Supply in the Foreign Exchange Market

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Only exporting US products is of course not the only thing that occurs in foreign exchange market. Therefore people who buy US dollars actually sells it and in return receives currencies of other countries. This is actually what called US imports. With this, they can import foreign goods, services and assets that might also include stocks, business, or even bank deposits. Thus, this completes the supply and demand mechanism of the foreign exchange market.

As already discussed in previous parts, the traders buy US dollars when the rates are low. Finally, a time comes when the exchange rate rises and the traders decide to sell the dollars they have. This makes the US dollars to return to the market once again, and as a result of that, the supply controls the demand for it in foreign exchange market. Now the supply of US dollars depends on various factors such as:

  1. The need for importing goods and services in the US.
  2. Exchange rate.
  3. Estimated exchange rate in the future.
  4. The rate of interest of that time in the US and also other countries.

Next, we will learn about how exchange rate regulates the supply or availability of the US currencies in the foreign exchange market, under thesituation when remaining three factors is constant. This phenomenon can be understood by going through law of supply related to foreign exchange in the market.

The law of supply of currencies:

According to this law, when other factors remain constant, the exchange rate in the foreign exchange market rises. This results in a greater supply of the US dollars in the market because people will tend to sell the US dollars at a higher exchange rate. Take as an example, suppose the exchange rate hikes up from 100 yen to 120 yen. Then the traders unexpectedly sell more dollars than what they had planned. This provides an increased supply of US dollars in  foreign exchange market.

The provision of dollars in the market changes due to the changing expected rate due to the following factors:

  • Profit that has been expected
  • The imported effect

Import effect:

The greater amount or products of higher value if importedfromthe US, it willcause a larger supply of US dollars in the foreign exchange countries. The cost of the US imports in the market regarding US dollars is also another driving factor in determining the value of these imported products. Again the prices of this products change with the exchange rate. These foreign products would be of low price when the exchange rate is hiked, only if other factors remains constant. Moreover with the rise in the exchange rate of the US dollars, with other factors remaining constant, this would produce a greater amount of foreignnumber resource in  foreign exchange market.

Expected profit effect:

When the exchange rate increases high, then the chances that traders sell the US dollars in the market.This will enhance their profit part (all other factors remaining constant). As a result of all these phenomena, the best thing that happened is the US dollars finds a greater supply in the market. Therefore it is evident enough that this process is just the opposite of the mechanism of demand of US dollars.


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