Debate on Fixed Exchange Rates
Investopedia has published an article on the benefits and drawbacks of fixed exchange rates. Lee (2021) used China’s 2010 economic policy as an example. According to additional researchers, “Since the collapse of Bretton-Woods in the 1970s, countries have had various exchange rate regimes where many have exited fixed (pegged) exchange rate regimes in favor of flexible (floating) exchange rate regimes”(Bizuneh, 2021, p.63). However, despite the risks, China successfully implemented its strategy and achieved overall favorable outcomes from the intervention.
Benefits
The article highlights the potential benefits of fixed rates. Namely, China has managed to take advantage of its trade relationships with other countries (Lee, 2021). By maintaining a low currency value relative to the US dollar, the country has achieved greater profitability from exporting its products abroad. On the one hand, this ensures affordable options attractive to international buyers. On the other hand, when revenue is returned to its original form, loss is minimized.
An additional benefit mentioned by the authors is the ability to navigate potential fluctuations and crises in other countries. By creating a stable domestic currency environment, changes in the international market are less damaging to the domestic economy (Lee, 2021). In addition, more stability in the national financial setting is achieved by fixing rates. This allows countries such as China to improve their citizens’ living conditions, regardless of barriers in the global arena.
Limitations
The need for sizeable monetary research is the first con highlighted in the article. As domestic money is bought and sold in an unstoppable regime, the lack of funds can undermine the stability of the strategy (Lee, 2021). However, China’s fast-growing economy allowed for such decisions to be made, “as the country’s living standards continue to rise” (Hill, 2020b, p. 273).
On the other hand, the presence of such substantial findings can, by definition, facilitate barriers, specifically, high inflation. Hence, despite the possibility of pegging rates, the need for monetary supply remains higher. In this case, prices for goods within the countries increase, creating unfavorable conditions for its citizens.
Example
The Thai baht situation highlights an example of a system failure. The fixed regime has created significant economic issues following currency depreciation due to instability in the capital market (Lee, 2021). Despite partaking in a decision-making tactic similar to China’s by fixing the baht to the US dollar, the outcomes included a 40% depreciation. Needless to say, both advantages and disadvantages are emphasized, noting that, in some instances, fixed rates can benefit actors who choose to adopt them. In other instances, however, the method is destructive, causing financial losses that are difficult to recover from and requiring the involvement of international financial institutions.
Application
The article can be applied to the reading, namely, to the topic of floating rates and differences between the regimes. Hill cites the journal article, noting that “monetary expansion can lead to inflation, which puts downward pressure on a fixed exchange rate” (2020a, p. 332). A similar concern was expressed in the article concerning the significant funds required for a nation to engage in the tactic. In addition, the textbook implies that a “fixed exchange rate system might be more enduring and might foster the stability that would facilitate more rapid growth in international trade and investment.” (Hill, 2020a, p. 334). Even though numerous developed countries have flexible systems, specific ones can lead to internal and external success, as exemplified in China’s case.
References
Bizuneh, M. (2021). Are we floating yet? Duration of fixed exchange rate regimes. Eastern Economic Journal, 48(1), 63–89.
Hill, C. W. L. (2020a). Chapter 11: The international monetary system. In International Business: Competing in the global marketplace (13th ed., pp. 324-353). McGraw-Hill.
Hill, C. W. L. (2020b). Chapter 12: The global capital market. In International Business: Competing in the global marketplace (13th ed., pp. 354-373). McGraw-Hill.
Lee, R. (2021). Pegged exchange rates: The pros and cons. Investopedia.