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The Exchange Rate Essay

2769 words - 12 pages

The exchange rate

An exchange rate is the rate at which one currency is exchanged on another one. This rate differs from country to country and depends on many economical variables, the main of which are the general balance and disbalance of economy, monetary and fiscal policy, the state of the budget, international policy, the condition and development of the country’s economy compared to the world situation and dominating countries, purchasing power of the currency, and other internal and external factors.
The history of world exchange rate systems shows us that the world community (in its majority) has in fact shifted from the system of fixed exchange rates to floating exchange ...view middle of the document...

Therefore the exchange rates between different countries equaled to the ratio of gold content linked with the currencies. This system existed until 1913, and, as we can see, represented the fixed exchange rate idea (since the gold content of each currency was fixed).
None of the countries offered 100% backing for their currency, and therefore the demand and purchasing power of a particular currency depended on the credibility of the currency; the countries with weaker or slower economical development had less credible currencies. The problems started to appear after World War I, when most of the countries were trying to improve their economical condition after the war and were undertaking speculative attacks, to increase the purchasing power of their currency and to decrease the purchasing power of other countries. Naturally, the economies of the countries with less credible currencies have been affected by such attacks, and the state of these economies has worsened. This situation has shown one of the weaknesses of fixed exchange rate system.
With the development of financial and banking system the backing of currencies has shifted from gold standard to backing by government debt instruments, such as treasury bills etc.
Since the currencies progressively less depended on the gold content, the main variable that defined the purchasing power of a currency was the credibility of it. Economical fluctuations and crisis specified the instability in currency exchange rates. Until World War II the world community has undertaken attempts to return to the gold standard, but they were not very successful because of the changed economical conditions .
After World War II the major countries adopted the Bretton-Woods system, which continued the policy of fixed exchange rates, but offered a shift from the inefficient gold standard to the so-called gold exchange standard. The exchange rates were fixed compared not to gold, but to the US dollar; the US dollar, in its turn, was linked by a specific exchange rate with gold. The change of exchange rates (either devaluation or evaluation) was allowed only in extreme cases. This system strengthened the position of the US as a dominating economy, and affected the exchange rates of countries with weaker economies.
As an attempt to solve this disbalance, the International Monetary Fund (IMF) has been created. The countries with weaker economies were given loans on specific conditions to improve their economical state. Nevertheless, the huge gap between the stability and level of exchange rates of dominating countries and the exchange rates of other countries proved that the existing exchange rate system needed to be improved.
The main controversy between exchange rates and domestic policies is that, on one hand, fixed exchange rates offer relative stability and better conditions for local and international trade conditions; the enterprisers could easily predict the rates and plan their work according to...

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