Kids And Fnance

There were many system regulating exchange rates, one of which was the Bretton Woods system.

The Bretton Woods agreement of 1944 established fixed exchange rates, defined in terms of gold and the US dollar. Between 1944 and 1971, many currencies were pegged against the US dollar, their parities with the US dollar were fixed. In this period, ? US dollar was ? promissory note issued by the United States Treasury. If anybody requested it, the Treasury had to exchange the note for 1/35th of an ounce of gold. Under this system, overvalued or undervalued currencies could only be adjusted with the agreement of the International Monetary Fund. Such adjustments are called devaluation and revaluation. The Bretton Woods system of gold convertibility and pegging against the dollar was abandoned in 1971, because following inflation, the Federal Reserve did not have enough gold to guarantee the American currency.

Gold convertibility was replaced by ? system of floating exchange rates. (Today, the US dollar – the unofficial world currency – is merely ? piece of paper on which is written ‘In God We Trust.’ God, not gold!). In the late 1970s and early 1980s, the American, British and other governments deregulated their financial systems, and abolished all exchange controls. Residents in these countries were enabled to exchange any amount of their currency for any other convertible currency. This has led to the current situation in which 95% of the world’s currency transactions are unrelated to transactions in goods but are purely speculative.

? freely (or clean) floating exchange rate is determined purely by supply and demand. Theoretically, in the absence of speculation, exchange rates should reflect purchasing power parity – the cost of given selection of goods and services in different countries. Proponents of floating exchange rates, such as Milton Friedman, argued that currencies would automatically establish stable exchange rates which would reflect economic realities more precisely than calculations by central bank officials. Yet they underestimated the impact of speculation, and the fact that companies and investors frequently follow short-term money market trends even if these are contrary to their own long-term interests. The disadvantage of floating exchange rates is that markets may overreact to the activities of speculators and this may lead to dramatical appreciation and depreciation of currencies (although markets learned ? little at least not to overreact in that way, but it’s still not ? perfect system).

Few governments, however, leave exchange rates wholly at the mercy of market forces. Most of them attempt to influence the level of their currency when necessary. Managed (or dirty) floating exchange rates are more common than freely floating ones. In 1979, most Western European governments joined the EMS (European Monetary System), with its ERM (Exchange Rate Mechanism). This established parities between member currencies, and a margin of plus or minus 2 1/4%. If the rate diverged by more than this amount from the central parity, governments and central banks had to intervene in exchange markets, buying or selling in order to increase or decrease the value of their currency.

Managed floating system doesn’t seem to work well too. The speculators on the market seem to be much stronger than any government or any central bank intervention and government policy can easily be defeated by the combined action of international speculators. For example, on ? single day in September 1992 the Bank of England lost five billion pounds in ? hopeless attempt to support the pound sterling. For weeks, ?ll the world’s financial institutions and rich individuals had been selling their pounds, as everyone except the British Government believed that ever since it joined the ERM in 1990, the pound had been seriously overvalued. When the British central bank ran out of reserves and could no longer buy pounds, the currency was withdrawn from the ERM and allowed to float, instantly losing about 15% of its value against the D-mark. The next year, speculators attacked the French franc, the Belgian franc, the Danish crone and the Spanish peseta. In August 1993, the European Monetary System was more or less suspended. In this conditions an appropriate system may be half and half system whereby central banks do intervene and try to calm things down, where you may have target zones.

Many manufacturers are in favor of fixed exchange rates, or ? single currency. Although it is possible to some extent to hedge against currency fluctuations by way of futures contracts, forward planning is difficult when the price of raw materials bought from abroad, or the price of your products in export markets, can rise or fall by 50% in only ? few months. (Since exchange controls were abolished, currencies including the US$ and the pound sterling have in turn appreciated by up to 100% and then depreciated by more than 50% against the currencies of major trading partners).

Other supporters of fixed exchange rates or ? single currency include extreme conservatives who want to return to something like the gold standard, as well as people on the left who believe that speculators have too much power. Opponents say that if you have ? world currency you have no exchange rates, and that is presumably good for trade and, like under the gold standard, means ? very stable and certain economic environment, but then there is a need for ? world central bank, and that’s quite ? tall order (difficult to implement). There is also a need to have some kind of world fiscal system to cushion whatever shocks may happen in parts, only in parts of the world -  it’s ineffective if there is a global shock. Supporters of flexible rates include monetarists who want countries to follow strict monetary rules, as well as Keynesians who want to be free to devalue in the attempt to reduce unemployment.

The recent event in the world monetary system was the appearance of a new currency – euro. It was introduced in 1998, but went in circulation in 2002. All currencies of european countries were put out of circulation. This allowed European countries to make capital circulation easier and to increase the volume of trade and investment. Besides that, all the countries that make payments with euro, now do not have problems with exchange rates fluctuations and speculators, thus avoiding financial losses.

Published on 14 Aug 2011 in Uncategorized, by hanun

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