Forex exchange-rate index is designed to measure how, over time, movements in the dollar will affect U.S. imports and exports. And to do this well, Forex index must also take account of any differences between the rate of inflation in the United States and the rates of inflation in other countries. Suppose that the rate of inflation were 10 percent a year in the United States but only 3 percent a year in Germany. The buying power of the dollar in the United States is falling 7 percent a year faster than the buying power of the German mark.

Now suppose that Forex exchange rate of the dollar declined by 7 percent from one year to the next against the mark. Then German buyers would be getting 7 percent more dollars for their marks; but the decline in the exchange rate would be exactly undone by the greater increase in prices in the United States than in Germany. The number of Mercedes that it took to trade for one Boeing 757 would be the same in the two years. (At least, this would be true on average for many goods.) This means that, when a change in Forex exchange rate simply compensates for differences in inflation rates, the relative prices of U.S. imports (from Germany) and U.S. exports (to Germany) do not change.

Readers let us notify: international Forex trade economists do it differently. One of the most confusing concepts in economics is the way in which Forex rate of exchange between two currencies should be expressed. As we indicate in the article, we choose to express the rate as the number of units of foreign currency that can be purchased with one dollar (e.g., let