Forex Economic Theory and Reality

A few weeks ago in a discussion thread on the EUR / USD found an interesting post in which the user pointed to the contrast between economic theory and current developments in the market. The paper was the fact that the economic purchasing power parity theory predicts the evolution of the pair EUR USD, which is exactly opposite from the progress we have been during the last half of witnesses. This article aims to explain why so often leads to large differences between the predictions of economic theory and current events in the market.For once I mentioned the difference in the approach to analyzing the market traders and economists. This difference is due to the fact that traders are risking real money, whether their own or their clients, while most economists risking their analysis up to its reputation.Another difference is that most economic theories, analysis and prediction is shaped for the long term. For example, structural problems of American economy (the debt ratio, the huge deficit on trade account, etc.) are generally known for a long time. Yes, in the future probémy are really serious and will require aggressive solution and probably the fall of USD. This does not mean that in the short and medium term could lead to further strengthening USD. The vast majority of traders but do not hold the position long term. It must therefore respond to market developments, whether this development is considered to be rational or irrational.When the lead, as The Economist's time to change my prediction, so as to reflect the latest published reports. Trader must respond flexibly to events and be able to evaluate which part of the published report is the most important. This implies another difference: most economists carefully study every detail so as to get the most objective view of the total events. Trader mostly concentrates on one number in the report or a single sentence in the speech of important personalities. Attention span traders in comparison with economists generally limited. teórico PPPs for many people it probably does not add a good mood, but at this moment we can not do without some, at least the basic economic terms and theories ...So let's do it. teórico purchasing power parity is based on the fact that the efficient market, a market that is large enough and has a high level of competition (so that no one can control the price) is the price of an identical product the same for all vendors / manufacturers (This idea is called "law of one price"). If the price of one dealer was lower, as market participants would simply buy the product at a lower price and would immediately sell it on the market for higher market price, which would realize a profit. Realized gains by purchasing the product at a lower price with one seller (be it anything from a pound of apples, watch through to luxury yachts) and the immediate sale at a higher price to another buyer, or in another market is called "arbitrage." Arbitrage in the most ideal form has the advantage that it is entirely without risk.Unless we know what the market price and find someone who is willing to sell us a product below market price, so we can not lose. Unless of course does not change the situation on the market. A side effect of arbitration is that arbitration is destroying itself. Increased demand for goods at a lower price because the demand increases, which moves the price up to market value so the next opportunity for arbitrage disappears. And now, finally, to what this theory has to do with the forex market. Unless the price is the same identical product, so it should be the same on foreign markets. That logic is ultimately a popular index of "Big Mac Index" prepared by The Economist. As the name indicates, this index measures the price of a Big Mac at McDonalds (that is absolutely identical product) across many countries and tries to determine, depending on whether the currency is undervalued or overvalued against the USD.The exchange rate should therefore reflect the price level in two different countries, so that the price of an identical product remained the same. Inflation (change in price level), should therefore have an effect, at least according to this theory, the exchange rate. Higher inflation should lead to currency depreciation. As we can see on the chart, inflation in the U.S. for several months, higher than in the EU. The above theory would therefore be anticipated that there will be depreciation of USD against EUR. As we all know, the reality is different ...