Chapter 4

The Terms of Trade


Let’s generalize the results to a disturbance that improves the US terms of trade or real exchange rate. If the after-tax cash flows to US-based companies increase, what would we expect to see happening to the foreign exchange value of the dollar and the market value of US-based assets? It would not be too difficult to argue that the asset values should rise. Will the adjustment be instantaneous? We would argue that it would not. One key reason is that the adjustment is costly. We would argue that the real exchange rate cycles associated with local disturbances are best described as an inverted V. This is also an important fact that leads to some interesting economic and investment insights.

Investors who, ...

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