U.N. panel: diversify world reserve currency away from USD

[Nova Andromeda]

By Jeremy Gaunt, European Investment Correspondent

LUXEMBOURG (Reuters) - A U.N. panel will next week recommend that the world ditch the dollar as its reserve currency in favor of a shared basket of currencies, a member of the panel said on Wednesday, adding to pressure on the dollar.

Currency specialist Avinash Persaud, a member of the panel of experts, told a Reuters Funds Summit in Luxembourg that the proposal was to create something like the old Ecu, or European currency unit, that was a hard-traded, weighted basket.

Persaud, chairman of consultants Intelligence Capital and a former currency chief at JPMorgan, said the recommendation would be one of a number delivered to the United Nations on March 25 by the U.N. Commission of Experts on International Financial Reform.

"It is a good moment to move to a shared reserve currency," he said.

Central banks hold their reserves in a variety of currencies and gold, but the dollar has dominated as the most convincing store of value -- though its rate has wavered in recent years as the United States ran up huge twin budget and external deficits.

Some analysts said news of the U.N. panel's recommendation extended dollar losses because it fed into concerns about the future of the greenback as the main global reserve currency, raising the chances of central bank sales of dollar holdings.

"Speculation that major central banks would begin rebalancing their FX reserves has risen since the intensification of the dollar's slide between 2002 and mid-2008," CMC Markets said in a note.

Russia is also planning to propose the creation of a new reserve currency, to be issued by international financial institutions, at the April G20 meeting, according to the text of its proposals published on Monday.

It has significantly reduced the dollar's share in its own reserves in recent years.

GOOD TIME

Persaud said that the United States was concerned that holding the reserve currency made it impossible to run policy, while the rest of world was also unhappy with the generally declining dollar.

"There is a moment that can be grasped for change," he said.

"Today the Americans complain that when the world wants to save, it means a deficit. A shared (reserve) would reduce the possibility of global imbalances."

Persaud said the panel had been looking at using something like an expanded Special Drawing Right, originally created by the International Monetary Fund in 1969 but now used mainly as an accounting unit within similar organizations.

The SDR and the old Ecu are essentially combinations of currencies, weighted to a constituent's economic clout, which can be valued against other currencies and indeed against those inside the basket.

Persaud said there were two main reasons why policymakers might consider such a move, one being the current desire for a change from the dollar.

The other reason, he said, was the success of the euro, which incorporated a number of currencies but roughly speaking held on to the stability of the old German deutschemark compared with, say, the Greek drachma.

Persaud has long argued that the dollar would give way to the Chinese yuan as a global reserve currency within decades.

A shared reserve currency might negate this move, he said, but he believed that China would still like to take on the role.

(To read Reuters Global Investing Blog click here; for the MacroScope Blog click on blogs.reuters.com/macroscope; for Hedge Fund Hub click on blogs.reuters.com/hedgehub)

(editing by Patrick Graham)

-So the Fed decided to print money and tanked the USD (US Dollar) a little while ago. Now a UN panel (I wonder if they 'speak' for the UN) is on board with suggestions from nations like Russia to move from the standard USD reserve currency to a basket of various currencies. I imagine this can't be good for the USD. In fact, one can imagine a scenario where nations decide to move from reserve USD and kill it in a rush to sell first and not last. If anyone else has some idea of what the likely impact(s) is(are) please post (even a list of possible impacts would be nice).

-[edit]It has also been my understanding that a large part of the US's economic dominance is due to the fact that everyone uses USD and holds USD as a reserve currency. Can anyone speak to this?[/edit]

[Gerald Tarrant]

-[edit]It has also been my understanding that a large part of the US's economic dominance is due to the fact that everyone uses USD and holds USD as a reserve currency. Can anyone speak to this?[/edit]

Yes and no.

The US Dollar as a reserve currency has some pluses and minuses from the perspective of the American people.

The demand created for the dollar by its reserve status push up its value. This is where some of the pluses and minuses enter in.

Pro:
High value of dollar = high exchange rate meaning Americans could consume more for their buck.
High demand for dollar denominated assets made debt cheaper in the US, and it's a big bonus right now, in that financing future deficits hasn't caused crippling interest payments. Steinglass shows what it looks like for countries without such easy credit.
An addendum: debt has been cheaper for companies too, that might have been part of the driving force in increasing productivity in the US (although differing labor and regulatory climates from a more controlled European model probably have assisted this).

Con:
Cheaper debt encouraged people to enter into ridiculous financial arrangements.
Cheaper debt led to lower savings rates in the US.
High dollar value made exports more expensive hurting American companies' competitive abilities.
Low (relatively speaking) foreign currency values made foreign imports more competitive and probably hurt American companies' market share at home.

The bolded are examples of the USD's impact on American business competitiveness. Economists generally agree that a weak currency is good for exporting businesses.

[Jalinth]

-So the Fed decided to print money and tanked the USD (US Dollar) a little while ago. Now a UN panel (I wonder if they 'speak' for the UN) is on board with suggestions from nations like Russia to move from the standard USD reserve currency to a basket of various currencies. I imagine this can't be good for the USD. In fact, one can imagine a scenario where nations decide to move from reserve USD and kill it in a rush to sell first and not last. If anyone else has some idea of what the likely impact(s) is(are) please post (even a list of possible impacts would be nice).

-[edit]It has also been my understanding that a large part of the US's economic dominance is due to the fact that everyone uses USD and holds USD as a reserve currency. Can anyone speak to this?[/edit]

I'd actually flip your statement around. The USD became the reserve currency because of US' economic dominance. Having the USD as a reserve currency helps keep the US as an economic superpower but you need to be very large and very stable to start with before everyone will accept your currency as being "the" currency.

Also, moving away from the USD (even to a basket) implies you have a viable alternative. Pound - no. Yen - no. Rubble - not a chance in hell. Yuan - no way in hell given the complete lack of faith in Chinese economic statistics, the pegging of the currency, and extreme opaqueness. Swiss Franc - simply too small of a country. Euro - the only viable candidate right now and they haven't been stress tested yet. It could become the or a reserve currency but it needs to survive the current economic problems first (or at least better than the US). Moving to a basket of currencies - meaning giving up on fiat currencies generally and moving to a new gold standard (use gold, silver, platinum, and other metals/minerals such as oil). Pretty extreme solution and the knock on implications would be far reaching.

Some implications:
The USD dollar will almost certainly take a tumble. Imports will obviously drop and exports will increase. So kiss much of Asia's economies to hell that are dependent on US exports and the US might end up with a reasonable current account deficit.
The US will lose a significant amount of seignourage income - foreign countries currently soak up what would otherwise be inflationary pressures.
Likely more investment and purchases in the US by foreigners due to relatively cheaper currency. So the US might end up with its multinational companies taken over by Euro (assuming it becomes the reserve currency) companies for a relative song.
Many foreign countries will take a shelacking on their $USD investments. China for one.
Expect that some commodities will try to be priced in the new reserve currency. Oil and gold. Whether or not it works is another issue.
If the US government maintains their current spending, I'd expect them to start having increasing problems issuing $USD debt. So the US government will either need to absorb much higher interest rates or foreign exchange risks by issuing foreign denominated debt.

[Nova Andromeda]

Pro:
High value of dollar = high exchange rate meaning Americans could consume more for their buck.
High demand for dollar denominated assets made debt cheaper in the US, and it's a big bonus right now, in that financing future deficits hasn't caused crippling interest payments. Steinglass shows what it looks like for countries without such easy credit.
An addendum: debt has been cheaper for companies too, that might have been part of the driving force in increasing productivity in the US (although differing labor and regulatory climates from a more controlled European model probably have assisted this).

Con:
Cheaper debt encouraged people to enter into ridiculous financial arrangements.
Cheaper debt led to lower savings rates in the US.
High dollar value made exports more expensive hurting American companies' competitive abilities.
Low (relatively speaking) foreign currency values made foreign imports more competitive and probably hurt American companies' market share at home.

The bolded are examples of the USD's impact on American business competitiveness. Economists generally agree that a weak currency is good for exporting businesses.

-I seem to be missing something here. How does a strong currency hurt exports necessarily. If the currency is strong stuff companies need from outside of the country are cheaper which should balance the fact that they can't sell their products for as much. In the case where you produce something like timber and sell outside of the country, the company ends up w/ dollars that buy more which balances the fact that they get few of those dollars. The opposite is true for a weak currency.
-I see two other factors that matter far more than how strong the currency is: 1. how the currency value changes and 2. the cost of doing business (this relates to the standard of living, how much middlemen skim, gov. 'fees', executive compensation, labor force skill level, etc.). In case 1, a stable currency is good since an unstable currency can negatively reset the 'value' of what ever you are doing overnight (e.g., you buy wood when the currency is high only to have to sell furniture when the currency value is low resulting in a net loss due to your lack of ability to predict where the currency is going). In case 2, the cost of doing business is impacted far more by things other than currency value.

[Ekiqa]

-I seem to be missing something here. How does a strong currency hurt exports necessarily. If the currency is strong stuff companies need from outside of the country are cheaper which should balance the fact that they can't sell their products for as much. In the case where you produce something like timber and sell outside of the country, the company ends up w/ dollars that buy more which balances the fact that they get few of those dollars. The opposite is true for a weak currency.

A strong currency hurts exports by making your products too expensive to sell on the world market.
A strong currency also makes it cheaper to import, hurting your own domestic industries.

It happened to the UK post-WWI, when many countries switched to US exports.

[DarkSilver]

I seem to be missing something here. How does a strong currency hurt exports necessarily.

Others with better knowledge can correct me if I'm wrong, but a stronger currency hurts exports simply by the fact your currency is worth more than the importers currency.

Which means it takes MORE of their money, to buy one unit of your stuff. Which hurts because it'll be less likely to sell, as compared to a a local product (or one imported from a "cheaper" country) because it is available for less.



Do I have that right? I think I do, but i may have either oversimplified, or have a misunderstanding of the process from the begining.

[ArmorPierce]

long story short, despite what many people seem to think, having a overly high valued currency is not a necessarily a good thing and tends to slow your economic growth.

[Ryan Thunder]

long story short, despite what many people seem to think, having a overly high valued currency is not a necessarily a good thing and tends to slow your economic growth.

Alternatively, the price of things could just, you know, change appropriately so that we don't end up carrying around mountains of nearly worthless change, or have the relative value of our stored cash decrease over time with absolutely fuck all control over the rate at which it does so...

[General Zod]

long story short, despite what many people seem to think, having a overly high valued currency is not a necessarily a good thing and tends to slow your economic growth.

Alternatively, the price of things could just, you know, change appropriately so that we don't end up carrying around mountains of nearly worthless change, or have the relative value of our stored cash decrease over time with absolutely fuck all control over the rate at which it does so...

Are you suggesting we introduce price-fixing? That didn't work terribly well when Russia tried it, you know.

[Ryan Thunder]

long story short, despite what many people seem to think, having a overly high valued currency is not a necessarily a good thing and tends to slow your economic growth.

Alternatively, the price of things could just, you know, change appropriately so that we don't end up carrying around mountains of nearly worthless change, or have the relative value of our stored cash decrease over time with absolutely fuck all control over the rate at which it does so...

Are you suggesting we introduce price-fixing? That didn't work terribly well when Russia tried it, you know.

I'm suggesting a fixed-value currency. Of course, I have a sneaking suspicion that it's the same thing and the economic system somehow makes it impossible or totally unfeasible one way or another...

[General Zod]

I'm suggesting a fixed-value currency. Of course, I have a sneaking suspicion that it's the same thing and the economic system somehow makes it impossible or totally unfeasible one way or another...

Oh, so you mean like Zimbabwe. Yeah, that didn't work out terribly well either.

[Stark]

I'm suggesting a fixed-value currency. Of course, I have a sneaking suspicion that it's the same thing and the economic system somehow makes it impossible or totally unfeasible one way or another...

This is the best thing about the internet. Totally uninformed people being frustrated or angry that their simpleminded yet utterly bogus ideas aren't taken seriously.

Economics might be complex, but the idea of money value isn't. You could seriously read wikipedia and improve your understanding, but you'd rather say WHY CAN'T IT BE LIKE IN MONOPOLY EVEN THOUGH IT'S TOTALLY UNREALISTIC.

[Nova Andromeda]

-Fixed currency arguments aside (they aren't mine), I'm still confused. Therefore, I'm going to write down a couple scenarios so others can show me where I've gone wrong.

Scenario 1 (strong dollar):
-1 dollar = 2 credits
-Raw materials sell for 2 credits per unit. Devices require 5 raw materials units and 1 dollar productions costs (labor, etc.) and sell for 8 dollars per unit.
Total device build cost = 6 dollars (12 credits)
Device sell value = 8 dollars (16 credits)
Profit = 2 dollars (4 credits) = 33%

Scenario 2 (weak dollar):
-2 dollars = 1 credit
-Raw materials sell for 2 credits per unit. Devices require 5 raw materials units and 4 dollars productions costs (standard of living, etc. the same as scenario 1) and sell for 10 dollars per unit.
Total device build cost = 24 dollars (12 credits)
Device sell value = 32 dollars (16 credits)
Profit = 12 dollars (4 credits) = 33%


-As can be seen from above, regardless of whether a currency is weak or strong the sell value is set by the profit percentage, the raw material cost, and the production cost. I assume a rational market / economy and stable currencies. The raw material cost is set by demand for one material verses other things. The profit percentage is set by how much the market will tolerate (it will not drop below material costs without external reasons). The productions costs are set by things like cost of living, living standards, etc. None of these things are related to the strength of a currency.
-As I mentioned before, the only 'problem' is when a currency's relative value changes during production. In such a case the producer is basically investing in currencies as well as selling something they make.


-Clearly I'm missing something so I'd appreciate it if someone would modify the scenarios appropriately.

[Ryan Thunder]

I'm suggesting a fixed-value currency. Of course, I have a sneaking suspicion that it's the same thing and the economic system somehow makes it impossible or totally unfeasible one way or another...

This is the best thing about the internet. Totally uninformed people being frustrated or angry that their simpleminded yet utterly bogus ideas aren't taken seriously.

Economics might be complex, but the idea of money value isn't. You could seriously read wikipedia and improve your understanding, but you'd rather say WHY CAN'T IT BE LIKE IN MONOPOLY EVEN THOUGH IT'S TOTALLY UNREALISTIC.

Hey, fuck you, Stark. Is it unreasonable of me to expect that the economy be set up such that the cash in my wallet--which itself is nothing more than a measure of buying power that had to have been arbitrarily set at some point, anyways--doesn't mystically decrease in value over the time it takes me to drive from the bank to my house?

[Illuminatus Primus]

I'm suggesting a fixed-value currency. Of course, I have a sneaking suspicion that it's the same thing and the economic system somehow makes it impossible or totally unfeasible one way or another...

This is the best thing about the internet. Totally uninformed people being frustrated or angry that their simpleminded yet utterly bogus ideas aren't taken seriously.

Economics might be complex, but the idea of money value isn't. You could seriously read wikipedia and improve your understanding, but you'd rather say WHY CAN'T IT BE LIKE IN MONOPOLY EVEN THOUGH IT'S TOTALLY UNREALISTIC.

Hey, fuck you, Stark. Is it unreasonable of me to expect that the economy be set up such that the cash in my wallet--which itself is nothing more than a measure of buying power that had to have been arbitrarily set at some point, anyways--doesn't mystically decrease in value over the time it takes me to drive from the bank to my house?

Yes it is. It is an evidence-free assertion by fiat. What do you think qualifies as "reasonable"?

[Lusankya]

-Fixed currency arguments aside (they aren't mine), I'm still confused. Therefore, I'm going to write down a couple scenarios so others can show me where I've gone wrong.

Scenario 1 (strong dollar):
-1 dollar = 2 credits
-Raw materials sell for 2 credits per unit. Devices require 5 raw materials units and 1 dollar productions costs (labor, etc.) and sell for 8 dollars per unit.
Total device build cost = 6 dollars (12 credits)
Device sell value = 8 dollars (16 credits)
Profit = 2 dollars (4 credits) = 33%

Scenario 2 (weak dollar):
-2 dollars = 1 credit
-Raw materials sell for 2 credits per unit. Devices require 5 raw materials units and 4 dollars productions costs (standard of living, etc. the same as scenario 1) and sell for 10 dollars per unit.
Total device build cost = 24 dollars (12 credits)
Device sell value = 32 dollars (16 credits)
Profit = 12 dollars (4 credits) = 33%


-As can be seen from above, regardless of whether a currency is weak or strong the sell value is set by the profit percentage, the raw material cost, and the production cost. I assume a rational market / economy and stable currencies. The raw material cost is set by demand for one material verses other things. The profit percentage is set by how much the market will tolerate (it will not drop below material costs without external reasons). The productions costs are set by things like cost of living, living standards, etc. None of these things are related to the strength of a currency.
-As I mentioned before, the only 'problem' is when a currency's relative value changes during production. In such a case the producer is basically investing in currencies as well as selling something they make.


-Clearly I'm missing something so I'd appreciate it if someone would modify the scenarios appropriately.

It might be easier to see with a volatile currency. If you look at the Australian dollar, it's quite volatile - it's not uncommon for the Australian dollar to lose or gain 1/3 of its value within a few months.

The producers within Australia run all their business using the Australian dollar, which maintains the same value for goods/services produced within Australia with little regard for the value of the dollar in international trade.

When the dollar is high (say, 80 US cents), foreigners buying Australian goods pay US$80 for every AU$100 that they are charged. When the dollar is low, (say 55 US cents), foreigners pay US$55 for every AU$100 they are charged. In both cases, the costs for the Australian company is the same in the local currency, and thus in both cases they make the same profit in AUD, despite selling for a completely different price in USD.

For the Aussie dollar, this is quite convenient, since our exports are based mainly on commodities, and the value of the Australian dollar follows commodity prices. This means that most Australian export industries are actually relatively unaffected by the price of the dollar.

If two currencies have a fixed trade rate, it becomes less intuitive, but the same principle applies, especially when you consider that weaker currencies tend to have lower wages and lower costs of living.

[Stark]

Hey, fuck you, Stark. Is it unreasonable of me to expect that the economy be set up such that the cash in my wallet--which itself is nothing more than a measure of buying power that had to have been arbitrarily set at some point, anyways--doesn't mystically decrease in value over the time it takes me to drive from the bank to my house?

You know that part where I suggested you could improve your understanding of economics and understand these issues just by reading wiki articles? Don't get angry; try learning instead.

[Jalinth]

-As can be seen from above, regardless of whether a currency is weak or strong the sell value is set by the profit percentage, the raw material cost, and the production cost. I assume a rational market / economy and stable currencies. The raw material cost is set by demand for one material verses other things. The profit percentage is set by how much the market will tolerate (it will not drop below material costs without external reasons). The productions costs are set by things like cost of living, living standards, etc. None of these things are related to the strength of a currency.
-As I mentioned before, the only 'problem' is when a currency's relative value changes during production. In such a case the producer is basically investing in currencies as well as selling something they make.

Markets aren't perfect in terms of material costs. You need to divide your input costs into local currency (salaries, but also a reasonable chunk of your fixed assets, power, and other supplies) and foreign currency (some raw materials that are commoditized). So what % of your input costs are truly subject to foreign exchange?
What percentage of your sales are subject to foreign exchange? If you buy 25% of your inputs in $USD and sell 95% of your outputs in $USD (primary commodity sellers), then an increase in the $USD:local currency exchange rate actually makes you money from a local standpoint and vice versa. But if you are a finished goods producer who mostly sells to $USD markets, then a drop in the exchange rate makes you money. So how good/bad exchange rates are really depends on the industry.

Lastly, a number of businesses have a huge fixed cost which lengthens the time frame over which foreign exchange fluctuations impacts them. You've already paid for the fixed costs (land, building, etc...) and you can "milk" them for a length of time, which gives you time to try to fixed your business model for permanently changes in foreign exchange rates.

[Phantasee]

There's a relationship like that between the Canadian dollar and the US dollar. Usually our dollar is weaker so we can export stuff to you guys easier. Recently, something caused the Canadian dollar to shoot up to parity, and actually got above the US dollar for a bit. This meant I could buy shit for cheap in the US, but it almost killed our manufacturing sector.

$10 CAD = $7 USD (CAD at $0.70 USD)

This means that things you pay $7 for in the US, cost me $10 if I want to import them. But for you, your dollar is worth something like $1.30 CAD, so your $10 is worth $13 or so here. So you could buy more per dollar, if you were importing from Canada. This is why the US imports so much from Canada, our resources and manufactured goods are cheaper for you.

When we got to parity, we had to pay less to get US goods. $10 CAD = $11 USD (CAD at $1.10 USD). So my dollars went further in the US. At the same time, the usual advantage the US had over Canada was gone, and our stuff was more expensive for you to buy.

Do the numbers help a bit?

[Gerald Tarrant]

-Fixed currency arguments aside (they aren't mine), I'm still confused. Therefore, I'm going to write down a couple scenarios so others can show me where I've gone wrong.

Scenario 1 (strong dollar):
-1 dollar = 2 credits
-Raw materials sell for 2 credits per unit. Devices require 5 raw materials units and 1 dollar productions costs (labor, etc.) and sell for 8 dollars per unit.
Total device build cost = 6 dollars (12 credits)
Device sell value = 8 dollars (16 credits)
Profit = 2 dollars (4 credits) = 33%

Scenario 2 (weak dollar):
-2 dollars = 1 credit
-Raw materials sell for 2 credits per unit. Devices require 5 raw materials units and 4 dollars productions costs (standard of living, etc. the same as scenario 1) and sell for 10 [24 actually] dollars per unit.
Total device build cost = 24 dollars (12 credits)
Device sell value = 32 dollars (16 credits)
Profit = 12 [8 actually] dollars (4 credits) = 33%

Labor costs should be the same in Dollars in both scenarios. I'll explain why after I modify your example


Scenario 1 (strong dollar):
-1 dollar = 2 credits
-Raw materials sell for 2 credits per unit. Devices require 5 raw materials units and 1 dollar productions costs (labor, etc.) and sell for 8 dollars per unit.
Total device build cost = 6 dollars (12 credits)
Device sell value = 8 dollars (16 credits)
Profit = 2 dollars (4 credits) = 33%

Scenario 2 (weak dollar):
-2 dollars = 1 credit
-Raw materials sell for 2 credits per unit. Devices require 5 raw materials units and 1 dollars productions costs(standard of living, etc. the same as scenario 1) and sell for 10 dollars per unit.
Total device build cost = 21 dollars (10.5 credits)
Device sell value = 28 dollars (14. credits)
Profit = 7 dollars (3.5 credits) = 33%

In the above scenario, what you see is that the unit became cheaper (in units)for foreigners to buy. Unfortunately it's more expensive in dollar based consumers. Comparing Sc. 1 and Sc. 2, a consumer is much happier getting something for $8 instead of $28. How much their real incomes fluctuates depends on how much of the economy is import dependent though. And Browsing through the NEA's tables it looks like they have reams and reams of tables dedicated to that sort of question.

now back to what you said

-As can be seen from above, regardless of whether a currency is weak or strong the sell value is set by the profit percentage, the raw material cost, and the production cost. I assume a rational market / economy and stable currencies.

An issue here. I'm sorry but I was a bit inexact in referencing "strong dollar/weak dollar". And I think that's where much of your confusion may come from. The Issue about currency strength mostly deals with changes in the strength of that currency. So when talking about a weak dollar, the comparison is to the status quo, with labor costs relatively fixed. Similarly for a strong dollar. There's a further issue though, in the US Imports account for something around 10% of the economy, so wages don't necessarily track entirely with the amount of value the currency loses. I.E. a 10% fall in the value of the dollar might only see dollar denominated wages increasing by 5% (depending on how much of the imports are consumer goods) to offset the higher cost of living. A currency depreciation is almost never mirrored on 1:1 basis with increases in cost of living, which means that even when real wages remain the same (i.e. wage growth matches the change in CPI) we should expect that labor has become relatively cheaper.

The raw material cost is set by demand for one material verses other things. The profit percentage is set by how much the market will tolerate (it will not drop below material costs without external reasons). The productions costs are set by things like cost of living, living standards, etc. None of these things are related to the strength of a currency.
-As I mentioned before, the only 'problem' is when a currency's relative value changes during production. In such a case the producer is basically investing in currencies as well as selling something they make.

For most things production is pretty much continual, so changes in currency evaluation have immediate impacts on the competitiveness of various goods. I'm not sure I understand the comment on "investing in currencies".

In any case while looking up some data about this I ran into this great FAQ answer from the BEA

Question: Can you see the effects of dollar depreciation in the GDP accounts?

Answer:Yes. The obvious effects of dollar depreciation are evident in the impact on net exports, GDP, and other exchange rate sensitive components, but there are also a number of measures in the accounts specifically designed to measure the effect of changes in export and import prices.

Prices. Changes in import vs. export prices are captured in the difference between the gross domestic purchases price index and the GDP price index. See the price index FAQ for more information on these prices.

Terms of trade. The terms of trade (shown in NIPA table 1.8.6) is a measure of the relationship between the prices that are received by U.S. producers for exports and the prices that are paid by U.S. purchasers for imports. It is defined as the ratio of the deflator for the sum of exports of goods and services and of income receipts from the rest of the world to the deflator for the sum of imports of goods and services and of income payments to the rest of the world. For example, in the fourth quarter of 2007, the price index for imports of goods and services increased 12.8 percent (annual rate), while the price index for exports of goods and services increased 6.2 percent. The terms of trade for that quarter declined 4.7 percent.

Changes in the terms of trade reflect the interaction of several factors, including movements in exchange rates, changes in the composition of traded goods and services, and changes in producers' profit margins. For example, if the U.S. dollar depreciates against a foreign currency, a foreign manufacturer may choose to absorb this cost by reducing the profit margin of the product it sells to the United States, or it may choose to raise the price of the product and risk a loss in market share.

Command-basis gross national product. A related measure, also shown in NIPA table 1.8.6, is command-basis gross national product, which measures the goods and services produced by the U.S. economy in terms of their purchasing power. In calculating command-basis GNP, the current-dollar value of the sum of exports of goods and services and of income receipts is deflated by the deflator for the sum of imports of goods and services and of income payments. Thus, when the terms of trade decline, the purchasing power-or "command value"-of U.S. GNP in international markets declines by more than the value of production in U.S. prices. For the fourth quarter of 2007, real GNP grew 1.3 percent, but command-basis GNP grew less than 0.1 percent. In other words, because of the decline in the terms of trade in that quarter, the purchasing power of the U.S. economy did not grow as rapidly as its real output. Similarly, the price index for gross domestic purchases grew 4.0 percent in the fourth quarter of 2007, while the GDP price index increased 2.8 percent. The difference in these indexes indicated that prices paid by U.S. residents were increasing more rapidly, on average, than the prices they received for their production.

I think the bolded section is the real kicker, as it's mostly empiricial. I'm playing around with their tables right now, but these two Here and here are the things to graph against each other (although both tables will probably need to be converted to percentage changes).

Also lots of people have posted good answers in the time between when I started writing this and when I completed posting. Apologies if I repeat anything.

[Akkleptos]

There's a reason why Japan's yen is kept at such a ridiculously low value, compared to the USD. Or, in a perhaps more apropriate wording, why Japan doesn't try too hard to elevate the Yen anywhere near USD parity. The status quo seems to work for them (and China, and... )

Also, manufacturers in many countries have to buy machinery from the US or that is otherwise priced in USD, so it's something that must be factored in when calculating the total cost of a product or commodity (yes, specialised machinery that has to be paid for in USD is -more often than not- used for producing these goods as well).

[Nova Andromeda]

The raw material cost is set by demand for one material verses other things. The profit percentage is set by how much the market will tolerate (it will not drop below material costs without external reasons). The productions costs are set by things like cost of living, living standards, etc. None of these things are related to the strength of a currency.
-As I mentioned before, the only 'problem' is when a currency's relative value changes during production. In such a case the producer is basically investing in currencies as well as selling something they make.

For most things production is pretty much continual, so changes in currency evaluation have immediate impacts on the competitiveness of various goods. I'm not sure I understand the comment on "investing in currencies".

-Thanks for clearing things up for me. It's a matter of changing currency values. "Investing in currencies" means that when a company imports or exports it relies on the exchange rate either not changing or changing in its favor. This means said company is basically doing currency investment. Honestly, I really don't like the idea of changing currency exchange rates. It makes international trade very risky.

[Gerald Tarrant]

-Thanks for clearing things up for me. It's a matter of changing currency values. "Investing in currencies" means that when a company imports or exports it relies on the exchange rate either not changing or changing in its favor. This means said company is basically doing currency investment. Honestly, I really don't like the idea of changing currency exchange rates. It makes international trade very risky.

Most of the time currency exchange rates move predictably. Long-running trade surpluses increase a currency's value (assuming no government manipulation to counterbalance this), deficits do the opposite (again, absent government intervention). There are a couple of exceptions; first when the excess currency is flipped and reinvested in the country with the deficit the currency tends to stay stronger, and second the USD has defied this probably due to its reserve status. If another currency (EURO maybe?) ever got widespread reserve status it would probably get a slight boost to its exchange rate too. Also I keep hearing rumors that large currency traders sometimes engineer "runs" on a currency for fun-and-profit (although it's not clear how big those swings can be, since the resources of any private trader are minuscule in comparison to a central bank.) And remember currency rates are set in a market, so they are sometimes subject to irrational expectations.

As to the risk for trading companies, there are futures contracts in currencies too. The contracts are a great tool for managing the financial risk that a non-financial international company sometimes faces.