one of the most liquid in the currency market. However, the
liquidity of the pair combined with the availability of trading instruments makes the British
pound/U.S. dollar an excellent choice for all types of currency traders.

When determining the relationship between these two currencies, the most important factor is the
strength of the two countries’ economies. If U.S. economic performance is stronger than the
U.K.’s, the dollar will strengthen against the pound. If U.K. has a better performance than the
U.S., the dollar will weaken against the pound.

One specific feature of trading the British pound is that there is often conjecture that the U.K.
may choose to join the European Monetary Union. If this were to happen, the U.K. would have
to give up the pound and use only the euro. It is generally believed that if the U.K. were to join
the European Monetary Union, it would first need to devalue the pound. Therefore, when U.K.
politicians are speaking in favor of joining the European Monetary Union, the pound typically
depreciates; when U.K. politicians speak against joining the European Monetary Union and in
support of keeping an independent currency regime, the pound typically strengthens.

5.3. U.S. dollar – Swiss franc

Switzerland has always been a stable and safe nation. Due to its neutrality, it has long appeared
to be a world itself. Economically, we can mention the Swiss banking system, which is one of
the most famous systems around the globe.

Even though Switzerland has not entered the European Union, the country trades intensively
with its European countries, the United States of America and other countries from the world.
A direct and important consequence of the neutrality Switzerland has always adopted is the
safety which the Swiss franc is thought to have. As a result, many investors choose to hold a
portion of their assets in this currency. Another situation that may occur is when either political
or economic turmoil increases, causing the volatility to increase on the financial markets,
investors turn to the Swiss franc, due to its safety and stability.
Both the U.S. dollar and Swiss franc are viewed as a safe solution during difficult times, so no
prediction regarding the option of the traders, during such times, can be made.

However, during less volatile times, investors should take into account that the Swiss franc has a
high correlation with the euro. When the euro apreciates, so does the Swiss franc.

5.4. Euro – Romanian leu

In January 2002, the moment of the introduction of the unique currency euro, euro was valued at
28.814 lei.

In 2003, euro continued to appreciate against the Romanian leu, and although the National Bank
of Romania tried through emission of money on the market to keep the exchange rate constant,
in November 2003, euro was valued at more than 40.000 lei.

In 2004, the relationship between euro and leu changed its direction, the Romanian leu starting to
appreciate against euro. (from 41.117 to 39.378 lei for 1 euro)

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In 2005, the euro continued to appreciate, as it can be seen in the graph above. This appreciation
continued during 2006, with small fluctuations.

During year 2007, the Romanian currency appreciated against euro in the first months of the
year, appreciation which was followed by a sudden depreciation, especially in the last two
months of the year. Among the causes of this depreciation we can mention: since some statistic
data was made public regarding inflation, the economic growth and deficit of current account,
the trust the investors had in the Romanian economy declined.

Starting with year 2008, the circumstances changed, leading to an increasingly depreciation of
the Romanian leu against euro. Causes such as the international financial crises, the national
political climate, the expectations that the actors from the currency market had from the National
Romanian Bank contributed to this depreciation.

As for the last 365 days, from what we can see in the graph above, in December 2008, euro had
its minimum value against the leu, that is 3.8090 RON, and from that point on, it started to
increase, reaching the maximum value of 4.3127 RON in January 2009.
According to the report from November of The Economist Intelligence Unit, the exchange rate
between euro and RON will have in December 2009 the value of 4.33 RON/euro, decreasing to
3.97 RON/euro in December 2010. The report also states that the Romanian leu will have to face
additional difficulties if the political climate does not stabilize and if the government will not
control its expenses.

6. Conclusions
After World War II, nations adopted the U.S. dollar exchange rate. The USD was backed by
gold, and all the other currencies were exchanged into USD. Because many nations preferred
holding reserves of dollars instead of converting them into gold, soon the dollar had become
more valuable than gold.
In 1960 USA was confronting with what was called Triffin’s Dilemma. This meant that the use
of a national currency as global reserve currency leads to a tension between national monetary
policy and global monetary policy. This meant that in order to sustain the Bretton Woods system,
the USA was supposed to run a balance of payments current account deficit to provide liquidity
for the conversion of gold into U.S. dollars. But with more U.S. dollars in the system the citizens
began to speculate, thinking that the U.S. dollar was overvalued. This meant that the US had less
gold as people starting converting the U.S. dollars to gold and taking it offshore. With less gold
in the country there was even more speculation that the U.S. dollar was overvalued. In the same
time USA had to run a balance of payments current account surplus to maintain confidence in
the U.S. dollar. It is impossible to run a balance of payments current account deficit and surplus
at the same time.
Even so, USA will not renounce to having the principal reserve currency in the world just
because of this. The advantage is that oil and gas price is established in U.S. dollars. This means
that all the countries in the world that import oil will need dollars for buying it. This higher the
demand for oil results in higher demand for dollars. This in turn allegedly allows the US
government to gain revenues through seignorage and by issuing bonds at lower interest rates
than they otherwise would be able to. As a result the US government can run higher budget
deficits at a more sustainable level than can most other countries.
Due to the supremacy the U.S. dollar had after the World War II, European politicians tried to
seek a greater economic integration between European countries. Consequently, plans for a
single European currency began in 1969, but the process proved to be a challenging one which

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required time. In 1999, a non-physical form of euro was adopted by the states forming the
European Economic Community. In 2002, the cash euro was introduced.
Since European nations have alltogether a powerful economy, euro is a currency that cannot be
ignored on the international financial markets.
The most traded pair is the U.S. dollar / euro, this pair proving to have a short-, respectively a
long-run volatility of the exchange rate, with complex economic effects. There are several
factors which influence the exchange rate between the U.S. dollar and the euro. The most two
important are the level of the interest rates and the dual forces of demand and supply. As for the
latter, we can mention some factors which in turn affect the demand and supply such as: the
business environment, stock market, political factors and economic data.
The relationship the U.S. dollar has with currencies such as the Japanese yen, the British sterling
pound or the Swiss franc is also important to analyse. Due to its low level of interest rates, the
yen is attractive to investors. The exchange rate U.S. dollar / British sterling pound is greatly
influenced by the permanent debate upon UK joining the European Monetary Union. As for the
pair U.S. dollar / Swiss franc, this will have as a specific characteristic the safety the Swiss franc
is thought to have.
If we analyse the relationship between euro and the Romanian leu, it can be seen that with the
exception of short periods, the Romanian leu has constanly depreciated against the euro. This
may be due to the fact that Romania does not have a strong economy to support the effects of all
influencing factors.
Nowadays, all the other economic powers like Japan, countries in EU, OPEC and especially
China are rethinking the system. China states that the principal reserve currency should be a
basket of currencies like Japanese yen, Chinese yuan, euro, dollar and possible also Russian
rouble. This would balance the economy and it should also be a solution for Triffin’s Dilemma.
But meanwhile USA does not even want to hear about it, some countries, especially OPEC, hold
about 2.1 trillion dollars reserves, so they do not rush in taking a decision that might bring them
bankruptcy.

7. References

 Badea, Dumitru G., Novac, Laura. (2005). International Trade

and Finance. Bucharest: Economica Publishing House.
 … (2004). Dollarization and currency exchange. Journal of
Monetary Economics. Vol. 51. Nr. 4. Pp. 671-689.
 Journal of Policy Modeling published by Elsevier for the Society
of Policy Modeling, available at www.sciencedirect.com

 http://economics.about.com
http://inventors.about.com
www.9am.ro
www.eu4journalists.eu
www.independent.co.uk
www.infomondo.ro

www.investopedia.com
www.mees.com
www.nber.org
www.news.bbc.co.uk
www.scientificamerican.com
www.sfin.ro
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www.squidoo.com
www.usdollarrate.com
www.ziare.com

http://www.fgmr.com/true-picture-of-the-us-dollar.html
http://www.fgmr.com/true-picture-of-the-us-dollar.html
http://useconomy.about.com/od/inflation/i/dollar_decline_2.htm

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