Foreign Exchange Rate Determination and Related Issues - Essay Example

Title: Foreign exchange rate determination and related issues Dated: May 8, 2010 The foreign exchange rate between two currencies determine the worth of one currency as in relation to other currency for the determination of their worth in relation to each other. The foreign exchange rate is also called as exchange rates or forex rare is the value of a foreign nation's currency as in relation to the currency of the home country. The relationship between all the foreign currencies as in the shape of exchange rate is inter-convertible and interchangeable depending on the requirements of the home country and that of the foreign country through the foreign exchange market. The economic and monitory condition of a country in relation to the other country determines the currency exchange rate as on bilateral basis. The conversion of one currency into another currency depends upon the conditions and the factors as regulated by the foreign currency exchange market which is one of the largest markets in the world. The current exchange rate is also called as the spot exchange rate for a currency on a particular period of time and the forward exchange rate refers to an exchange rate arrangement that is coated and traded during a particular day but for the delivery and for the payment depends on a specific future rate of the currency. Exchange rates reflect the status of the economic stability among the international communities and help the investors and business entrepreneurs to take their strategic decisions for the finalization of their business deals. The nations preferred to adopt spot exchange rate or the forward exchange rate depending upon their economic systems and for the betterment of their respective financial mechanism. Japanese yen is selected for the explanation of the foreign exchange rate determination and relating issues during the period of from 2000 to 2009 as compared to that of US dollar in terms of its convertibility and other related issues(Ryuzo,2007). Foreign currency exchange rates and the quotations: The foreign currency exchange system quotation is extended by giving the number of units of quote currency as payment currency that can be exchanged for a particular currency as base currency. Base currency has its relationship with the quote currency as to exchange the two currencies in inter-convertible shape with a value for each of the two currencies (Sheffrin et al, 2003) . For example, in a quotation that says yen/USD exchange rate is having a special relationship 94.84 a dollar, shows that the worth of 94.84 Japanese yen is equivalent to 1$. In this type of relationship Japanese yen is the base currency and the USD is the quote currency for the determination of the foreign currency exchange rates for both of these currencies (Milton, 1988) . In many parts of the world especially in Europe and in the non-professional markets in the United Kingdom, EUR and GBP are in a reversed shape for the creation of GBP as the base currency as in its relationship with EUR. In many other areas of the world where both the currencies that is EUR and GBP are not listed in the market, the market convention is to use the base currency which provides an exchange rate greater than that of 1.000. The process avoids rounding issues and the exchange rates are being coated as in the form of four decimal places. This principle for the currency exchange has its exception in many parts of the world like the Japanese often describe their currency as the base currency in relation to other currencies of the world (Hutchison et al,2001). The strengthening of a particular currency leads to decreasing the rate of the other quoted currency as for example, at one particular date 95 Japanese yen are equivalent to 1$ and later on 93 Japanese yen have reached at the level of 1$, the position illustrates that the worth of Japanese yen as quoted currency has improved and strengthened as compared to that of the US$. The currency quotation as per market convention mechanism was in the shape of pairs and were quoted to four decimal places for their transactions up to six decimal places as in case of forward outrights(Garegnani,1970). The fractional part of the currency conversion also plays a significant role in the currency exchange mechanism as for example if the conversion rate for Euro versus USD at a particular day is at the level of 1.4232 to a dollar and subsequently has changed to the level of 1.4228 to a USD, than the financial experts will take care of 0.4232 and 0.4228 for the determination of the currency exchange rates for the two currencies in the currency market. These decimal fractions with slight variations have profound impact on the financial worth of the currency under consideration; therefore, the financial experts notice the changes even in the fractions (Moore, 1988) . Japanese Yen and Exchange rates: Japanese yen is the currency of Japan which is the third most traded currency at the international level through foreign exchange market. The first and the second most traded in the foreign exchange market include US$ and EUR. Japanese yen (JPY) also serves as a reserve currency along with US$, Pound sterling. Yen is counted in the shape of 10000 or multiple of tens in the same pattern as the value of other currencies are counted in thousands. The conversion rate for the Japanese yen during last ten years has fluctuated between 89.51 in 2009 and 133.89 in February 2002. The currency rates for the yen to the US $ has passed through the stages of fixed values of the yen, under valued of yen and its free conversion to US$ for the determination of a relationship between the two currencies. The currencies of the world including Japanese yen have been influenced by the recent currency crisis at the world over. These currency crisis passes through a situation in which a particular currency experiences different shapes. These shapes include heavy selling pressure exchange market pressure or speculative attack on the currency exchange market. Japan has long standing issues with its bank and the stock market index as a crisis has its negative impacts on the status of currency. In 1989, the stock exchange crisis has influenced major currency of the world; however, yen due to its stable position has not suffered in the crisis. Japanese yen during the post world war II period has lost most of its values. During the period of instability, the value of yen was fixed at the level of 360 yen per 1 US $. The fixation plan was designed by the United States of America as a part of the Breton Woods System. The purpose of the Breton Woods system was to stabilize the prices in the Japanese economy. The same arrangement remained functional until 1971 and had led to the floating exchange rates in 1973. During 1970s, the Japanese yen had become under valued in the foreign exchange and currency market. The undervaluation of the currency of a particular country has its impact on other sectors of economy like high costs for the imports from abroad and low prices for the exports to the international trading market. The position as in the shape of undervaluation of currency has the capacity to destabilize the trading system and negative balance of payments in the shape of surplus imports and less exports during a particular trading year. The current account position has its relationship with the currency of the country; however, at some times the currencies do not respond in the same pattern as in the correspondence period. The position of current account turned surplus during first half of 1980s in the economic history of Japan. During the period, the Japanese was quoted as in relation to the USD as per given below positions for the period January 1980 to January 1985 as under: Serial # Year (In the month of January) Yen/USD 1 1980 238.80 2 1981 205.20 3 1982 228.45 4 1983 238.40 5 1984 234.74 6 1985 254.78 The position of the current accounts as in the form of surplus accounts had not helped in the strengthening of the currency as the yen remained as in average form at the level of Ґ239 from the year 1981 to the year 1985. Explanation: The value of Japanese yen moved in the framework of Ґ 202.05 to a dollar in November 1985 to a level of 269.40 in September 2002 during the period 1980 to 1985. An increase in the current account surplus has generated a demand for the yen in the foreign stock exchange and was an encouraging factor for the strengthening of the currency in the international market. However, this demand as was initiated by the trade related issues did not help the currency for its strengthening due to a number of domestic factors like more imports as compared to that of the exports to the foreign world(Steedman,2009). These factors included high interest rate in the United States of America than that of Japan and a continued wave of de-regulation in the international inflow of capital into the country and a large flow of foreign exchange from Japan to rest of the world (Thomas,1992). These factors have led to the outflow of yen from the domestic market into the international market with a de-stabilizing impact on the strength of the currency in the domestic market. All these factors have kept the yen as a weak currency as compared to that of US$ in synergetic pattern and had fostered a rapid increase in the trade figures as surplus during early part of 1980s. The relative worth of the currency like yen is determined through foreign exchange markets with the assistance of the economic forces in the domestic as well as at the international market. The economic forces like supply and demand play a key role for determining the relative value of the yen. The desire of the business community and the investors for yen creates a demand for the currency (Samuelson, 2000). Similarly, the foreign investors make demand for yen for the purchase of goods and services in Japan, therefore, play a significant role in the determination of the financial worth of yen in the domestic as well as in the international market. Bank of Japan through low interest rates has played a role in the determination of the strength of yen in the international market(Kirman,1992). The status of yen during the period 2000 to 2009: Yen has started its journey during early part of 2000 as a strong currency viz-a-viz US$, however, a clear declining trend has been observed during early part of the year 2002. The following figures as taken for the month of January for each year will illustrate the position: Serial # Year Yen/USD (In the month of January) Lowest value in the year Highest value in the year 1 2000 106.90 114.90 105.29 2 2001 116.38 131.47 116.38 3 2002 132.94 133.89 117.97 4 2003 119.21 120.11 106.97 5 2004 105.88 111.67 103.17 6 2005 103.58 119.46 103.58 7 2006 117.18 118.01 111.85 8 2007 120.59 124.64 111.24 9 2008 107.60 109.24 90.28 10 2009 89.51 98.31 89.51 The above data has demonstrated that yen has witnessed the lowest value during the period 2000-2009 versus US$ as 133.89 during the year 2002 and highest value as 89.51 during the year 2009. The international value of yen has demonstrated steady results with the exception of the year 2002 as the same year was the post bubble years of the Japanese economy as during the same year in February 2002 yen has declined to the level of 134.00 to a dollar. The financial policies as announced by the bank of Japan with zero interest rate has discouraged the investors for making investment in yen and adopting a policy to invest in other currencies like pound sterling and US $. The economist in 2007 has estimated that the yen as a currency is 15% under valued against other currencies like US $ and, similarly, undervalued by 40% against the EUR. Yen as international reserve currency: Yen as international currency has acquired the status of international currency after the currencies like USD, pound sterling, and euro. The same has been recognized by the Special Drawing Rights (SDR) Valuation in the form of International Monitory Fund (IMF) basket for the international currencies along with yen. The SDR valuation basket is reviewed on five yearly basis and the currency value is recorded on daily basis(Vienneau ,2005). The status of yen as international currency reserve with other currencies for the year 2009 is given below: Serial # Currency Percentage share 1 US $ 61.5 2 Euro 28.1 3 Pound sterling 4.2 4 Yen 3.0 5 Others 3.2 The inclusion of yen as a currency for the international reserves demonstrates the financial worth of the currency in the international currency market and among the major financial institutes like IMF and the World Bank(Godley et al,1989). The share of the yen as foreign reserved currency has started its share as 6.8% in the year 1995 and has maintained a level of 3.0 % in the year 2009. These figures demonstrate the international stature of the currency among other major currencies like USD, Pound sterling and Euro as the reserved currency at the world over. Recommendations: Foreign Exchange rates determine the worth of a currency as its relationship with other currencies on bilateral bases and all the financial experts take necessary steps for the maintenance of the financial status of the currency. The currencies are exchanged through the currency exchange markets. The governments need to take judicious decisions including the imports and exports levels for the country (White, 2001). The central banks require maintaining balanced interest rates for the stabilization of the financial system of the government. Yen as international currency has proved its worth as a strong international currency and has attained the status of a currency for the international reserves(Altvater,1993). A special focus of the financial experts will help in enhancing the share of yen as reserve currency at the international level. Conclusion: The rates of the currency in the international foreign markets play a significant role in the determination of the financial worth of the currency. The foreign currency exchange rates regulate the financial systems and economies of the nation through stable currency rates. Yen as currency in Japan has matured its strength in the economic markets and has attained the status as a currency of the international reserves. Yen as a stable currency will continue to influence the economic systems of the world due to its international acceptance and stability (Adam, 2005). All the experts in the currency businesses need to focus on the exchange rates and supply and demand position for the currency like that of yen in Japan. References: 1. Alan P. Kirman, "Whom or What Does the Representative Individual Represent?" Journal of Economic Perspectives, V. 6, N. 2 (Spring 1992): pp. 117-136 2. Altvater, E. (1993). The Future of the Market: An Essay on the Regulation of Money and Nature After the Collapse of "Actually Existing Socialism. Verso. pp. 57. 3. Arrigo Opocher and Ian Steedman, "Input Price-Input Quantity Relations and the Numeraire", Cambridge Journal of Economics, V. 3 (2009): 937-948  4. Basij J. Moore, Horizontalists and Verticalists: The Macroeconomics of Credit Money, Cambridge University Press, 1988 5. Friedman, Milton (1988) “Monetary Policy for the 1980s,” in Kurt R. Leube, editor, The Essence of Friedman, Stanford, California: Hoover Institution Press, pp. 404-28. 6. Glick, Reuven, and Michael M. Hutchison (2001) “Banking and Currency Crises: How Common Are Twins?,” in Reuven Glick, Ramon Moreno, and Mark M. Spiegel (eds.), Financial Crises in Emerging Markets, Cambridge: Cambridge University Press, pp. 35-69. 7. Graham White, "The Poverty of Conventional Economic Wisdom and the Search for Alternative Economic and Social Policies", The Drawing Board: An Australian Review of Public Affairs, V. 2, N. 2 (Nov. 2001): 67-87 8. Humphrey, Thomas M. (1992). "Marshallian Cross Diagrams and Their Uses before Alfred Marshall: The Origins of Supply and Demand Geometry" Economic Review. http://www.richmondfed.org/publications/economic_research/economic_review/pdfs/er780201.pdf 9. Michael Anyadike-Danes and Wyne Godley, "Real Wages and Employment: A Sceptical View of Some Recent Empirical Work", Machester School, V. 62, N. 2 (Jun. 1989): 172-187 10. Mikami Ryuzo,(2007). An article about the yen in Sekai Daihyakka Jiten, Kato Shuichi(ed.), Vol.3, Tokyo: Heibonsha 11. O'Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 458. ISBN 0-13-063085-3. 12. Paul A. Samuelson, "Reply" in Critical Essays on Piero Sraffa's Legacy in Economics (edited by H. D. Kurz) Cambridge University Press, 2000 13. P. Garegnani, "Heterogeneous Capital, the Production Function and the Theory of Distribution", Review of Economic Studies, V. 37, N. 3 (Jul. 1970): 407-436 14. Robert L. Vienneau, "On Labour Demand and Equilibria of the Firm", Manchester School, V. 73, N. 5 (Sep. 2005): 612-619 15. Weiss, Adam (2005). "A Comparison of Economic Democracy and Participatory Economics". ZMag. http://www.zmag.org/znet/viewArticle/6345. Retrieved 2008-06-26 Appendix The velue of yen veses USD FROM 1973 TO 2009 http://en.wikipedia.org/wiki/Japanese_yen Read More