An exchange rate refers to the value a currency is given at the international market. This enables a nation to know its economic position and compare its activities with those of other nations (Piersanti 3). This paper uses the term international business to mean trading activities that involve a nation and other nations. This essay explores various issues about exchange rates and international business.
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China’s Move to Adopt a Floating Exchange Rate
A floating exchange rate refers to a situation where a currency’s value is determined by global market conditions like economic growth and crisis. China is experiencing significant growth in its international operations and seems to be growing at a commendable rate (Hill 2). Most of this is achieved through contracts signed with African countries, which has promoted China’s economy.
Currently, this country uses a fixed exchange rate determined by internal forces like lending regulations observed by local banks. Even though this country manages to maintain its currency stability, this essay assumes that it has decided to adopt a floating exchange rate and signed an agreement with the World Trading Organization (WTO) to implement this change in three stages. This new exchange rate regime will affect China, the United States, and other trade partners.
First, China will have a stable exchange rate in the international market since its currency’s value will remain constant. It will continue to transact its international business without fear of inflation or economic crisis. If this occurs, it will affect all nations regardless of their level of participation in international trade. However, if it experiences an economic crisis, it will be bailed out by the World Bank just like it did to Brazil and Greece in 2002 and 2010, respectively. Thirdly, China will have many investment opportunities since it will open its gates for international business (Goldstein 78). Some investors are reluctant to invest in nations with fixed exchange rate systems since their economies are usually unpredictable.
Also, there will be employment opportunities since the local market will develop its operations. It will also be easy to expand local activities since there will be a market for their products. Lastly, this will be an effective way for China to reduce its balance of payment and trade deficits. However, according to the Mundell-Flemming Economic Model, this will affect China’s ability to control its currency; therefore, denying it sovereignty over its economic policies. It will also be forced to adopt some policies that may not favor its operations, like banking policies and the national budget.
This decision will allow China to compete with America regarding the value of their currencies in international markets. Nations will evaluate China’s economic power by comparing its economy with that of the United States. Therefore, the U.S. Dollar will face stiff competition from the Chinese Yuan since there will be less demand for a currency that will be trading very low (Hill 6).
Lastly, China will benefit by floating its exchange rate on the international market since it will encourage investors to explore its potential (Fisher 23). This means that most international businesses will establish their branches in China. There will be a standard exchange rate among different nations’ currencies, which means that China will have opportunities to participate in international trade without restrictions. It will also be forced to seek membership in international trading blocks to ensure its rights are safeguarded. However, other countries may take advantage of this to dictate China’s economy, which may affect its business activities.
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General Motors Invading China
This company has secured a significant portion of China’s market, which has motivated it to establish new factories there. However, this may not be a wise move since several challenges may affect its operations. First, there are many logistic challenges involved in establishing international markets and setting up businesses in foreign countries. Even though this company has already commanded a large market in China, this does not reflect its profits from the local market.
Also, this company does not rely on China’s market only. Establishing two factories in this country may not be profitable since it may involve huge operation costs that cannot be covered with the local market’s profits (Hill 9). Thirdly, it is better to export goods to China than establishing industries there since the cost of the former will be less than the tax levied on this company by the Chinese government if it decides to build its companies there.
It is also necessary to suggest that it should consider establishing one company and evaluating its performance before thinking of adding another since the market trends are unpredictable (Piersanti 22). It should consider establishing a partnership with a similar company in China to reduce competition from the local market. This will also reduce the costs involved in building new companies and obtaining licenses from relevant authorities.
Appropriateness of the Fixed Exchange Rate System
International business activities used to be conducted based on the value of a gold ounce. All currencies were equated to this commodity, which means that it was the standard exchange rate (Hill 13). It regulated the value of currencies from nations that participated in international trade. However, its shortcomings made the United States withdraw its currency from this system (Fisher 45). The following are some of the common disadvantages of the fixed exchange rate system. First, it gives nations the ability to control the value of their currencies, which means that they control other trading partners’ activities to suit their interests.
Secondly, this system violates the Bretton Wood Trade Agreement that gives the IMF the power to devalue countries’ currencies if they experience regular deficits in their balances of trade. A country cannot use its domestic financial policies to correct this situation, which made this system futile (Goldstein 79). Lastly, this system has uncertainties that lead to speculations; thus, a nation cannot predict its future economic position. Therefore, it is not a good system and should not be adopted by any country.
International business activities are regulated by exchange rates that should favor the participant to generate profits and expand investment opportunities. Nations should float their currencies in international markets to allow investors to explore their resources, stabilize their currencies, and widen their international operations. Fixed exchange rate systems are restrictive and limit nations’ abilities to participate in international trade and correct their balances of trade. Multinational corporations should partner with local companies to establish strong foundations and manage competition without incurring heavy expenses.
Fisher, Irving. The Debt-Deflation Theory of Great Depressions. New York: CreateSpace Independent Publishing Platform, 2012. Print.
Goldstein, Morris. The Future of China’s Exchange Rate Policy: Policy Analyses in International Economics. Washington, D.C: The Peterson Institute for International Economics, 2009. Print.
Hill, Charles, W. L. International Business. New York: McGraw-Hill, 2013. Print.
Piersanti, Giovanni. The Macroeconomic Theory of Exchange Rate Crises. New York: Oxford University Press, 2012. Print.