The Foreign Exchange Market- Macro 6.3

Summary

This educational video explains the basics of Foreign Exchange, focusing on the supply and demand dynamics of currencies. It uses the example of US and Canadian dollars to illustrate how exchange rates are determined. The script introduces 'shifters' that affect exchange rates, such as interest rates, and demonstrates how a higher interest rate in the US can lead to the appreciation of the US dollar and depreciation of the Canadian dollar, as demand for US dollars increases while demand for Canadian dollars decreases.

Takeaways

• 🌐 The concept of Foreign Exchange (Forex) is introduced, focusing on currency supply and demand dynamics.
• 📈 The exchange rate is defined as the ratio of one currency to another, e.g., how many Canadian dollars you get for each US dollar.
• 🔄 The demand for a currency is determined by foreigners, while the supply comes from the home country of that currency.
• 📊 Four main 'shifters' affect currency exchange rates: taste and preferences, price level or inflation, income, and interest rates.
• 📈 Interest rates are highlighted as a key factor influencing currency demand and supply, with higher rates attracting foreign investment.
• 📉 When interest rates in the US are higher than in Canada, Canadians are incentivized to convert their currency to US dollars to gain higher returns.
• 💹 This conversion increases the demand for US dollars and the supply of Canadian dollars in the Forex market.
• ⤴️ As a result of the increased demand and decreased supply, the US dollar appreciates relative to the Canadian dollar.
• 📉 Conversely, the Canadian dollar depreciates because it now takes more Canadian dollars to exchange for one US dollar.
• 🔄 A rule of thumb is that demand and supply for currencies always move in the same direction: if one increases, so does the other.
• 🧠 The script emphasizes the importance of understanding who is demanding and supplying currencies to accurately predict currency movements.

Q & A

What is the key concept discussed in the video?

The key concept discussed in the video is Foreign Exchange, specifically focusing on the supply and demand dynamics for different currencies.

What determines the exchange rate according to the video?

The exchange rate is determined by the supply and demand for a currency, which is expressed as the amount of one currency you get for each unit of another currency.

What is the initial exchange rate example given in the video?

The initial exchange rate example given in the video is a one-to-one relationship, where one Canadian dollar is exchanged for one US dollar.

Who is considered the demander and supplier of US dollars in the foreign exchange market?

In the foreign exchange market, Canadians are considered the demanders of US dollars, while Americans are the suppliers of US dollars.

Who are the demanders and suppliers of Canadian dollars in the foreign exchange market?

Americans are the demanders of Canadian dollars, and Canadians are the suppliers of Canadian dollars in the foreign exchange market.

What are the four shifters of Foreign Exchange mentioned in the video?

The four shifters of Foreign Exchange mentioned in the video are taste and preferences, price level or inflation, income, and interest rates.

How does an increase in interest rates in the United States affect the demand for US dollars?

An increase in interest rates in the United States leads to an increased demand for US dollars, as investors seek higher returns on their investments.

What happens to the supply of Canadian dollars when Canadians convert their currency to US dollars for higher interest rates?

When Canadians convert their currency to US dollars for higher interest rates, the supply of Canadian dollars increases in the foreign exchange market.

What is the outcome of the scenario where US interest rates are higher than Canadian interest rates?

In the scenario where US interest rates are higher than Canadian interest rates, the US dollar appreciates relative to the Canadian dollar, and the Canadian dollar depreciates.

What is the rule regarding the relationship between demand and supply in currency exchange?

The rule is that demand and supply always increase or decrease together. If one country wants more of another country's currency, they must supply more of their own currency to obtain it.

How does the video explain the impact of interest rates on currency appreciation and depreciation?

The video explains that when interest rates are higher in one country, the demand for that country's currency increases, leading to appreciation, while the demand for the other country's currency decreases, leading to depreciation.

Outlines

00:00

🌐 Introduction to Foreign Exchange

The video script introduces the concept of Foreign Exchange (Forex) and explains the basics of supply and demand for different currencies. The focus is on the US Dollar and the Canadian Dollar. It's clarified that the exchange rate is determined by how many units of the second currency (in this case, Canadian Dollars) one gets for one unit of the first currency (US Dollars). The script emphasizes the importance of understanding who is supplying and demanding each currency, with Americans supplying US Dollars and Canadians supplying Canadian Dollars. The video also introduces four 'shifters' that affect the Forex market: taste and preferences, price level or inflation, income, and interest rates.

📈 Impact of Interest Rates on Currency Exchange

This part of the script delves into the impact of interest rates on currency exchange rates using the US and Canadian interest rates as an example. It explains how higher interest rates in the US would lead Canadians to convert their Canadian Dollars to US Dollars to take advantage of the higher returns on American bonds. This increased demand for US Dollars would cause the US Dollar to appreciate relative to the Canadian Dollar. The script uses a hypothetical scenario where the exchange rate shifts from a 1:1 to a 2:1 ratio, illustrating the appreciation of the US Dollar and the depreciation of the Canadian Dollar. It also touches on the concept that demand and supply for a currency move in tandem, and that higher interest rates in one country can reduce the demand for another country's currency.

Keywords

💡Foreign Exchange

Foreign Exchange, often abbreviated as Forex or FX, refers to the conversion of one currency into another. It is a global decentralized market where transactions take place between traders. In the video, the concept of foreign exchange is central as it explains how different currencies interact in terms of supply and demand.

💡Supply and Demand

Supply and demand are economic concepts that explain the interaction between the quantity of a resource and the desire for that resource among various entities. In the context of the video, supply and demand are used to describe the dynamics of currency exchange rates, where the balance between the two determines the value of one currency relative to another.

💡Currency Appreciation

Currency appreciation occurs when a currency increases in value relative to another currency. This is a key concept in the video, where the US dollar appreciates relative to the Canadian dollar due to higher interest rates in the US, making the US dollar more desirable.

💡Currency Depreciation

Currency depreciation is the opposite of appreciation; it is when a currency loses value relative to another. In the video, the Canadian dollar depreciates because it offers a lower interest rate compared to the US, leading to a decrease in demand for Canadian dollars.

💡Exchange Rate

The exchange rate is the value of one currency expressed relative to another. It is a crucial concept in the video as it is used to illustrate how the value of the US dollar and the Canadian dollar are determined by supply and demand forces in the foreign exchange market.

💡Shifters

Shifters are factors that can cause the supply and demand curves for a currency to shift, thereby affecting the exchange rate. In the video, four shifters are mentioned: taste and preferences, price level or inflation, income, and interest rates. These factors can influence the attractiveness of a currency in the market.

💡Interest Rates

Interest rates are the cost of borrowing money and the return on savings. In the video, interest rates are highlighted as a significant shifter that can affect currency exchange rates. Higher interest rates in the US lead to an increased demand for US dollars as investors seek higher returns.

💡Inflation

Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, the purchasing power of currency is falling. Although not explicitly detailed in the video, inflation is implied as a factor that can influence the demand for a currency, as higher inflation can erode the value of money.

💡Taste and Preferences

Taste and preferences refer to the inclinations of individuals towards certain goods or services. In the context of foreign exchange, these preferences can influence the demand for a currency if, for example, there is a preference for goods from a particular country, leading to an increased demand for that country's currency.

💡Income

Income is the money received, typically on a regular basis, for work or through investments. In the video, income is mentioned as a shifter that can affect the demand for foreign currencies. Higher incomes can lead to increased demand for foreign goods and services, thus affecting the exchange rate.

💡Quantity

In the context of the video, quantity refers to the amount of a currency available for exchange in the foreign exchange market. Understanding the quantity of a currency is essential for analyzing supply and demand dynamics and how they influence the exchange rate.

Highlights

Introduction to Foreign Exchange and its key concept

Explanation of supply and demand for different currencies

Clarification on the price of an American dollar in terms of Canadian dollars

The concept that the exchange rate is determined by supply and demand

Initial assumption of a one-to-one exchange rate between US and Canadian dollars

Identification of who demands and supplies US dollars in the foreign exchange market

Identification of who demands and supplies Canadian dollars in the foreign exchange market

Introduction to the four shifters of Foreign Exchange

Emphasis on the role of interest rates as a shifter in Foreign Exchange

Example of how a higher US interest rate affects currency demand and supply

Explanation of currency appreciation when demand increases

Explanation of currency depreciation when supply increases

Rule that demand and supply always increase or decrease together

Bonus round on the impact of higher interest rates on currency demand

Discussion on the decrease in demand for Canadian dollars due to higher US interest rates

Final rule that US dollar will appreciate and Canadian dollar will depreciate under given conditions

Encouragement for practice to understand currency appreciation and depreciation

Transcripts

[Music]

heyy how you doing Mr Clifford it's ACDC

con we're talking about a key concept

that you absolutely have to know it's

called Foreign Exchange in this video

I'm going to explain the idea of supply

and demand for different currencies

right and then I'm going talk about the

shifters in the next video what I want

you to do is I want you to practice okay

figuring out which country's currency

appreciates which one depreciates right

now we've got two different currencies

right this is not products this is

currencies right supply and demand for

dollars supply and demand for Canadian

dollars right so US dollar doar over

here we got to figure out what's the

price of an American dollar well it's

how many Canadian dollars you get for

each US dollar and so it's always the

other currency over the currency that

you're analyzing right we're looking at

US Dollars this is the quantity of US

Dollars well it's good old fashioned

demand and Supply that gets the exchange

rate the exchange rate is how many

Canadian dollars you get for each

American Dollar and let's say to start

off let's say it's a one toone

relationship you get one Canadian dollar

for one Us doll and there's obviously

some sort of quantity out here available

for people to exchange their currencies

on the other side we're going to analyze

the Canadian dollar so up here it's

going to be the US dollar divided by the

Canadian dollar the value of a Canadian

dollar is how many US Dollars you get

for it down here is the quantity of

Canadian dollars available in the

Foreign Exchange Market here's the

demand here's the supply exchange rate

what's going to be one to one

relationship that's the idea okay now

before we go any further we have to

figure out who who is demanding and who

is supplying when we're analyzing

dollars who is the ones that demanding

United States dollars don't say

Americans right Americans don't demand

dollars we're supplying them right the

demand is determined by Canadians right

who's supplying Wells we're supplying is

by the US you got to keep that straight

because that's going to help you out

later on now over here who demands

Canadian dollars in the foreign exchange

well Americans This Is by Americans and

Canadians are the ones who are supplying

now before we shift this thing let's

talk about the four things that will

shift it right the four shifters of

Foreign Exchange all right here they are

the first one is taste and preferences

another one is price level or inflation

the next one is going to be income the

last one is interest

rates and that's one we're going to use

for this example okay let's focus on

interest rates let's say that in the

United States right the interest rate is

15

% right and in Canada the interest rate

is 2% so let's think about what are

Canadians and Americans going to do the

Canadians are going to take their

dollars convert them into American

dollars and then turn around and buy

American bonds and get that 15% return

right the demand is going to increase

for American dollars why well because

Canadians want more of them if the

Canadians want these they've got to

supply their Canadian dollars right

they've got to go to the foreign

exchange and supply Supply those and so

when they Supply them that leads to an

increase in supply of Canadian dollars

and that ends up being a new location

right here and here let's say the

situation of being 2: one what does this

have to be it has to be 1:2 right what's

happening unit States dollar did it

appreciate or depreciate well it

appreciated appreciation is when the

currency gets stronger or now you get

two Canadian dollars for each one

American dollar so the United States

dollar appreciated relative to the

Canadian dollar what happened to the

Canadian dollar well it

depreciated now you need two Canadian

dollars to get one American dollar right

now I'm going to give you a rule here

right demand and Supply always increase

or decrease together right if one

country wants another country's currency

they've got to supply more of their

currency to do it quick bonus round okay

that's one way to analyze it remember

what I told you was that Canadians are

going to want more American dollars

because they want to get that higher

interest rate they want to get that

return of 15% compared to the 2% they

get in their own country there's also

something else going on here right

normally the United States would turn

around and go buy like Americans would

buy a certain number of Canadian assets

but when we have a higher interest rate

are they going to do that anymore the

answer is no and so what also would

happen in this situation is the demand

would fall for Canadian dollars right

Americans would prefer not to have

Canadian dollars they'd rather have

American dollars by because they get a

higher interest rate United States is

demanding less Canadian dollars then

they would be supplying less US dollars

in the foreign exchange right now you're

thinking like whoa whoa which one is it

well it depends on what the question's

asking if the question asks you well

what happens to the demand when the

interest rates higher in the United

States well demand would go up what

would happen to supply well Supply would

go down the point is no matter how you

draw this thing United States dollar is

definitely going to appreciate no matter

what happens Canadian dollar is

definitely going to depreciate okay

hopefully this makes sense now it's time

to practice okay good

luck until next time