Rate of Exchange – 2900 words

Economics Essay

The rate of exchange renders a big influence on many macroeconomic processes occurring in a society. If a level of a rate of exchange to help the prices for goods and services made in the different countries are compared, it is cl.ear that competitiveness of national goods in  world markets, volumes of export and import, and, hence, a condition of balance of the current operations depend on this.

The rate of exchange also influences a direction of the international streams of capital. The decision on an investment of the national capital of this or that country is accepted s proceeding from the expected real profit on investment of the capital which depends on the interest rate and expected changes of a rate of exchange.

The rate of exchange, alongside with the interest rate, in itself acts actively on this At presence of the advanced active markets today’s cost of a performance which is expected in the future, is determined by discounting its future cost according to the interest rate and an expected level of a rate of exchange. Dynamics of a rate of exchange, and a degree and frequency of  fluctuations, are parameters of the economic and political stability of a society.

The rate of exchange acts as an object of a macroeconomic policy. To help quite often there is a settlement of the balance of payments.

The rate of exchange plays the important role by development and carrying out credit – a monetary policy as maintenance of the certain level of a rate of exchange can demand use of official currency reserves that will inevitably be reflected in the offer of money in an economy. In countries with a transitive economy, the stabilization of the rate of exchange can be used in the struggle against high inflation or a hyperinflation.

If the given work factors influencing change of a rate of exchange are considered, the analysis of changes of rates for 2008 can be made, and also an attempt made to forecast a rate by the beginning of 2010. For any price, a rate of exchange deviates a cost basis – purchasing capacity of currencies (volume of the commodity weight got on monetary unit) – under influence of a supply and demand of currency. The parity of such supply and demand depends on lines of factors. Many factors of rate of exchange reflect its connection with other economic categories: cost, the price, money, interest, the balance of payments, etc. And there is their complex interlacing and promotion as one deciding that, other factors depending on economic conditions and the political situation in the country and the world. Among them it is possible to allocate the following.

  1. The rate of inflation. The parity of currencies on its purchasing capacity (parity of purchasing capacity), reflects action of the law of cost, serves as an original axis of currency rate. Therefore the rate of exchange is influenced by the rate of inflation. The above rate of inflation in the country should be below a rate of its currency if other factors do not counteract. Inflationary depreciation of money in the country causes reduction in purchasing capacity and the tendency to falling rates of currencies in countries where rate of inflation is lower. The given tendency is usually traced in a short-and the long-term plan. Alignment of a rate of exchange, and its reduction conformity occur to parity of purchasing capacity on an average of two years. It shows that the daily quotation of exchange rate is not connected to its purchasing capacity, and also that there are other rate-forming factors.

However, the course parities of currencies cleared of speculative and tactical factors change according to the law of cost, with change of purchasing capacity of monetary units.

Dependence of a rate of exchange on the rate of inflation is especially great in countries with a great volume of international trade in goods, services and capital. It tells us that the closest connection between dynamics of a rate of exchange and relative rate of inflation is shown by calculation of a rate on the basis of export prices. The prices of the world market represent the term of money of international cost. As for import prices, they are always less comprehensible by calculation of relative parity of purchasing capacity of currencies as in many respects depend on dynamics of a rate of exchange. The index of wholesale prices is comprehensible for such a calculation only for advanced countries where the structure of wholesale domestic trade and export is to a certain similar high level. In other countries, this index does not include many exported goods. Similar calculation on the basis of retail prices can give a misleading picture, which includes a number of the services which are not the object of world trade. Finally, in world markets, there is a spontaneous alignment of rates of national monetary units according to real purchasing capacity. The real rate of exchange is defined as a nominal rate (for example, pound to dollar), that is increased on the attitude of price levels in the Great Britain and the USA.

  1. The condition of the balance of payments. An active balance of payments promotes increase of a rate of national currency if it demands increases on the part of foreign debtors. The passive balance of payments generates the tendency of a reduction of a rate of national currency, as debtors sells on a foreign currency for repayment of external obligations. Instability of balance of payments results in spasmodic change of supply and demand on corresponding currencies. In modern conditions, influence of the international movement of capital on the balance of payments is sharply increased by a rate of exchange.
  2. A difference of interest rates in different countries. Influence of this factor on a rate of exchange involves two main factors. First, a change of interest rates in the country influences other things, such as the international movement of capital, first of all short-term. Basically, the increase of the interest rate stimulates inflow of foreign capital, and its reduction encourages outflow of capitals abroad. Movement of capital, especially speculative “hot” money, strengthens instability of balances of payments. Second, interest rates influence operations of the currency, credit, and share markets. Banks consider a difference of interest rates in the national and world markets of capitals with the purpose of the extraction of profits. They prefer to receive cheaper credit in the foreign market of loan capitals where rates are lower, and to place a foreign currency in the national credit market if interest rates are higher.
  3. Activity of the currency markets and speculative currency transactions. If the rate of any currency tends to downturn, firms and bank sell it against steadier currencies which worsens positions of the weakened currency. Currency markets quickly react to changes in the economy and policy. Thus they expand opportunities of currency gambling and the spontaneous movement of “hot” money.
  4. A degree of use of a certain currency in the euro market and in international payments. For example, that fact, that 60 % of operations of euro banks and 50 % of international payments are carried out in dollars, determines scales of a supply and demand of this currency. Therefore periodic growth of the world prices and payments on external duties promotes an increase in exchange-value of dollar even in conditions of falling of its purchasing capacity.
  5. The course parity of currencies is influenced also by an acceleration or a delay in international payments. A pending decrease in a rate of national currency has its own impact: for example, importers aspire to speed up payments to contractors in a foreign currency to avoid losses at the increase of the rate. When the national currency strengthens, the aspiration of importers is to a delay of payments in a foreign currency. Such tactics (which have has received the name ‘Leeds and legs) influences the balance of payments and a rate of exchange.
  6. The degree of trust of a currency on national and world markets. This is determined by the condition of the economy and political conditions in a country, and also by the factors considered above, thereby having an influence on a rate of exchange. Dealers take into account not only rates of economic growth, inflation, a level of purchasing capacity of currency, parity of a supply and demand of currency – but also the prospect of their dynamics. Sometimes even expectation of the publication of official data on trading and payment balances or results of elections affects an exchange rate. At times in the currency market, there is a change of priorities for the benefit of political news, news about resignation of ministers, etc.
  7. Currency policy. The parity market and state regulation of a rate of exchange influences its dynamics. Formation of a rate of exchange in the currency markets through the mechanism of a supply and demand is usually accompanied by sharp fluctuations in a currency. In the market there is a real rate of exchange – a parameter of a condition of the economy, trust in a certain currency. State regulation of a rate of exchange is directed on its increase or decrease, proceeding from problems of currency – economic policy. With this purpose, certain currency policy is carried out.

All these factors contribute to a rate of exchange: the complex multifactor processes caused by the interrelation national and economic and a policy.

The year 2008 has caused investors many surprises. So, the second half-year in the international currency market there were many fluctuations. The main background of the “development” of financial markets certainly became a global financial crisis, contributing to a general economic recession. Investors began to leave financial platforms, thus aggravating a collapse of share markets.

For these reasons, only during the period from the middle of July to the end of November, the American dollar has become stronger to the uniform European currency by 20 %, having reached an on par EUR/USD level 1,25 (whereas in July it was 1,59).

The pound sterling, in March 2008 cost more than two dollars (2,01), but by the end of year was at a level 1,5. Now a pound is worth just more than a dollar. Thus, from levels of the maximal value the British currency has lost more than 25 %.

At the beginning of December in the international currency market, trends changed. Participants reflected on whether or not the national currency of the USA and state debt papers denominated in it should be considered reliable and safe. As a result, in less than a month the European currency managed to win back a dollar rate more than 12 % of the cost lost for the last quarter.

All these enormous fluctuations in the international currency market were accompanied by repeated ineffective attempts of financial authorities in key countries to stop total economic recession. Practically at every session the Central Banks of the leading states of the world, the monetary and credit policy was ‘softened’. Consequently, by the end of the year key rates in these countries achieved long-term minimal levels. Many Central Banks actually deprived themselves of the opportunity to use such a traditional tool of monetary regulation as a change of interest rates.

It is expected for the dollar to ease against other main currencies in the coming year. And if in the first half-year 2009 it is possible to predict some lateral movement in key pairs in the currency market, in the second half of the year (in the process of the stabilization of economies) the dollar is likely to fall. The measures accepted by financial authorities in the USA for the stimulation of the economy all undermine the trust of investors to invest in American ‘paper values’  more.

The EUR/USD in the first half-year 2009 should see movement in a range 1,30-1,55 with the subsequent easing of the dollar in the second half of the year up to the values 1,55-1,75. Even a pessimistic outlook would see perhaps a rate of two dollars to one Euro.     

The British pound will most probably win back a part of the weak GBP/USD rate. The target range on the given currency tandem will probably be established the next year at a level 1,40-1,90.

The important macroeconomic indicators by the end of 2009 will have a generally pessimistic character, indicating an ongoing recession, both in the industrial sector, and in area of services. The published data on a rate of unemployment will still testify to serious problems in the labour market. Indicators of business activity for most part of year will stay on minimum levels. Volumes of consumer credit and personal charges will make also be rather modest in value.

The decrease in rates of gross national product for the majority of countries in the world will amplify deflationary processes in economically advanced states, as well as the further mitigation of a monetary and credit policy there where it is still possible (the Euro zone and the Great Britain).

To determine the basic trends of the movement of the main currency pairs next year, observers should consider the current fundamental preconditions, capable of rendering the greatest influence on the movement of the rate of the American dollar in the foreseeable future. In such recessionary conditions the destiny of the American dollar in the future is unenviable. In particular, because of the huge burden of debt in its “sick” economy, the USA will find it difficult to fund any move to support the dollar. Therefore, the USA will most likely not allow an increase in its rate of national currency and let the dollar fall naturally.

As a whole, the situation in the international currency market will be characterized still by the trend of highest valuation, an absence of an unequivocal fundamental trend of movement, and all the same uncertainty concerning the further prospects of the development of the world economic system as we see today.

The important macroeconomic indicators at the end of 2009 will have a generally pessimistic nature, indicative of a deepening recession. Published data on the rate of unemployment still will testify to serious problems in the job market in all developed countries. Indicators of business activity for most of the year will stay at minimum levels. Volumes of consumer credit will also be minimal.


In conclusion, it is possible to foresee the basic influencing factors on rates of exchange: these include, the structure of the trading balance and dependence on external countries which are sources of raw material; the presence of economic growth, which will be seen from parameters (a total national product, volumes of industrial production, etc.); the level and the forecast of inflation; the growth of monetary weight in the housing market, as currency and local monetary unit; the levels of the rate of refinancing; solvency of the country, convertibility of currency and trust of that national currency in the world market. The degree of development in other directions of financial world market, for example the share market, will probably compete with the currency market and will depend on it too.

Econometric analyses indicate only to role of a reserve currency, of course. There are many more considerations: for instance, a country’s size, its financial depth and rates of return, the effects of decisions by private citizens regarding the currencies they hold for transactions etc. Each international currency influences others, especially in a globalised world: if central banks have more reserves in euros, they do more transactions in euros. The euro could become a major moving currency in the foreign exchange market. If the dollar overtook the euro as a reserve currency, it could be predicted that the international use of the dollar might also be overshadowed by the euro in other ways as well.

Various predictions indicate that the euro might overtake or stand as a rival to the dollar as a world leading currency, and the pound is also likely to gain leading status in financial markets as early as 2010. The surpassing of the euro over dollar would be a significant once-in-a-century event; it also happened to pound in last century. But it could, and possible even will, happen at some stage in future.















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