Money (Part III) - Money in the international market

Local and Foreign Currency

It’s a pretty obvious understanding but nevertheless I’ll go ahead with the definitions of them. Local Currency is the notes and coins that are used by a country within its geographical boundaries. Every country has its own local currency. It might be internationally used but still it’s their local currency as well. So Foreign Currency is naturally any other currency (note or coin) that is being used by other countries.

So when it comes to the International trade how does this work out? Two different currencies may have two different values altogether. For an example, $1 will most likely not equal the value of GBP1 or 1 Euro. Although the face value is 1, the real value, i.e. the good and services that can be bought with this 1 dollar, Great Britain pound or the euro will not be the same. To overcome this, economists have come up with the term ‘Exchange Rate’.  

Exchange Rate

Exchange Rate is the rate at which one currency unit of one country is exchanged with another currency unit of another country.

For an example as of today (19-02-2012) 1 US Dollar = o.759 Euros

                                                                      1 US Dollar = 0.631 Pounds

                                                                      1 Euro = 0.83 Pounds

Almost all the country’s currencies can be converted as above.

The practical application of the exchange rate is as thus. In the above figures, 1 US Dollar equals 0.759 Euros. This means that any good that costs 1 dollar in the United States will only cost 0.759 Euros in the European region. So we can roughly come to a conclusion that goods in the European region are cheaper than that of the US, hence they cost less.

There are two types of Exchange Rates mainly.

1) Fixed Exchange rate – the exchange rate of the domestic currency is fixed with another country. It’s not allowed to fluctuate. This is done by the Central Bank of a country on behalf of the Government. Fixed exchange rates could have many advantages, the most prominent being predictability. Importers and exporters are aware of the exchange rate and can be pretty sure about the future rate as well. This will help avoid unexpected losses due to exchange rate fluctuations.

2) Floating Exchange rate – here the exchange rate is allowed to float at will. Not at will exactly, but it will float mainly based on demand and supply factors and a million other small factors. An increased demand for the local currency will improve its value and thus decrease the exchange rate and vice versa. However from time to time the Central Bank will influence this rate to get things back in favour. This is known as ‘Managed Floating rate’.   

Foreign Direct Investments (FDI)

These are capital investments made by one country in projects of other countries. Here the exchange rate is widely used since fluctuations in the exchange rate could affect the value of the investments.

International Monetary Fund (IMF)

IMF is an international organization striving to achieve global monetary cooperation, secure financial stability, sustainable economic growth and reduce poverty around the world. (Source : http://www.imf.org/external/about.htm) It grants funds to poor countries to complete various projects. For more info visit : http://www.imf.org/external/index.htm

IMF headquarters is located in Washington DC, USA.

World Bank

World Bank is another international regulator, who provides funds, grants, loans and various subsidies for developing countries.

For more info visit : http://www.worldbank.org/

The headquarters are located in Washington DC, USA.

From the next article we hope to bring you all about the black money and how an economy responds to black money.

Thanks for reading.

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