Foreign exchange rates essay

Foreign exchange rates are used by the general public on a daily basis and are compiled by the department of financial markets. The value of a certain currency is assessed against the value of other currencies, and the rates represent the rates of buying and selling currencies of forex market participants (Michael 13). For example, the US dollar is used as the foundation measure for other currencies around the world. A discussion of the value of particular currencies in relation to the US dollar is significant, taking into account the value that either appreciates or depreciates and analyzing the pattern through time. The study focuses on currency fluctuations in the United States, India, the United Kingdom, and China. Exchange Rate between the UK, US, India, and China

Figure 1.1 India/U.S foreign exchange rate

Figure 1.2 China/U.S foreign exchange rate

Figure 1.3 U.S/U.K Foreign Exchange Movements

The scatter graphs drawn above represent information obtained from Federal Reserve Bank of St. Louise database. The data shows monthly exchange rates which are adjusted nominally. Normally, the value for money either goes up, which is appreciation or goes down the depreciation depending on the market condition present. Appreciation results from an increase in the demand which happens to be higher than the supply of money (Michael 13). On the other hand, depreciation occurs when the supply of money is higher than its demand. Thus foreign exchange rate is the price which expresses another currency regarding another currency that is the domestic money/currency against the foreign money/currency.

Appreciation and Depreciation Periods of Exchange Rates against the Dollar since 1980

For the Chinese currency which is the Yuan, it has appreciated in value against the United States dollar form 01/01/1981 to around mid-1986. At 1986 Chinese Yuan increases drastically in value whereby it stagnates against the U.S dollar to around 1990. In 1990, the Chinese Yuan increased drastically in value against the U.S dollar whereby it stagnates to the year 1991 and thereon increases with a slope which is not very steep to mid-1994. In 1994, the Chinese Yuan appreciated steeply against the U.S dollar till it reaches its maximum. From 1995 – 1996, the U.S dollar gains more value over the Chinese Yuan; hence the Chinese Yuan starts depreciating. The two currencies foreign exchange rates remain constant to the year 1999 where they remain constant to around 2006. The Yuan depreciates with a slightly steep slope against the U.S dollar to mid-2008, remains constant to the year 2011. A slight depreciation in the foreign exchange rate of the Yuan is observed to the year 2014 whereby it starts appreciating in value against the dollar to the year 2017.

For the Indian Rupee against the U.S dollar, there has been appreciation in the Rupee exchange rate against the dollar from 01/01/1980 to 01/09/1991. At 1991, the Rupee appreciates drastically. Normal appreciation is observed for the Indian Rupee from the year 1992 to 2002 whereby it starts depreciating to 01/05/2008. An appreciation for the Rupee again is observed where the peak is reached at 2009, and it depreciates with a steep slope to 01/09/2011. The Indian Rupee has continued to increase with a slight slope to the year 2017.

Nevertheless, based on U.S dollar to one British pound, the exchange rate for the dollar has been depreciating from 01/01/1980 to 1985 which is the lowest point on the scatter graph. A drastic appreciation of the U.S dollar is observed against the U.K pound to the year 1985 where it again depreciates to the year 1990. Again, appreciation for the dollar is observed, where the dollar appreciates drastically reaching a peak point at the year 1991 and then drastically depreciates to the year 1992 again increasing to the year 1993 and drastically falling on the same year. Slight appreciation for the dollar is observed from the year 1993 to 1996 again depreciating slightly against the U.K pound to the year 1997. Alternating appreciation and depreciation of the U.S dollar against the U.K pound are observed to the year 1999 where there happens to be depreciation with a slight slope to the year 2002. Appreciations are observed again where at some point increase drastically to reach a maximum point in the year 2008. Drastic depreciation of the dollar against the U.K pound is observed to the year 2009. At 2010 there happens to be a drastic appreciation which is alternated by a drastic depreciation to 2011. Alternations are observed of appreciations and depreciation of the dollar against the U.S pound where at 2014 the dollar depreciates with a steep slope to the year 2017.

The Usage of Theories of Exchange Rates in Discussion

First is the purchasing power parity (PPP) also known as the inflation theory (Michael 16). The price of goods relationship with that of different currencies value is in an address by the theory of absolute PPP. The theory assumes the world is risk-neutral. Competitive products and integration are evident in the theory of absolute PPP. Movement of goods is free which is less the export quotas, customs duties, and shipping costs. This scenario is unrealistic in the realm. Absolute PPP contradiction does not imply it is absent in the market. The purchasing power parity came into an introduction to aid in the description of price-exchange rates relationships in different economies. Risk and uncertainty consumer preference and production technology differences in practical influence value of the purchasing power parity.

Second, we have the interest rate parity. Monetary policies influence the exchange rates changes, which is a conclusion made by monetary policymakers (Michael 19). Domestic interest rates rise, precedes domestic currency appreciation, and a decrease in rates of domestic interest which follows the national currency devaluation. The theory of interest rate parity has two subdivisions which are the covered and uncovered interest parity, that is, CIRP and UCIRP respectively. For the covered interest rate parity, the difference in yield between two different currencies persists continuously at any time. The UCIRP arises from the uncertainty of future events happening. Future exchange market expectations greatly influence the forward exchange rate.

The third is the Mundell-Fleming model. Money serves as the storage device, dominant value, and medium of exchange which are of great importance. IS-LM model extension led to the development of the Mundell-Fleming model. Three markets are taken into consideration by IS-LM model that is, money and goods, goods, and an analysis of the fiscal and monetary policy effects. International payments balance is equivalent to money, goods and steady state in the case of Mundell-Fleming model (Michael 72).

Fourth is the productivity and exchange rate: The Balassa-Samuelson model. Supply-demand interaction level determines the price level. The behavior of the consumer and producer, associate themselves with the products demand and supply. This is the real exchange rate determination preliminary point (Bhandari & Jagdeep 41). Given productivity levels both at home and abroad, the highest gross domestic product which is the home given at nominal value leads to real exchange knowledge. Furthermore, devaluation of real exchange rate occurs due to higher economic growth rate arising from higher productivity in the non-passable country of origin and a foreign country.

Real Effective Exchange Rate Long-Term Trend and the Effect of Index on Exports

The long-term trend for the United Kingdom, India, and China has been constant for the index of the real effective exchange rate of the U.K pound, Indian Rupee, and Chinese Yuan. Net exports with a positive figure highly contribute to the growth of the economy. More output from factories results in more exports. The Greater number of employees is evident hence keeping the factory running (Bilson & John 38). Goods and services in export are representatives of the value of goods plus other market services which reach out to the rest of the world. It is inclusive of freight, insurance, transport, merchandise, construction, information, financial, business, and government services. Amounts excluded are transfer payments, investment income, and employees’ compensation.

Exports and imports grow in a healthy economy. This indicates the strength of the economy and sustainability in trade deficit or surplus. Growth in exports and a significant decrease in imports indicate a better shape of the rest of the world in the domestic economy. For instance, the United States trade deficit worsens when there is a strong growth in the economy. Exchange rate affects the trade deficit or trade surplus. When the domestic is weak, it acts as a stimulus for exports making the imports more expensive. For instance, let’s consider an exporter from India selling garments to the primary market which is the United States. The exporter’s selling price to the U.S is $10. The exporter gathers 500 rupees from the sales made at the U.S market if the Rupee exchanges to the U.S dollar at a rate of 50 per dollar. But if the dollar strengthens and weakens the Rupee to 55 against the dollar, the exporter can receive the same amount of $500 by selling the garments at a price of $9.09, therefore, improving the exporter’s level of competition in the United States market.

Five Years Trend of the Index of Real Effective Exchange Rate and Effect on Exports

In the case of India, for the last five years, the U.S dollar has been increasing in value over the Indian Rupee. There has been a tremendous increase in the real exchange rate whereby the Indian rupee is depreciating against the United States dollar. In the year 2017, the Indian rupee is stabilizing against the U.S dollar hence appreciating in value. When the Indian currency is weak, it makes the imports very expensive, and exports become less competitive in the market. When an exporter sells the export commodity, he receives an amount of lesser value compared to the commodity value. This makes the exporter less competitive, and it may result to market exit by the trader (Bhandari & Jagdeep 24).

On the other hand, the United Kingdom pound has been gaining value over the U.S dollar for the last five years. This makes the trade market favor the U.K traders using the pound due to competitive advantage in the market. For the Chinese Yuan, the U.S dollar has been increasing in value over the Yuan for the last five years, hence favoring the exporters using the dollar and disadvantaging the exporters using the Yuan, like the case of India.

2016 Trend of the Index of Real Effective Exchange Rate and the Effect on Net Exports

United Kingdom trend for 2016 is that the U.K pound was depreciating against the U.S dollar. For the Indian Rupee, the U.S dollar was appreciating for the year 2016, and the U.S dollar against the Chinese Yuan was depreciating. The appreciation and depreciation of these currencies against the dollar have their effect on the economy (Johnson & Harry 18). For instance, the case of the dollar appreciating against the U.K pound it means that the U.K pound has depreciated against the U.S dollar. The exporter using the U.K pound is disadvantaged in the market where his competitive advantage is reduced to the reduced value of the currency. For the Chinese Yuan traders, they gain a competitive advantage in the market due to the appreciation in value of their currency against the dollar. An increase in currency’s value benefits the users of the currency which has appreciated. The Indian Rupee depreciates against the U.S dollar. The traders using the currency are disadvantaged regarding competitive advantage in exporting their goods whereby the dollar has increased in price leading to a reduction in benefits derived from the trade activities.

In summary, ten percent appreciation of the United States dollar against the Indian Rupee renders the United States exports uncompetitive but on the other hand, makes the United States import Indian shirts at a lower price for the consumers (Johnson & Harry 33). A depreciation of the rupee by ten percent is another side of the coin which improves the level of competition of the garments from India which are exports. On the other hand, it has become expensive for Indian buyers to import electronic components. However, the scenario above is multiplied by transactions regarding millions the idea of the impact to which exports and imports are affected by currency moves.

Countries try to come up with solutions to their economic problems by settling to methods that artificially coin their currency with the aim of gaining a competitive advantage while trading internationally (Bilson & John 45). Competitive devaluation is one technique that is used which refers to the strategic boosting of the export volumes and the depreciation of the domestic currency in a large scale which will aid in the boost. Domestic currency suppression is another method which will aid in keeping it at abnormally level which is low. China had a preference for this state which made them hence holding its Yuan in a steady state from the year 1994 to 2004 that is a decade. Subsequently, the Yuan appreciated gradually against the United States dollar. Despite the fact that the United States had reserves in foreign exchange and biggest trade surpluses in the world, Yuan appreciated in value.

Conclusion

In conclusion, using the United States dollar, an analysis has been made to show the exchange rate index of different countries that is China, India, and the United Kingdom. Trends for different sets of data have been analyzed to show and help understand better what we mean by appreciating and depreciating of the exchange rates. Also, the effects of appreciation and depreciation of currency on the net exports are well explained.

Works cited

Bhandari, Jagdeep S. Exchange rate determination and adjustment. Praeger Publishers, 2011.

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Bilson, John FO. “Rational expectations and the exchange rate.” The economics of exchange rates: Selected studies (2012): 75-96.

Hounshell, Tyler. “Disaggregated cost-benefit analysis incorporating ecosystem services and disservices: A case from SAI Sanctuary.” Consilience: The Journal of Sustainable Development 15.1 (2016): 233-255.

Johnson, Harry G. “Towards a general theory of the balance of payments.” International trade and economic growth (2015): 153-168.