If I might muck this discussion up a bit (please read it and then go back to what you were doing if it has no use).
A lot of money is made and lost trading money, so I got curious just what theoretical assumptions the people speculating on exchange rates operate under (goodness the things you find out hanging out at FT bulletin boards). One group at the BB sticks with the idea that an exchange rate should stick close to what PPP says it should be. Problems include arriving at PPP and then deciding whether or not a given exchange rate is that much out of line with it. Another group goes by the idea that 'markets' rationally read the state an economy is in and then buy or sell a currency based on that understanding. If this held, why would 'markets' consistently advance the yen against the dollar from the late 80s to the late 90s? Another school says, that a currency should go to its trade weighted value. These guys are the ones who keep saying the yen is UNDERVALUED against the dollar since Japan has a huge trade surplus with the US (never mind the fact that even if the yen is pretty much limited to Japan, the dollar sure isn't). The idea is that the yen should continue to appreciate until Japan-US trade is balanced (like wow, this assuming there is a solid relationship between the two and nothing else matters). Finally, the Jannuzi theory, at least as to what actually works with the dollar-yen value. No one trading currency long term bets on the yen losing value against the dollar because for the past 15 years the US has consistently either worked to cheapen the dollar against the yen or refrained from propping up the dollar when the markets were buying and appreciating yen. Anyone who bets against this without hedging is asking to lose. It's interesting everytime the yen does lose some value against the dollar (like 10-15%) and stays that way for more than 6 months, a bank discovers a 'rogue trader' to blame currency trade (or currency linked) losses on. Charles Jannuzi
