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| Factors Affecting Spot Exchange Rates |
By:
grisel |
This could be accomplished in only one fashion: by continued deficits in the U.S. balance of payments, i.e., a continuous increase in the liabilities of the United States. On the one hand, this provision appeared to put the United States in a privileged position relative to other countries; it could run deficits continuously without being forced to curb its domestic economy. On the other hand, the markets started raising questions as to the reasonableness of the increased amount of U.S. dollars in foreign hands. Now the crises of confidence turned away from deficit countries, such as the United Kingdom and France, to the surplus countries. Actually, turning funds into the currencies of the surplus nations was the same as getting rid of unwanted U.S. dollars. The difference was that now the pressure was felt most directly by the surplus countries that saw themselves flooded with speculative funds attracted by the possibility of an upvaluation of these currencies against the U.S. dollar-a devaluation of the U.S. dollar against these currencies.
These crises continued through the late 1960s until August 1971, when the United States cut the link between the value of its currency and gold, let the U.S. dollar's value float in the market, and stopped convertibility of its currency into gold. By the end of that year, with the Smithsonian Agreement, a new value for the U.S. dollar in terms of gold had been established, and the developed world returned to a system of fixed rates at the newly revised parities. However, the U.S. dollar remained unconvertible into gold at the official rate.
The country which had resisted monetary crises the longest in the past. the United Kingdom, was the first now to allow the value of its currency or Money to float in the exchange markets injure 1972. Early 1973 was to put the final seal on the new economic reality that fixed rates are very hard to maintain in a market where currencies are freely convertible into one another, and where a large amount of liquid funds can move from one currency into another. After a second devaluation of the U.S. dollar in February 1973. the turmoil of the forex markets forced the major European currencies to declare that they would allow the value of their currencies to float against the U.S. dollar. However, the exchange rate of the cu ardencies participating in this bloc, the European Monetary Union-also referred to as "the snake"-was to remain relatively stable through intervention of the participating countries.
Floating rates as an accepted general adjustment mechanism in the international monetary system had come of age. The remaining part of 1973 and 1974 witnessed wide fluctuations in the exchange markets.
Forces that had been clamped down in previous periods were now free to operate. In addition, the quadrupling of oil prices at the end of 1973 was to bring the world into thelargest downswing since the Great Depression. Some individuals say that under such conditions, exchange rates fluctuated within reasonable bounds; a system of fixed exchange rates would not have survived the economic instability of those years.
In spite of the limitations attributed to the system of fixed rates, now that the world had had a taste of widely fluctuating exchange rates, there was a desire for some stability. By the end of 1975 and in early 1976 governments were signing agreements in support of a greater stability in the exchange markets.
The mechanism to achieve this goal, while maintaining the freedom of floating exchange rates, was to encourage better coordination among the economic policies of the various countries.
Anybody who has witnessed the difficulties of reaching compromises among different parties within the domestic economy can imagine the problems of coordinating economic policies among countries.
Thus, 1976 saw some of the largest fluctuations in the values of currencies in the postwar period. Again, the pound sterling was to lead the world into this new pattern of behavior. The value of the pound sterling moved from $2.00/£ to $1.60/£. The lira also experienced a large devaluation. The mark up valued toward the end of the year. Floating exchange rates so far had proven to be highly volatile.
For a picture of the nature of fluctuations in exchange rates for the period 1973-1976, see Exhibit 6.3. Of course, flexible rates were used only by the major currencies of developed countries. Most of the countries in the world continued in a system of fixed rates with their currencies' values usually pegged to one of the major currencies.
It is true that the social, economic, and political pressures in the countries undergoing the large fluctuations in their exchange rates during the 1970s were unprecedented in the postwar era. Perhaps the exchange markets were just reflecting the instability of the economic conditions of those countries.
However, it was clear that governments had become much less willing to try to oppose the prevailing forces in the foreign exchange market. Forecasting the intervention of governments in the exchange markets was much more difficult. Some would argue that even the direction in which the governments would intervene was less predictable. Some even said that governments had, on occasion, joined the market forces in precipitating impending changes in the value of their currencies.
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