Expert: Dr.VSR.Subramaniam - 11/6/2008

Question
I'm willing to know if you could tell me about the economic fluctuation of currency and the factors that influence it to fluctuate as it's been fluctuating so rapidly in present period of time..!

Answer
Welcome to the allexpert’s pool with your question. The exchange rate fluctuation is like the contents Pandora’s box.. This is opened daily by the (elected or self imposed) rulers  of all nations. The output results in a favourable situation to some nations and  equally unfavourable  to other nations. The sum of this favour+unfavour position is a constant.

A) PREFACE

Exchange rate of a domestic currency in the international market is actually an after effect of the economic activity inside a nation. It is an index of the net effect of   the balance of payments of a nation. It is made up of the (Exports – Imports) + (Borrowings – Payments) between 2 countries. If it is plus or favourable (Exports > Imports and all borrowed funds are paid), then the exchange rate of any domestic currency will be strong. But this is true for developed nations (UK, USA etc..) with a higher domestic economic development index. This never happens in any developing or under developed nations, because of the deteriorating internal productivity, lower quality products, domestic disputes, strikes, apartheid, self-centered elected representatives in the governments etc..  Balance of payments is the “head”, and the exchange rate is the “tail”. It is impossible to thrust an economic development into any country by catching the “tail” of the nation.

B) EXCHANGE RATE – AN ILLUSION

01) BELIEF -  Many  people and even hi-fi economists think that if the exchange rate of the domestic currency of a nation is strong, then the nation is economically prospering. It is absolute illusion !!.

02) BUYING POWER - Exchange rate of any one currency with reference to any other currency reflects only the buying power, among the currencies and it has nothing   to do with the domestic economic prosperity of both the nations.

Example – Assuming the same quality, say country A can buy 1 Ton of carrots from country B for 1,000 domestic currency. But B can buy  1 Ton of carrots from country A for only 500 of their domestic currency. Then the currency of country B has a double buying power than that of Country A. The exchange rate of  B’s money = 2 of A’s money.It has no relation to the internal economic prosperity of either country A or B.

03) BALANCE OF PAYMENT - The   exchange rate of any one currency with reference to any other currency depends on the balance of payments between the 2 nations. It is mainly reflected by the Export and Import parity.
Example  : If country A do not export to or import from country B, any commodities, then the 1 Currency of A =  1 Currency of B. Because the balance of payments between the 2 countries = Zero. If  Country A exports commodities worth 1 million of their domestic currency to country B & Imports commodities worth 1 million worth of their domestic currency from country B, then also  the balance of payments between the 2 countries = Zero.  The exchange rate  will be 1 : 1 between the 2 countries. Only when the export value is not equal (<>) to the import value between the 2 nations, measured in their respective domestic currency, the exchange rate of the larger import country goes down.It further proves the economic prosperity of either country A or B is not reflected by the exchange rate.

04) TIE UP – The exchange rate is like an aero  plane  ! People get into an aero plane at the ground level. The plane  takes  off and flies at about 35,000 feet above the ground level. But it is a fact that the people  are  also flying at 35,000 feet and navigate !! Have the people on board have gained the power to fly like this on their own strength. No  !!  It is the illusionary support of the  plane to the people inside, which has made them to perform this feat !!

EXAMPLE - The planes are US$, GBP (Great Briton Pound) EURO or other basket of European currencies (Developed National Currencies = DNC). The people on board are the nations (however  developed or weak) who have tied their domestic currencies to these selected DNCs.
In 2007,  the US$ value has gone down with reference to the European currencies. Many nations including China, Japan, Oil rich Arabian nations who have tied their currency to US$, are suffering with a low exchange rate  for their domestic currencies in the international market.  Other weak nations who have tied up their domestic currencies to European currencies (India and many far-east nations) are enjoying an inflated exchange rate.It is a practical example to prove further that  the domestic economic prosperity of any nation is not reflected in the exchange rate.

C) US DOLLAR PUMPING.

“Consider that for some reason, the US has decided to pump in billions of dollars into the Indian Economy” is a dangerous and imaginative proposal. Any pumping activity increases pressure huge enough to inflate the receiver, tear into pieces and destroy beyond repair.  If US dollar is pumped into India, the balance of payment from India to US will be inflated. The pumped money is not planned for any productive utilisation to pump back into the Indian/Foreign market, in terms of goods of any nature, to get an advantageous rate of return. As a result 1US$ will jump from the current 42.645 INR to 426.45 INR 10 times or even more). India will go bankrupt in the International market. India will suffer from a heavy inflation, by price increase on all commodities (Because money is pumped in to buy, to inflate the demand, with the stagnant production. Hence, demand will for exceed the supply).

US need not pump the money to destroy India. Indian government is doing it by getting loans from all possible sources, wasting the inflow of money, without any productive activity to get a favourable rate of return !!! These loans are not paid back. So don’t worry, this is already in work in the hands of the rulers in Delhi !!!

D) EXCHANGE RATE – GOOD ASPETS.

If the exchange rate of  the currency of a nation is lower in the international market, then the prices of the export products of that nation will be cheaper. By the law of the propensity of price leverage acting on the demand and supply in the market, the lower currency rate nation gets an advantage to boost their exports. But the  increased demand for export will be offset  if the quality, longevity, utility value and after sales infrastructure (wherever applicable) are not good,.

E) EXCHANGE RATE MANIPULATION

Nations with power and unity can formulate self-centered and advantageous strategies and improve the exchange rate of their domestic currencies as well as their economic development

1) UK is an unique nation, which keeps their currency strong for ever, as well as boost the domestic economic status. GBP (Great Briton Pounds) always remain as the strongest, because UK strategically manipulates a favourable import export ratio through their colonial methodology. As of 2007 UK has 14 overseas territories under their control, but without owning them (1.Anguilla, 2.British Antarctic Territory, 3.Bermuda, 4.British Indian Ocean Territory, 5.British Virgin Islands, 6.Cayman Islands, 7.Falkland Islands, 8.Gibraltar, 9.Montserrat, 10.St Helena and Dependencies (Ascension Island and Tristan da Cunha), 11.Turk and Caicos Islands, 12.Pitcairn Island, 13.South Georgia and South Sandwich Islands, 14.Sovereign Base Areas on Cyprus.

(Source - http://www.fco.gov.uk/servlet/Front?pagename=OpenMarket/Xcelerate/ShowPage&c=Pag...)

UK directs all their imports to their territories and bring into UK as a domestic transfer. The import parity is loaded on the territory nations and not on UK. But UK exports are accounted on their books. As a result, GBP always enjoy a low import and high export parity and hence an everlasting  higher exchange rate. They have not joined and never join the EURO currency group to share this monarchial advantage and dilute the prestigious position of the GBP.

2) Similarly, all the technologically advanced European nations have joined to have one  currency  called “EURO” with many manufacturing and trade leverages among themselves. Hence their export quality, quantity and price leverage will support and   strengthen their common currency to gain in the international market.
Hence, any currency pegged to GBP or EURO will always have a higher value in the exchange market, irrespective of their internal economic status.

F) ECONOMIC DEVELOPMENT & PROSPERITY.

Motivated by the multi-national corporate units and the tie-up with the developed nations,   the developing and under developed nations invite  a large value foreign investment and foreign loan.  This is  an  un-favourable situation for any self-dependent economic development. The multi nationals utilise the cheap infrastructure, material and labour resources of the host nation and pump out the profits to their home countries. The foreign aids/loans lead the host nation to be a debtor and slave of the aiding nation and end in increasing the balance of payments substantially.

The term economic development is a domestic and internal term for the people to enjoy a higher standard of living within their income and leave a surplus for the future. This cannot be  inducted  by any external nation or agency. The primary factor for this is the essential needs (food, shelter and clothing) of a house hold of  4 (husband+wife+2 children) should be 45% or less of their Per-capita income, irrespective of their rural or urban location. Providing a 30% for their luxury needs (bikes, refrigerator etc..), they should be able to save the balance 25% for the future and emergency needs. (It is assumed that health, hygiene and education are made available to the domestic population at free of cost or at subsidised rate up to a reasonable level). This happens in all the developed nations.  
I join with Sir Arthur Lewis (Nobel Laureate of 1979 in Economic Science, and my association with him during 1982-1986) in the concept that “People who cannot eat well cannot think high”. The 45%+30%+25% formula is not workable in all underdeveloped and developing nations, because of  the  expanding  population and non-development oriented activities of the elected government. What is the solution for  this ?

01. Productivity and Management decision related to any activity in a nation should be measured with reference to the Socio-Economic development units as primary and quantum aspects  as secondary
 
02. Management decisions should consider the intangible aspects in the nation (psycho, socio, international, universal) as priority factor.

03. Domestic investments should be supported by Domestic savings (even though a foreign source to start with).

04. Domestic technology (latest moderated to suit the domestic environments) should be manned by the Domestic human potential.

This is happening in all developed nations like USA, UK and dynamic nations like Japan, China etc..  and not happening in internal problem surrounded nations like India, Pakistan, Bangladesh, Srilanka etc..( Apartheid , Ethnic, Leadership, Linguistic, Population, Religion, Water sharing, etc…)

SOURCE : SED BY DRVSRS (SED = Socio-Economic Development. Algebraic and Geometric models) and SOMA BY DRVSRS (SOMA = Social Management) at  http://www.drvsrs.com/drvsrs-store/books.htm

G) FURTHER REFERENCES

Search in the internet (preferably Google) with key words “exchange rate” eExchane rate and economy” “exchange rate impact” etc… You will get over 1,000 reference listings.

With Regards
DR.VSRS
Book Store -  http://www.drvsrs.com/drvsrs-store/books.htm
Website    -  http://www.drvsrs.com