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Exchange Rates Essay

2484 words - 10 pages

Exchange Rates
Missing Two Graphs

“For many years it has been believed that if countries import more than they export and so have a deficit on the current account of the balance of payments then their currencies will tend to fall in value. Yet over the last two years the dollar has been a strong currency even though USA has had a record current account deficit. How can this fact be explained? What does it tell us about the factors, which determine exchange rates? What policy decisions with regard to exchange rates do you think USA and other governments should take in response to these developments?”

Exchange rates

Exchange Rate, in relation to foreign exchange of money, is the price of a country's currency expressed in terms of one unit of another country's currency. The Foreign Exchange rate indicates the value of any given currency relatively to another. Thus, a pound sterling note is money in the United Kingdom, but is foreign exchange in the U.S.

The use of foreign exchange arises because different nations have different monetary units, and the currency of one country cannot be used for making payments in another country. Because of trade, travel, and other transactions between individuals and business enterprises of different countries, it becomes necessary to convert money into the currency of other countries in order to pay for goods or services in those countries. The transfer of money values from one country to another and the determination of the price at which the currency of one country will be surrendered for that of another constitute the main problems of foreign exchange. Foreign exchange is a commodity, and its price fluctuates in accordance with supply and demand. Exchange rates are published daily in the principal newspapers of the world. By international agreement fixed exchange rates with a narrow margin of fluctuation existed until 1973, when floating rates were adopted that fluctuate as supply and demand dictate.

Balance of Payments

Balance of Payments is the relationship between the amounts of money a nation spends abroad and the income it receives from other nations. The balance of payments is officially known as the Statement of International Transactions and includes two main accounts. The first, the current account, tracks activity in merchandise trade - exporting and importing, income earned from investments abroad, money paid to foreign investors, and transactions on which the government expects no returns.

The second, the capital account, tracks both loans given to foreigners and loans received by citizens. It is well known that the balance of payments is the reflection of a nation's financial stability in the world market, and because of that the International Monetary Fund (IMF) uses these accounts to make decisions such as qualifying a country for a loan.

Strictly speaking, the balance of payments always balances because of official financing. However, a balance of...

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