![\"Two](\"https:\/\/commoncents.blogwyrm.com\/wp-content\/uploads\/2016\/03\/Two-Country-Model.png\")
<\/a><\/p>\nNow suppose the good that is being traded is cars; G has cars it wants to sell to people in U.\u00a0 At the initial time, the exchange rate favors G, as its currency is undervalued compared to U, and G promptly ships some number of cars to U.\u00a0 Upon arrival in U, the cars make their way to a dealership where a citizen of U, call him C, purchases one. \u00a0C pays for the car with U currency and happily drives away completely unconcerned with how the money makes its way back to G; that isn\u2019t C\u2019s problem.\u00a0 G\u2019s agents in the U have to deal with that.\u00a0 They do so by finding someone willing to buy Us for Ds.\u00a0 Since the supply of Ds in the exchange market goes up, there is a upward pressure on the value of Us compared to Ds and soon the exchange rate reflects that by adjusting the buying power of G, compared with U, down to parity.\u00a0 This floating currency exchange serves to naturally limit the number of cars that G can sell in U and an equilibrium results.<\/p>\n
Next, expand the model so that G is part of a larger economic entity comprised of itself and H (H stand here for Greece \u2013 either because H comes after G or because Hellenic is an adjective used for ancient Greece; the reader is free to decide for himself).\u00a0 Also suppose the H has no goods to trade with U at all.<\/p>\n
Now suppose the same situation occurs in this new model as occurred in the old.\u00a0 G has cars to sell and U has people wanting to purchase them.\u00a0 H is a complete bystander in the first leg of the transaction, having no goods to ship to U.\u00a0 However, H plays a pivotal role when the currency exchange occurs after the purchase.\u00a0 Since there is a larger supply of U, as H has a supply in addition to G, there is less of a mismatch on the exchange market and less of an upward pressure on D (or downward on U).\u00a0 Simply put there are now fewer Ds chasing Us in a relative sense.\u00a0 It takes longer for an equilibrium to set and during this time, H\u2019s purchasing power is remains low.<\/p>\n So although there is no direct exchange of either currency or products between them, H effectively transfers wealth to G in the form of better export conditions for G and poorer import conditions for H.\u00a0 The poorer H is, the more pronounced is the drag it produces on the upward trend in D, the longer it takes to reach equilibrium and the more wealth is transferred. \u00a0If people could move freely between H and G, then a mechanism would exist to equilibrate faster and more citizens of H would share in G\u2019s windfall. \u00a0In some real sense, it's like U is robbing H to pay G.<\/p>\n Although these models are highly simplified, they reasonably capture the essence of some of the tricky situations that result with import\/exports and currency exchanges.\u00a0 Several interesting articles exist (a nice one can be found here<\/a>) on similar situations during the Nixon presidency that ushered in the end of the Bretton Woods System.\u00a0 But that is a story for another day.<\/p>\n","protected":false},"excerpt":{"rendered":"<\/a><\/p>\n