Exchange Rates And Their Effect On Trade

Essay, Research Paper

Exchange Rates and Their Affect on Trade

I. INTRODUCTION

Objective

The general objectives of this study are to describe recent trade problems and examine

why these problems are related to, and affected by exchange rates. The study first

examines the exchange rate and how it is determined. The study will explore, in detail,

the agencies that determine these rates. This study will also present the pros and cons of

different prices of goods and services in different countries. Specifically, this paper:

(1) defines recent trade problems and how they are affected by the exchange rate;

(2) describes the steps taken within the agencies that determine the exchange

rates;

(3) examines the impact of these rates, both good and bad;

(4) analyzes the costs of similar goods in the U.S. and in foreign markets;

(5) discusses the pros and cons of the exchange rate and how it affects trade;

(6) examines various exchange rate systems: floating, fixed, and dirty floating.

Limitations of the Study

The topics of exchange rate and trade both have a variety of factors that cause changes.

As with any study that attempts to explore current developments in the economy, it is

hard to keep information current. It is also virtually impossible to report on the status of

every single government that is involved in the exchange market. One of the limitations

of this study is to report on up-to-date values of currency while choosing a sample of

governments that accurately represent the world economy. Therefore, the solution was to

use stastical figures from magazine articles and books that were written within the

previous year. Also, the countries that were chosen to be studied are considered to play

a significant role in the exchange rate market.

Plan of the Paper

This study first examines the relationship between the exchange rate and trade. This

examination includes a definition of the exchange rate, an explanation of how the rate is

determined, and a detailed description of the agencies involved in determining the

exchange rate, including the United States Treasury and the Federal Reserve Bank (the

Fed). The next section defines and evaluates three different exchange rate systems – the

fixed, the floating and the dirty floating. The third section defines trade problems, how

they are affected by the exchange rate, and also how trade is affected by the exchange

rate. Finally, this study analyzes foreign cost in terms of the costs of similar goods in

foreign markets and how similar costs are possible.

II. FOREIGN EXCHANGE RATE

Definition of the Exchange Rate

The foreign exchange rate is the price relationship between the currencies of two

countries. How the exchange rate is determined, the agencies involved in determing the

rate, and different exchange rate systems are outlined throughout this paper.

Determining the Exchange Rate

The exchange rate is determined by the supply and demand of services traded between

countries. Various agencies monitor the rate and intervene when needed, in order to

counter disorderly market conditions. Intervention involves buying dollars and selling

foreign currency, coming from th Exchange Stabilization Fund (ESF) of the Treasury, to

support the dollar.s price against another currency. Conversely, the Fed will sell dollars

and buy foreign currency to increase the strength of the dollar. The United States

Department of Treasury, the Federal Reserve, and central banks are the primary agencies

that become involved if intervention is needed.1 Although the U.S Treasury has been

assigned primary resonsiblity for internation financial policy by Congress, the Treasury

usually works alongside the Federal Reserve System when deciding to intervene. These

interventions do not occur often. Rather, they are implemented as an attempt to shift

supply and demand on a long-term basis.

Agencies Involved in Determining the Exchange Rate

The Federal Reserve Bank and the United States Department of Treasury are primarily

resonsible for keeping records on the Balance of Payments, which relates directly to the

determination of the exchange rate. These agencies are responsible for keeping track of

the flow of money that is used to purchase merchandise, securities, and services, as well

as payments made to other countries by the United States.

In addition, these agencies are responsible for determining when to intervene in the

exchange rate.

Balance of Payments and the Exchange Rate

The most important factor in determining the exchange rate is the Balance of Payments,

which is an accounting record of all international transactions for a particular country

during a specified time period. The Balance of Payments is figured using two primary

accounts: the current account and the capital account. The current account is further

subdivided into fo

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