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Does the Pound-Dollar parity reflect fundamental European and American economies?

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  1. Introduction
  2. Market reforms create the conditions for the penetration of foreign companies
  3. The United Fruit Company against dictatorial regimes
  4. The emergence of a labor movement
  5. The 1929 crisis has affected the monopoly of the United Fruit Company
  6. Expectancy from 1944 to the coup of 1954
  7. Conclusion

Fundamentals generally used in the exchange rate and various economic theories include inflation, growth, short rates, and their expectations at different horizons by markets. Parity includes both the level of the exchange rate that balances supply, and foreign currency exchange rate (nominal or real - i.e., relative price of goods and services, also called "term of trade" ) and variations (volatility, standard deviation of the time series of the nominal rate at various time horizons: day, week, month etc.)

In a system of flexible exchange rates (the euro against the dollar), changes in exchange rates are logical and desirable as they reflect a normal adjustment of the internal variables ("fundamentals"), while the internal variables are constrained by fixed exchange rates, leading to the defense of floating exchange rates by Friedman "Better to let the dog (the whole national economy) wag its tail (exchange rate) than the tail wag the dog."

However, current concerns about the €/$ rate reflect fundamental unbalance (financing of the U.S. economy) amplified by currency markets (overreaction, self-fulfilling expectations, herding effect). Hence, there are many high costs (Short Term: Eurozone growth though inflation is evident, Medium Term: Crisis on the dollar in the face of Asian growth, Long Term: deformation of the productive, hysteresis). This therefore justifies a public intervention which should be coordinated if possible.

The various theories of exchange rates only partly explain the level and changes in the € / $, and stress the importance of determinants in addition to the financial economic fundamentals.

The € / $ is characterized by high volatility and an apparent disconnect in relation to the basic aggregates in a context of persistent imbalances.

After being introduced in markets to $ 1.17 on 1 January 1999, the euro depreciated sharply and then to reach $ 0.82 in 2001 and then to pull up more than 40% (maximum 1.36 % in December 2004). It has since stabilized around $ 1.20 to 1.25.

The fundamentals behind this trend fairly well until 2002: the Fed rate is higher than the ECB to 2000 (up 6.5% against 4.75%) resulting in a lower sense of euro (increased by massive FDI in the United States, due to significant mergers and acquisitions in particular), then a reversal from 2000 (Fed rate to 1% and the ECB's 2%). But after 2002, this gap no longer changes and therefore cannot explain the continuing fall of the dollar until 2004. On the other hand they help to explain the recent rise in the dollar.

Even from 1999 to 2002, changes in interest rates are insufficient to explain the importance of volatility.

Today, the euro dollar is far from the equilibrium rate (as defined by Williamson). A study forecasting the direction of the Ministry of Finance (2005, Asian foreign exchange intervention and exchange rate equilibrium) shows a misalignment of the effective exchange rate (that is to say, weighted by the weight of trade) in 2004, the U.S. dollar by 23% (overestimation), the Yuan -32%, euro 16% (on the bilateral parity € / £, the euro appeared overvalued by 7%. The recent correction suggests that the current rate is the parity of balance.

Tags: pound; dollar; pound/dollar parity; European economy; American economy

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