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International Finance: Linking Exchange Rates to Dollar

Introduction

The United States of America uses the United States dollar as its official currency. This is usually abbreviated as USD, $ and US$. These are normally used to make it distinct from other countries which abbreviate their currencies using the dollar symbol. In addition, the USD is divided into 100 cents. The country’s currency is mostly used in international transactions. It is one of the world’s reserve currencies.

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On the other hand, it is mostly used as the official currency. Other countries have gone ahead to use it as their de facto currency. This implies that the dollar is used as a standard unit of currency. More so, this is seen in international markets where the dollar is used for commodities like petroleum and gold. Other companies that are involved in global businesses have used it to list their prices. Apart from being the world’s foremost reserve currency, countries (Institutions and central banks) have private holdings in it.

These ones are mostly evaluated in one hundred dollar banknotes. Wholesomely, most USD bank notes are held outside the United Sates of America. These bank note holdings that are held by USA non residents are called Eurodollars. They are highly considered regardless of the location (of the bank) that the person has his/her holdings in.

There is a lot of overseas demand for the dollar as a result of global trade that has continued to grow. As much as this demand has continued to surge, it has not caused the value of the currency to depreciate or readjust in any given case. This continued over reliance on the USD can have some global consequences as it was recently seen during the global economic crisis.

Discussion

The dollar and exchange rates

In recent years, many countries have linked their exchange rates to the USD. The dollar is still highly valued as an international reserve currency. This is because it has a high accumulation value. Although the Euro has also come up as a replacement, it has not been effective. It is expected that it will be a primary reserve currency.

Currently, the USD is regarded as the most important currency in the world. As a matter of fact, it comprises more than 60% of the world’s foreign exchange reserves (Goodman, 2005, p. 12). This explains why the currency is mostly used as a standard unit for all commodities which are traded on a global scale. Such commodities include oil and gold which are considered as international commodities.

Many countries are embracing the dollar because it is widely accepted by all countries as an international currency that can be used in global trade unlike other currencies which are not widely recognized (Suranovic, 2008, p. 4). Because of this, many countries (both developed and developing) have continued to utilize the dollar in their international trade. This can be explained from its accumulation value which is almost guaranteed unlike other currencies which seem to have unpredictable values.

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The dollar has continued to strengthen its value in recent years as many countries have adopted it by linking it to their exchange rates. For instance in 2009 its exchange rate with the Euro stood at 0.7176 units (Copeland, 2009, p. 6). By engaging in global business, many countries have an option of evaluating themselves with others by looking at the exchange rates. It is through these exchange rates that they are able to analyze how their exports are fairing. By considering the performance they can be able to devise ways of improving their projections.

Eighty percent of the world’s transactions are conducted in terms of the USD. This means that all countries are moving towards this direction (Copeland, 2009, p. 12). If most transactions are conducted using the dollar, then it means that countries have to link their exchange rates to it. Countries which do not embrace this are likely to have problems in exchanging their currencies. Global business dynamics are always changing and that is why countries have recognized that it will be easy to link their exchange rates to the dollar as it is mostly monitored by their fellow trading partners.

The USD is considered as the best currency which can withstand turbulent times and political uncertainties. This is the direct opposite of other currencies that are not reliable. United States of America is considered to be the world’s largest economy and as a matter of fact it does not have major political instability (Evans-Pritchard, 2007, p. 9). By being the largest economy it has the capacity to enhance stability in international trade. This explains why many countries are more secure to link their exchange rates to the dollar than doing this to other currencies.

As long as the US does not have any fears about its economy there will be a favorable exchange rate around the world. Over half of the world’s exports are paid in terms of the USD. This explains the necessity to link a country’s exchange rate to the currency (Cohen, 2006, p. 3). Good trade dictates that as much as a country has to import, it should also export to enhance its trade position. Therefore, to be secure most countries have linked their exchange rates to the dollar for sustainability.

Besides this, many countries are engaged in the dollarization of their currencies. This means that majority of them are engaged in adopting it as the official currency. As this practice picks up they have seen the need to link their exchange rates to the dollar. It is believed that with the USD, there is financial security and this explains why they have opted to use it for all exchange activities.

Apart from countries, the USD is a defacto currency that is widely accepted by people. This means that as it is widely accepted; economies have to facilitate their exchange rates by linking it to the dollar so that citizens won’t have any problems going about their business. Movements around the world can only be facilitated by the USD and this explains the need for countries to link it to their currencies (Ravenhill, 2005, p. 6). By doing this, they have made it easy for their citizens to go about their global issues without any difficulties.

Because of enhanced international trade, more and more countries are expected to link their currencies to the $. Over recent years, the dollar has maintained a stable exchange rate with other currencies and this argues well for countries (Helleiner, 1996, p. 17). As a matter of fact, this stability is set to continue. This means that more countries will likely link their exchange rates to the $. Currently other world major currencies are facing problems as much as the dollar but it has maintained a positive outlook which makes people to have faith in linking it to their exchange rates.

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International monetary system

These are internationally acknowledged rules with supporting institutions that have conventions (Cohen, 2006, p. 4). Their main aim is to enhance international trade together with various investments. All this is targeted at the reallocation of capital between different countries. To enhance this, international monetary systems come up with a means of payment that will be acceptable to sellers and buyers. This is supposed to take care of all individuals’ regardless of their nationality.

International monetary systems are supposed to inspire confidence that will ensure that there is sufficient liquidity. On the other hand, this is set to correct all global imbalances that may occur (Ravenhill, 2005, p. 11). They can likely grow as a result of numerous agreements between international economic actors. As a result of these international monetary systems, United States of America has ended up having a greater monetary autonomy.

Considering the fact that the country’s currency is used for international transactions, this greater autonomy can have serious implications. This can be more so incase the country experiences any problems that may end up being costly to other countries. The current global economic crisis emanated from the USA and slowly trickled to other countries (Copeland, 2009, 24). This autonomy does not argue well in the current world.

There are evolving exchange rates with various economic regimes. Because of this, the world has witnessed a radical alteration of the financial environment (Evans-Pritchard, 2007, p. 15). This alteration has not been within the expected frameworks and this has in one way or another destabilized trade and the way countries go about with their currencies.

The US dollar is relied on as the principal reserve currency. On the other hand, this over reliance is set to bring problems to the world as the US experiences financial and economic problems. Countries have been forced to hold precautionary reserves as a way of enhancing self insurance (Suranovic, 2008, p. 13). This is because the current International monetary systems have led to a high demand for external liquidity and foreign exchange. Although this can be as result of balance of payment problems, it can lead to global liquidity shortages.

The current International monetary systems have brought about some unexpected patterns of international capital flows. This has had some implications on how different economies perform in a broad perspective. Capital flows have an impact on the general economic stability of a given country. This therefore calls for more reforms that will ensure that the systems work well for the global economy.

To maintain stable exchange rates on a global scale, there is need to adopt a good system of fixed exchange rates. This is because many nations have fixed the value of their currencies in relation to the US dollar. Wholesomely, the current world and economies have seen turbulent and huge flows of capital. This is a result of international monetary systems. There are global liquidity problems that need to be reviewed for enhanced global sustainability. This is evident from the way IMF has boosted global liquidity by issuing $284 million in additional SDRs (Copeland, 2009, p. 6).

Conclusion

There is an increased demand for the USD as a result of the global trade which has continued to grow. As much as this demand has continued to surge, it has not caused the value of the currency to depreciate or re-adjust itself in any given case. The continued over reliance on the USD can have a number of global consequences as it was recently evident during the global economic crisis.

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Reference List

Cohen, B. 2006. The Future of Money. New Jersey: Princeton University Press.

Copeland, L. 2009. Exchange Rates and International Finance. New Jersey: Prentice Hall.

Evans-Pritchard, A. 2007. China threatens ‘nuclear option’ of dollar sales. London: The Daily Telegraph.

Goodman, P, S. 2005. China Ends Fixed-Rate Currency. Washington: Washington Post.

Helleiner, E. 1996. Bretton Woods and the Endorsement of Capital Controls: States and the reemergence of global finance. New York: Cornell University Press.

Ravenhill, J. 2005. Global Political Economy. UK: Oxford University Press.

Suranovic, S. 2008. International Finance Theory and Policy. Hampshire: Palgrave Macmillan.

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