Which direction is Exchange-Rate Flexibility Headed?

Since the IMF started allowing floating currency exchange rates, more and more nations have adopted this style of currency management (Daniels, et al, 2009). This has allowed for greater freedoms when new nations; like those born after the fall of the Soviet Union, can transition to a market economy. In a situation where the currency is based upon supply and demand for the nation’s output having a flexible currency makes sense (Daniels, et al, 2009).

Fixing a currency to the yen, euro or dollar has benefits and drawbacks. Some of the benefits are for smaller nations, which lack the demand for their products, and this helps stabilize their economies. Some of the drawbacks are the increased substitution of the pegged currency for the national one as well as a black market trade in currency (Adom & Sharma & Morshed, 2008). Currency substitution can also undermine a fixed exchange rate. Businesses and citizens will begin to substitute dollars or Euros or yen in place of the national currency making management of the fixed exchange rate harder to control (Odedokun, 1996).

In Asia the yen is an often traded and used currency, yet it is so linked to Japanese culture and business it is a poor substitute for a regional currency and as such is not often used to base on a floating rate (Daniels, et al, 2009). The Chinese Yuan is a potential rising power to rival the dollar and the euro. The Yuan is probably undervalued and if the world saw more actions engendering trust from the Chinese government about their manipulation of the currency the Yuan may ne an effective currency to float against (Obstfeld & Rogoff, 1995).

There is much speculation in Latin America. This has led to concerns with the currencies of many nations like Argentina (Daniels, et al, 2009). Flexibility in this region would have some positive benefits. The research results suggest that foreign companies exposed to exchange risks in emerging markets gain resilience when they take a cross-functional approach for the assessment and implementation of hedging strategies along with the decentralization to subsidiaries of the decisions and implementation of hedging initiatives. This helps companies in: elaborating scenarios, assessing the possible impact of exchange rate variations, designing pre-emptive measures and setting alternative strategies to mitigate potential impacts (Fornes & Cardoza, 2009).

Mitigating the wild fluctuations of a fixed currency that results are massive inflation would go a long way to benefiting Latin America. Horne makes a compelling argument for flexible rates by discussion eight conjectures about exchange rates. Some of these conjectures show that as economies grow from a fixed to floating rate, they gain the flexibility to react to the market forces of supply and demand faster and more efficiently allowing a better competitive edge (Horne, 2004).

Greater exchange rate flexibility aims to reduce global imbalances of wealth and increases demand from emerging economies such as Asia and Latin America. More flexible exchange rates in Latin America and Asia will provide a cushion if the US dollar were suddenly to devalue (Daniels, et al, 2009). While a growing possibility the Chinese Yuan has a way to go before it has the same status as the dollar or Euro in the world markets (Obstfeld & Rogoff, 1995). As the currency market uncertainty in Southeast Asia has shown, globalization can amplify the costs of inappropriate economic policies and responses (Caramazza & Aziz, 1998).

The ongoing trend towards more flexibility as either managed floats or freely floating will continue. Even nations pegged to the euro, or dollar will float as these currencies float (Daniels, et al, 2009).

References

Adom, A. , Sharma, S. , & Morshed, A. (2008). Currency substitution in selected african countries. Journal of Economic Studies, 36(6), 616-640.

Caramazza, F. & Aziz, J. (April, 1998), “Fixed or Flexible? Getting the Exchange Rate Right in the 1990” International Monetary Fund http://www.imf.org/external/pubs/ft/issues13/index.htm

Daniels, J. Radebaugh, L. & Sullivan, D. (2009). International Business: Environments and Operations. Twelfth Edition.

Fornes, G. , & Cardoza, G. (2009). Foreign exchange exposure in emerging markets. International Journal of Emerging Markets, 4(1), 6-25.

Horne, J. . (2004). Eight conjectures about exchange rates. Journal of Economic Studies, 31(6), 524-548.

Obstfeld, M.,and Rogoff, K. (1995)”The Mirage of fixed Exchange Rates.” Journal if Economics Perspectives 9 (Fall): 73-96.

Odedokun, M.O. (1996). Monetary model of black market exchange rate determination. Journal of Economic Studies, 23(4), 31-49.

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