imports products from the US. In order to pay for them, Australians need US dollars. Therefore, the Australian companies trade Australian dollars for US dollars. The net effect is an increase in the supply of US dollars and Australian dollars. The Australian demand for American goods and services contributes to the demand for US dollars while American purchases of Australian goods and services contribute to the supply of Australian dollars. The net difference between Australian purchases of American goods and services, and vice versa, is the merchandise trade balance between the two countries.The rate of inflation is another factor influencing currency exchange rates. Consumers try to avoid the eroding effect inflation has on their purchasing power. Consequently, goods from countries with a low inflation rate become more attractive than the goods from countries with higher inflation. As a result of that, the currency from the lower inflation country rises in value, while the currency from the higher inflation country falls in value. Both the inflation factor and the purchasing power of the currencies directly impact currency exchange rates. For example, if the United States is experiencing lower inflation than it’s trading partner Germany, the Deutsch mark /United States dollar ratio rises to reflect the growing price level in Germany relative to the United States. This fact is rooted in the concept of a purchasing power parity, which holds that, over the long run, a currency exchange rate adjusts to reflect the difference in price levels between countries.Speculation is another factor that affect exchange rates. Speculation is the process of buying and selling such items as securities, commodities, or land in the hope of sudden increases in their value, and often with the risk of sudden decline. If expectations of future value of a currency are pessimistic it is going to be very likely that holders of that currency will start se...
