The flow of funds between countries to pay for stocks and bonds purchases also contributes to the currency exchange-rate between currencies. In the near term, these capital flows are greatly influenced by yield differentials. All else being equal, the higher the yield on German securities compared to American securities, the more attractive German securities are relative to American securities. An increase in German yields would tend to raise the flow of U.S. dollars into German securities as well as decrease the outflow of Deutsche marks to American securities. The rate of inflation is another factor influencing currency exchange-rates.
Consumers try to avoid the eroding effect inflation has on their purchasing power.
Consequently, goods from countries with a low inflation rate become more attractive than the goods from countries with higher inflation. In turn, the currency from the lower inflation country rises in value, while the currency from the higher inflation country falls in value. Both the inflation factor and the purchasing power of the currencies directly impact currency exchange-rates. This fact is rooted in the concept of a purchasing power parity, which holds that, over the long run, a currency exchange-rate adjusts to reflect the difference in price levels between countries. For example, when an American wine merchant contracts to buy 1,000 cases of French wine, the merchant may agree to pay in French francs, say 600 francs per case, when the vintage is ready for shipment in two years.