Sources used in this document:

When discussing the exchange rate there are two components; the nominal exchange rate and the real. The former referring to "the rate at which a person can trade the currency of one country for the currency of another" (Mankiw, G.N. 2004), while the latter is " the rate at which a person can trade the goods and services of one country for the goods and services of another" (Mankiw, G.N. 2004). While the nominal exchange rate of one Dollar for .7593 Euros (Google Finance.com. February 14, 2012) garners the headline attention, it is the real exchange rate which is "a key determinant of how much a country exports and imports" (Mankiw, G.N. 2004). The practical application of the exchange rate is the appreciation or depreciation of a currency and the impact of that move on the affordability of goods and services.

Economists cite multiple factors for the movement of currencies relative to one another: inflation differentials, interest rate differentials, current account deficits, public debt, and political stability-economic performance (Investopedia.com. July 23, 2010). In the context of the Dollar-Euro trade, only a few of these factors directly play into the determination of the exchange rate. Inflation differentials mean very little due to the fact that Eurozone inflation year over year is averaging 2.748%, while the U.S.is averaging 2.96% (Global Rates.com. 2012). If there were a significant differential in inflation, lower inflation nations would have comparably stronger currencies. Interest rate differentials also have negligible impact in the Dollar-Euro currency trade. The Federal Reserve and European Central Bank have kept short-term interest rates under one percent for several years to encourage borrowing and liquidity. A large differential would indicate the country with higher rates would experience higher capital inflows and a currency appreciation. Both the Eurozone and U.S. run considerable current account deficits, the former 100 billion U.S. dollars in 2011 (Feldstein, M. November 30, 2011), while the latter experienced a 110 billion deficit in the third quarter of 2011 (U.S. Department of Commerce. 2012).

It is the last two factors which explain the largest movements in the Dollar/Euro trade; debt issuance and political stability and economic growth. The 800 pound gorilla in the room is that the Eurozone is in the midst of sovereign debt crisis which has poisoned the well of economic growth across the European economies. Greece, Spain, Portugal, Ireland and others are rife with high debt to GDP ratios which are strangling private sector opportunities. Germany and France remain the stalwarts of the EU economy, yet even these engines of growth are suffering from the ever increasing debt burden of ECB bailouts and the concomitant surge in possible sovereign credit defaults. While the U.S.