Not a Zero-Sum Game - Ludwig von Mises Institute

NOT A ZERO-SUM GAME
The exchange rate (the parity) will reflect the approximate pur-
chasing power of each currency in terms of the other, in the same
way that the four five-dollar bills purchase the same as the one
twenty-dollar bill. This equivalent purchasing power is called the
purchasing power parity (PPP). It would be the only determinant
of exchange rates if other factors did not affect the supply and
demand of foreign currencies; because, after all, it is supply and
demand that determines the price of things. Other factors that
influence demand and supply of foreign currencies are capital
flows from cross-country investments, international credit trans-
actions, family remittances, foreign aid and capital flight.
The political place of residence of the provider of the goods being
traded is irrelevant because a foreign supplier simply will not ship
the goods if the domestic importer does not have the wherewith-
al to pay; that is, if he has not bought the required foreign curren-
cy from the domestic country's exporters. When the demand for
foreign currency increases (or decreases), its price will just go up
(or down) like any other good.
Whether trade is domestic or international, it allows everyone
to share the savings brought on by increases in the productivity of
others. This sharing occurs because, as people reduce their own
costs through trade, their enhanced purchasing power allows them
to buy other things, at home or abroad, or to pay more to others
for what they want. When we purchase, we are in effect outbid-
ding other buyers. The more we save, the higher we can bid.
How FOREIGN EXCHANGE RATES (PARITY) WORK
For trade to occur between people in different countries (or dif-
ferent areas of the same country), the relative prices must be