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... nd required to keep the rate at equilibrium would be disrupted and create an exchange crisis. Trade Problems as a Result of the Exchange Rate The exchange rate creates a problem in trade when a currency becomes overvalued, either as a result of the inflation rate remaining higher than that of its trading partner, or because the currency to which it is adjusted is rising and dragging the lower currency up. This overvalue leads to poor competitiveness - resulting in a loss of trade.
In 1998, United States exports declined in almost all product groups, including agricultural items, industrial materials, capital goods, and even exports of services. To compound this problem, the U. S. experienced an increase in the number of imports.
These two factors are crucial when explaining the U. S. trade deficit; however, the shifting of exchange rates has also played a part in the erosion of the United States competitiveness in the global In light of these problems, the dollar still remains strong. Trade problems are not only a result of situations in the United States, but as a result of the stability (or instability) of the exchange rate in other countries as well. A floating exchange rate works well in the U.
S. because of the strength of the dollar. However, some countries have attempted to use an adjustable peg system, in which their currency is adjusted to that of a larger economy, with the option to adjust when underlying conditions change. This system has not proven to be beneficial, as in the cases of Brazil and Russia in 1998 - 99. Both of these countries experienced exchange-rate overvaluations and were forced to abandon their current exchange system. 4 This trend can be seen in the chart below. The economic crisis in Russia began to unfold in August of 1998, at the same time that the Ruble was decreasing in value.
As the Ruble became increasingly overvalued, the Russian economy experienced more strain. This kind of economic crisis leads to an increase in imports from these countries and a decrease in exports. Source: 1999 Country Report on Economic Policy and Trade Practices Exchange Rates and Their Affect on Trade The exchange rate is one of the leading factors when countries decide what products and services to import and what products and services to export. While it is not the only factor that is considered, the exchange rate affects the ratio of the prices and allows countries to decide whether it would be profitable or not to import or export certain goods.
For example, if the United States was considering trade with the U. K. , four factors would be considered when determining which products would be imported and which products would be exported: 1) the price of the goods in U. S. dollars, 2) the price of the goods in U. K. pounds, 3) the U.
K. price in dollars at the exchange rate, and 4) the ratio of the U. S. price to the U. K. price.
The following chart illustrates the hypothetical cost to sell soybeans, gloves, and stereos in the U. S. compared to the U. K.
Using the current exchange rate converts the cost of the goods into a common denominator, and allows each respective country to figure price differentials that are in their favor. It is assumed that there is a competitive market. As this chart shows, when comparing soybeans and gloves, the price of gloves in the U. S. are half the price of gloves in the U. K.
The price of soybeans is similar. The price of stereos, however, are in favor of the U. K. , since the cost 300 dollars in the U. S.
and would cost 180 dollars in the U. K. As a result of these differences, the U. S. would be more likely to export gloves and soybeans, and to import stereos from the U. K. 5 If the exchange rate were to change, the prices of goods in dollars would also change, possibly creating change in the desire for countries to import or export certain goods.
For example, if the exchange rate between the U. S. and the U. K.
grew to $ 10 per pound, than the cost of goods in the U. K. would become very expensive, and the U. S.
would want to One of the problems in trading that can occur as a result of the exchange rate is the option to create monetary barriers. These barriers are typically used by countries to eliminate trade or control the amount of imports. There are three types of monetary barriers that are typically used to controll the exchange rate: Countries that wish to eliminate imports restrict the availability of foreign exchange. Governments in each country can decide to block currency from various classes of foreign creditors. These countries designate certain currency for special use, not for free universal use, and currency that is blocked is cheaper than currency that is unrestricted.
The discounted rates also applied to foreign exchange. For example, Germany designated a number of special types of blocked marks which were only to be used as government officials designated. These marks were cheaper than free marks, which created a block on the number of marks exchanged. Countries who use this method set different rates for converting currencies into foreign monies in order to control the amount of import goods from a given country, usually in an attempt to control the flow of a particular commodity. 6 This method, which is rarely used due to the bad publicity it recieves and the strain that it puts on government relations, is used to set high conversion rates Analyzing the Cost of Similar Goods in Foreign Markets There are quite a few variables that can be analyzed when looking at the cost of goods in foreign markets. Not only does the exchange rate vary the costs of trade, but very country has different tariffs, trade sanctions, and barriers that they choose to impose on their import and export markets.
For example, the import and export market in agriculture between Japan and the U. S. , and China and the U. S. has undergone numerous changes in the past few years, including the import of rice. China, which describes its exchange system as a managed float, continues to impose barriers on the importing of U. S.
good and services. In 1996, China announced a new tariff that would apply to agricultural items, such as rice. However, as of late 1998, they had still not announced the specifics of this tax, which complicates trade in these goods. Japan has also imposed tariffs and barriers to restrict trade.
While it has reduced many of its formal tariffs, Japan still maintains control by imposing non tariff barriers, such as discriminatory standards. Japan has also begun to import rice into its country. However, rather than introducing the rice to the countrys consumers, the rice is stockpiled for food aid to third world countries. The exchange rate is one of the primary factors in the business of international trading. While there have been system changes in the United States, from the Bretton Woods to the present floating rate; and there are differing systems that are implemented throughout the world, the fact remains that the exchange rate is the basis for an amazing amount of financial decisions - including trade. Economists will argue over which system is best, but there is not doubt that whatever system is chosen will still have to be able to withstand the constant fluctuations in supply and demand.
In the past few years, the world has seen supposed stable markets plummet after an overvaluation of their currency. Brazil and Russia are just a few of the countries that were affected - Mexico, Asia, Thailand, Malaysia, the Philippines, and Indonesia are other countries who have had to overhaul their exchange system. Right now the dollar remains strong. However, the plight of these countries not only creates an internal crisis, but it creates a small amount Bibliography: Contained in footnotes above
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Research essay sample on Exchange Rates And Their Effect On Trade
