ABSTRACT
The dollar's depreciation between end-of-year 1993 and 1994—11 percent relative to the Japanese yen, 9 percent relative to the German mark, and 6 percent relative to the British pound—is one of those puzzling paradoxes that not infrequently occur in the marketplace. While the dollar depreciated, the US economy's performance continued to be much stronger and more vigorous than that of the European and Japanese economies whose currencies appreciated. The usual explanation that emphasizes the current account deficit argues that the payments required to cover it increase the supply of dollars in foreign exchange markets, thereby depressing the dollar's exchange value. But this deficit is relatively small—about $80 billion in 1993, and probably about $100 billion in 1994—less than 1.5 percent of the US GDP. To assess whether the dollar's foreign exchange value is more likely to rise or fall, the place to look is the capital account, rather than only the current account.
