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I know nothing of currency exchange, but the topic came up, so I will ask about this "official" exchange rate. Seems like that is what Bush is after China about, they won't let thier yen, or whatever they have, float against the dollar. Someone enlighten me.
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I shall do my best, though I make no guarantee. Countries have two options with regard to currency exchange rates: fixed or floating. Ours is floating, as per my example above. What China has done is to peg their currency to ours, so that a set amount of Yen is always worth a dollar. I am not sure if it is 1 to 1 or not, but for conversation sake lets pretend it is. So no matter what happens, 1 Yen will always be worth 1 Dollar. This is usually done in developing countries to add stability to their currency. Throughout the world our currency is seen as very stable, so it is a natural choice as a currency to be pegged to. Now here is where the problems start. Every country has economic ups and downs. In our country we rely on the FED and the government (please note that contrary to popular belief, they ARE relatively separate. Yes, they are related, but the government does not run the FED) to help regulate these ups and downs and to try and steady them into a relatively smooth upward (hopefully) slope. There are a few options available to them. The government can either raise or lower taxes, or raise or lower government spending. In the end it doesn't really matter which they do, the long term result *should* be the same. Who gets the benefits first in those examples is a topic of much debate. Doing one of these two things is known as Fiscal Policy. The FED also has tools it can use. They can raise or lower the reserve requirement, which is the % of deposits that banks must keep on hand. Raising this rate mean banks have less money available to loan out, thus shrinking the supply of loanable funds, and causing the interest rate to rise. The FED can also raise or lower the Discount Rate, which is the rate at which the FED loans money to its member banks. Raising or lowering this rate will also affect general interest rates. The last tool that the FED has is to affect the money supply. They do this through the buying and selling of Treasury Bills, Notes, and Bonds, commonly known as t-bills. When the FED buys t-bills, they increase the money supply since they are supplying money to purchase the bills. When they sell bills, they are decreasing the money supply since people are giving them money to purchase the bills, and this money is kept out of circulation. These tools of the FED are known as Monetary Policy.
OK now this is the tricky part with a fixed exchange rate. Let’s go back to the US/Britain example. Let’s also say that the US economy is on a down turn, so the FED wants to implement expansionary Monetary Policy, so they buy t-bills, putting more dollars into circulation. On the currency market, there is now an increase in the supply of dollars, which makes dollars less valuable, and they exchange rates will adjust accordingly. Now what happens to China in this situation? Let’s say they are in a similar situation, and need to expand. If they decide to expand their money supply via buying securities or by printing more money, then they too have in creased their money supply. The problem being that they have fixed their currency to ours, and as such the exchange rate can not adjust to equilibrium, even though there is pressure to do so. Let’s use simple numbers. In the US there is $100 in circulation. In China there is also 100 Yen, we have a 1:1 exchange rate, everything is great. Chinanow expands, and prints another 100Y. Exchange rate should naturally move to 2:1, but it can’t. If left alone, this can eventually completely undermine a countries currency value, making their currency worthless. This is what happened in Argentina. They pegged the Peso to the Dollar at a 1:1 ratio. They then printed ALOT of money, in secret, and managed to keep it hidden for a while. Eventually it was noticed that there were a lot more Argentinean Pesos going around then there was supposed to be, word got out, and now there Peso is almost worthless.
I have no idea, nor do I pretend to know, what President Bush is after with regards to other countries. Nor to I know how well China is managing their currency. Having your currency pegged to a standard strong currency is not inherently bad. It becomes bad when there is pressure for the rate to move, and the country does not do something to compensate for it. Remember all of our other tools: taxes, gov spending ect. The biggest problem occur when a country pegs its currency, keeps the exchange rate constant, then prints a lot of money without regard to the consequences. It will always catch up, and in this situation, their currency will always fail.