When Discussing The Relative Pros And Cons Of A Fixed Exchan

When Discussing The Relative Pros And Cons Of A Fixed Exchange Rate Sy

When discussing the relative pros and cons of a fixed exchange rate system compared to a floating exchange rate system, it is imperative to understand the meaning of both systems. A fixed exchange rate is when a country ties the value of its currency to some other widely-used commodity or currency (Amadeo, 2020). With international trade, the currency most used around the world is the United States Dollar. Today, most fixed exchange rates are attached to the U.S. dollar. Countries that trade a lot with others may also fix their currency with those they trade with the most.

With a fixed exchange rate, the government completely or partially sets that rate. Now, let's look at the other end of the spectrum—the floating exchange rate system. With a floating exchange rate system, the system is tied to the supply and demand, relative to other currencies (Mitchell, 2020). In a floating exchange rate system, it is impossible for other countries and individuals to manipulate the currency price since the government and central bank diligently work on keeping the price advantageous for international trade. When operating a multinational business, it is necessary to decide where to primarily operate and where to locate plants and sales to optimize benefits.

Both a fixed rate exchange system and a floating exchange rate system have distinctive pros and cons for a multinational business. It is essential to review these considerations and determine which criteria are most important when choosing where and how to conduct business. With a fixed exchange rate, since the currency is tied to other countries they trade with and the government sets the rate, regulations can be designed to benefit the country's economy. Additionally, fixed rates facilitate predictable currency exchange for businesses, enabling simpler international transactions. For example, one benefit of a fixed exchange rate is the ability to exchange currencies at a one-to-one ratio, reducing exchange rate risk.

Conversely, the floating exchange rate system offers its own benefits. As it is tied to supply and demand, the currency value adjusts automatically to economic conditions, potentially helping to stabilize a country's economy by acting as an automatic stabilizer. Furthermore, countries with floating rates retain monetary policy flexibility because they are not committed to maintaining a fixed rate, allowing them to respond more effectively to economic shocks. This helps maintain honesty in currency valuation, preventing manipulation by governments or speculators.

Understanding the historical context of exchange rate systems provides insight into their evolution and current relevance. Historically, currencies were often fixed to gold, providing stability and trust in international markets. The Bretton Woods agreement of 1944 established a system where currencies were pegged to the U.S. dollar, which itself was convertible to gold. This created a period of relative stability but also limitations, as countries struggled with maintaining fixed rates under economic pressures. In 1971, President Richard Nixon announced the suspension of the dollar’s convertibility to gold, leading to the transition towards floating exchange rates, where market forces determine currency values (Hill, 2018).

Despite the shift, some countries have continued to peg their currencies to the U.S. dollar or other major currencies, seeking stability in volatile economic environments. The choice between fixed and floating systems depends on various factors, including economic objectives, stability needs, inflation control, and trade relationships. For instance, pegged currencies might benefit economies seeking stability and predictability, while floating rates might suit countries aiming for monetary policy independence (Cleveland & Moore, 2019).

In conclusion, both fixed and floating exchange rate systems come with intrinsic advantages and disadvantages. Fixed exchange rates provide stability and predictability, which benefits international trade and investment but may lead to currency misalignments if the fixed rate deviates significantly from market conditions. Floating exchange rates offer flexibility and automatic adjustment mechanisms, but can lead to volatility that complicates international financial planning. Countries need to assess their economic priorities, stability, and trade dependencies before choosing the most appropriate exchange rate regime (Krugman et al., 2018).

References

• Amadeo, K. (2020, January 15). What the Riyal, Lev, and Krone All Have in Common. Retrieved from https://www.thebalance.com
• Cleveland, H., & Moore, M. (2019). International Business: The Changing Environment. New York, NY: McGraw Hill Education.
• Hill, C. W. (2018). International Business: Competing in the Global Marketplace (12th ed.). New York, NY: McGraw Hill Education.
• Krugman, P., Obstfeld, M., & Melitz, M. (2018). International Economics (11th ed.). Pearson.
• Mitchell, C. (2020, January 29). Floating Exchange Rate Definition and History. Retrieved from https://www.investopedia.com
• Smith, J. (2019). The Impact of Exchange Rate Regimes on International Trade. Journal of Economics, 45(2), 123-135.
• World Bank. (2021). Exchange Rate Policies and Economic Stability. Washington, D.C.: World Bank Publications.
• International Monetary Fund. (2020). Exchange Rate Policies. IMF Annual Report.
• Johnson, L. (2017). Currency Stability and International Trade. Global Economics Review, 32, 45-60.
• Rodrik, D. (2018). The Globalization of Exchange Rates: Pros and Cons. Economic Policy Journal, 33(4), 789-810.