Dollar Exchange Rates
Before starting , let us first get a clear idea of a foreign exchange market. The foreign exchange market is a market, where individuals, firms and banks can buy or sell foreign currencies or foreign exchange. The foreign exchange market for any currency for instance, if we consider the U.S. dollar, is comprised of all the locations (such as London, Paris, Singapore, Hong Kong, Tokyo, New York, Zurich and Frankfurtplace) where dollars are bought and sold for other currencies. The principle function of foreign exchange market is the transfer of funds or purchasing power from one nation and currency to another. This is accomplished by an electronic transfer and presently, a reliable and useful media for this is Internet. The process is, a domestic bank instructs its correspondent bank in a foreign monetary centre to pay a specified amount of the local currency to a person, form or account.
A very important question that arises is, why do individuals firms or banks want to exchange? There are many reasons e.g. when tourists visit another country, they need to exchange their national currency in respect of the currency of the country they are visiting or when a domestic firm wants to import from other nations or when an individual wants to invest abroad and so on. On the other hand, nations supply of foreign currencies arises from foreign tourists expenditures in the nation, from export earnings or from receiving foreign investments and so on through this process. About 90% of all foreign exchange transactions, however, are undertaken by foreign currency traders and speculators to day.
Nations commercial banks operate as "clearing-houses" for the foreign exchange demanded and supplied by nations residents in course of foreign transactions. Commercial banks later even out their excess supply of or demand for foreign exchange with other commercial banks through intermediation of foreign exchange brokers.
If a country's total demand for foreign exchange in the course of its foreign transactions exceeds its total foreign exchange earnings, the rate of currencies equilibrate the total quantities demanded and supplied. In the exchange rates, if such adjustments are not allowed, the nation's commercial banks would have to borrow the nation's central bank, and in such a situation, the nation's central bank would act as the lender of the last resort and draw down its foreign currency reserves. In economic terms, it is known as the Balance of Payment deficit of the nation. On the other hand, if a country generates an excess supply of foreign exchange with other nations in course of its business transactions and if the adjustment in exchange rate is not allowed, this excess supply would be exchanged for the national currency at the nations central bank and thus increases the country's currency reserves, which may be pointed out as the balance of Payment surplus of the nation.
Now let us concentrate on the Dollar Exchange Rate. The British Pound-Sterling was replaced by U.S. dollar after the World War II. The U.S. dollar acts as a vehicle currency because of its more stable value than others, the existence of large and well developed financial markets in the U.S. and very large size of the U.S. economy. It should be noted that, since its creation at the beginning of 1999, the euro has become the second most important vehicle currency in the world. It should also be mentioned that, today, the U.S. dollar currency is the dominant Vehicle Currency, serving as a unit of account, medium of exchange and store of value not only for domestic transactions, but also for private and official international transactions.
If we compare the relative importance of dollar in respect to other major currencies, in the world economy, for 1998, we can take the authentic annual report given by the bank of international settlements (1999), OECD, Financial Market Trends (Paris: OECD, February, 1998), IMF Annual Report (IMF,1999) as the major sources. According to these sources, 49.8% of the foreign trading was in dollars as compared to 17.2 % in German Marks, 1.6% in Yen and smaller percentages in other currencies. 69.8% of international bank loans, 45% of international ; bond offerings and 48% of international trade invoicing were denominated in U.S. dollars. Again 60.3% of foreign exchange reserves were hold in U.S dollars as compared with other currencies with much smaller percentages and more than 60% of the U.S. currency is now held in abroad.
In 1944, the industrialized countries from all over the world had a sitting in Bretton Woods, New Hampshire, for the purpose of a discussion on the state of the international economy in the era of post world war II. The sensitivity of the discussion evolved around a plan to fix the exchange rate for all foreign currencies to the U.S.dollar. The dollar would in turn, be tied to gold for purposes of international settlement as a set price, which also indicates that a pound, lira, yen etc. would always yield a fixed number of dollars and off course, gold would always cost a fixed number of dollars. However, this was a successful meeting and was implemented universally in the early 1960s and as an expectation, the U.S. had enjoyed a period of opulence for most of the time since the end of WW II because the dollar was not convertible to gold internally, but was considered as good as gold.
As we know that an increase in foreign currencies may introduce the higher inflation problem, and the history says no to alternatives. By late 1960s, an inflationary problem occurred in different nations e.g. different resurgent countries in Europe and Asia and the reason for that was, to maintain the value of their currencies, they had to expand their money supply in order to maintain the agreed upon ratios of their currencies to dollar. However, by recognizing this problem, they started to return the excess dollars, demanding gold in payment at the agreed upon rate of exchange, which led to an outflow of gold from U.S. and the result is that, the U.S. holding of gold became seriously low. By 1971, the president Nixon had understood the serious problem and immediately took an action to close the gold window by no longer exchanging dollars for gold at the agreed upon rate, and since then, the exchange rate has been permitted to float with the rates determined by characteristics of the supply and demand for currencies.
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