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Example research essay topic: Point Of View Exchange Rate - 1,814 words

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East Asia's attraction to foreign savers was a direct result of genuine growth in that region. This required productive investment in the construction of physical and human capital to increase the future productivity of workers. In turn, workers engaged in capital construction required food, clothing and shelter etc. (consumption), which was generally provided by the savings of other people. Because human capital are qualities such as education and knowledge, only physical capital contributes to the genuine growth of GDP per capita also seen as living standards. To understand why there is so much attraction to foreign savers, we need to see what the region in question can offer investors. Investors have a choice of how to finance their investment: using their own saving from wages / salaries , from business profit, or by borrowing or 'drawing' on the saving of other persons.

Although using personal saving or business profit for investment may be simpler, it is not always the most cost-effective since the priority of nearly all firms is to profit maximize. In order to do so, drawing on the savings of others allows access to a greater pool of saving and rate of investment, despite the downside regulations to protect the interests of savers and dependence on a continued flow of other persons's aging. In the case of East Asian economies, decades of uninterrupted growth in living standards were partly based on high domestic saving (what is left after consumption spending on living expenses). In comparison, foreign investors' living standards were higher and so an investing economy (such as the US) would likely choose to supplement its domestic saving with foreign saving.

Foreign saving is made through the current account of the balance of international payments; when this account is in deficit, the country is drawing on foreign saving each year by the extent of the deficit. This therefore provides a surplus for the East Asian economies. Allocation of savings is rationally decided by a person's expectations of return and risk and hence a greater risk of loss requires a greater expected future return. However since the future is unknown and therefore inherently risky, the assessment of return and risk are mostly affected by the emotional state of the decision maker. When prices accelerate or plunge to unsustainable heights or depths respectively, it could be said that greed and fear are dominating rational calculation. In a boom, expected returns are exaggerated beyond what is physically possible, while risk is either totally ignored or foolishly imputed at zero (as explained above) when this can never be the case, since the future always holds some kind of risk.

From the saver's point of view, equity is riskier than debt, but because of the attraction of higher expected returns from equity in the event the venture is successful, greed will allow this risk to be accepted. From the investor's point of view who fully intends to honour the commitment to repay debt, the issue of debt is more risky than equity because the funds must be repaid even in the event of project failure which could lead to business and personal bankruptcy. From the point of view of both savers and investors, international transactions in saving also involve exchange rate risk. When foreign savings are transmitted to the host's country, foreign currencies are bought for domestic currency at one exchange rate, but when these foreign savings are repatriated, a less favourable exchange rate may apply. For example, if the exchange rate between the Australian Dollar and the Yen is one to one, I will spend AUD 1 million to receive YEN 1 million. However, when I have to repay, if the Yen is worth two Australian Dollars, I will have to pay the equivalent of AUD 2 million in return.

Provided that I invest in an Asian business however, I will hedge against all exchange rate risk, because the profit made will be in the currency that I have to return the debt in. This will always be the case in a booming economy with high savings and high and productive investment. The ensuing inflow of foreign funds would raise the growth rate of the money supply because there is greater investment and hence greater saving (from GDP = C+I+G+X-M). When investment increases, the money supply increases. Greater saving also leads way to greater spending because a certain amount of the saving is used on extra consumption (which also increases GDP). As mentioned before, physical capital increases due to investment and so the demand for labour increases also.

Rural-urban migration occurs due to the higher investment as well. Because there is a high level of investment, there are both more jobs available in urban factories developing new technologies. Because of the higher demand for labour, the opportunity cost of urban living has increased. Because of this increased rural-urban migration there is more demand for land due to a greater population density. When demand rises for urban living, urban land prices increase. Both urban land price increases and population density are an indication that more real estate should be built.

Because of the increased growth in money supply, the economy appears to be stronger from a foreigner's perspective. The exchange rate between an East Asian country and another country will be much higher than before - see example ( ) above. This effectively increases profits immediately. Other factors of extra profit include the extra demand for labour. Since there is more demand for labour, employers can offer lower wages because the job market is more competitive. Higher demand for urban living and increased consumption also means that the large amount of real estate being built will attract a large number of buyers.

Another source of buyers are investors in real estate. Auctions especially will allow the people to bid the price up much higher than usual due to the large number of buyers. Because of the large number of buyers of real estate, there will be many more loans from banks and a large number of loans requested. Banking at this time is risky because the principal amount loaned out by banks involves the debt being repaid with interest earned from on-lending to investors. The ability for borrowers to repay the principal with interest cannot be guaranteed; especially when depositors are not prepared to lend as long as it takes for the principal amount and interest to be paid back. This risk is only reduced in 'normal' banking because the deposits are 'rolled over' from one depositor to another which is reliant on customer confidence.

A loss of confidence due to rumours or facts, can trigger a large number of people to withdraw their deposits making it impossible for banks to store funds from depositors and therefore also impossible to issue funds to borrowers. This can lead to banking collapse in which banks are forced to call in loans from credit worthy businesses, its employees, suppliers and customers to help meet the banks' commitments to depositors. Bankruptcy of competent entrepreneurs and their employees takes years to recover because they are such scarce resources. Generally some kind of banking regulation is necessary to withdraw funds in the event that loans do not perform (such as having adequate reserves of capital). An excessive proportion of savings was funneled into real estate where over investment occurred and losses were made. Building in anticipation of rising prices lead to an over supply of buildings, excessive vacancies and hence falling prices and the inability to service loans.

Banks accepted real estate mortgages as security for loans, but the security was an illusion because the market value of the asset fell below the value of the loan. When there has previously been a high inflow in anticipation of a high level of business activity and profit, a large rise in interest rates to combat inflation will have the dramatic effect of increasing lending which attracts more funds and tends to raise the value of the currency for which interest rates are being raised. However, the rise in interest rates will decrease business activity in the local economy and reduce profit on equity, so a large outflow will occur and the currency value will fall. A panic effect thus sets in with people withdrawing money from banks due to exchange rates falling (because the interest rates do not cover the devaluation of the currency). If interest rates did cover the devaluation of the currency, business and bank failure would set in because of the inability to repay debt - further driving the devaluation of the currency. Other triggers for the crisis included the flotation of several currencies after fixed exchange rate regimes, beginning with the Thai Baht with others following, resulting in a similar result of currency devaluation.

Professor Stiglitz's solution to the Asian Financial Crisis is to increase government spending and deficits and print more money. He claims that 'such a "Keynesian" response would have prevented recessions in the wake of the crisis, in contrast to what he calls the IMF's "alternative theory", which supposedly aggravated or even caused the contractions in output. The IMF's reaction to the crisis was to allow public finances to exert a stimulating impact on their economies, which deepened the reversal of capital outflow pushing the recession further than what it would have originally reached. Since the main cause of the initial crisis was due to investment - by financing investment, the IMF did more harm than good. The increase in investment spending is shown in the following table excerpt from Japan Economic Institute - Report No. 33 - August 28, 1998. (see bibliography for website details) Table 1: Japan's Balance of Payments, 1993 - 1998 (in billions of yen) Current Account Balance 1993 14, 669 1994 13, 343 1995 10, 386 1996 7, 158 1997 11, 436 The rise shown here in 1997 Current Account Balance would have been even greater had not the Bank of Japan intervened in the market in April and again with the Federal Reserve Board in mid-June to address the imbalance between the supply and demand for foreign and domestic currencies. In conclusion, when dealing with international finance, we must always consider why particular events occur rather than taking them for granted, and even then there are always different opinions of what will happen.

All of these opinions must be taken seriously to prevent future crises from occurring and will help to keep the economy stable in general. Investment should be to promote a better lifestyle for all rather than for profit-maximization. Risk-taking should be based on the risks themselves rather than the emotional state of the investor at the time. Ordinary people should take the time to understand the financial world that we are living in today. The day that people lay aside their greed and have nothing to fear is the day where the world economy will be truly global.


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Research essay sample on Point Of View Exchange Rate

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