Politics of Dollar as Exchange Rates
The US Dollar is usually used as the unit of reference in the international markets. The strength of other countries’ currencies is therefore measured relative to the US Dollar. Because of this, it is possible for the US to have financial deficits without experiencing a decline in currency value. However, it is critical to have a stable exchange rate in the world market due to increased capital mobility. The exchange rate is an essential price in any country due to its potential to affect all other prices. This calls for the need to select an effective exchange rate regime in order to trade favorably in the international market. Various policy groups select the exchange rate regime based on the economic needs for the country. For example, the developed nations which require stabilization of their currencies commonly select the fixed rate regimes.
The fixed exchange rate regime is pegged on the Dollar as the unit currency. However, this has proven problematic due to the potential to cause conflicts among the world nations. However, the use of the dollar also enables countries to evaluate their performance and thus provide strategies for improving the competitive advantage of countries. The use of the US Dollar as the standard fixed rate in the 19th century had already caused problems due to divisions between countries. This led to the distinction of the market into the hard money and the soft money trading systems. While the ‘soft money’ traders supported the continued use of the USD, the ‘hard money’ proponents wanted gold to be used as the standard instead. The use of the USD continues to cause conflicts as financial and commercial integration continues across the world (Streissler, 2002).
The use of the Dollar as a fixed rate implies that the valuation of other currencies has to be done relative to the USD. A country’s currency I converted to the equivalent USD in order to determine its value and impacts in the market. On the other hand, the USD is measured in value based on its increased value relative to other currencies. While this may not be challenging to the US, the limitation comes in other countries where there is significant political influence on the Central Bank. In this case, pegging the country’s currency to the USD may be difficult as the exchange rates are adjusted based on the self-interests of the political class. This affects the country’s economic performance (Copeland, 2010).
For instance, overvaluation of a country’s currency as was observed in Zimbabwe in 1980 can result in reduced affordability. This eventually led to the collapse of many firms in the country (Makin, 2009). While using the Dollar as the fixed rate, challenges have been met especially during the 2007 to 2009 recession which affected the value of the Dollar. Moreover, the fluctuation in oil prices also led to the devaluation of the Dollar.
Although the dollar is widely used in the international markets, there have been concerns raised by global policy makers on its validity. However, efforts to change the fixed currency by different countries have often failed due to the inability to meet currency reserves. This has led to continued dependence on the USD due to its stability in the international markets (Manzur, 2002). This has further advanced the use of the USD as the fixed rate in the floating regime. In addition to this, countries also shift towards the adoption of comparative advantage rather than focusing on the need for a stable currency. As such countries have to choose between the fixed and floating exchange rate regimes. This is done based on the level of political influence on the country’s economy and the national goals of the country.
Copeland, L. S. (2010). Exchange rates and international finance. Harlow [u.a.: Prentice Hall/Financial Times.
Makin, A. J. (2009). Global imbalances, exchange rates, and stabilization policy. Basingstoke, Hampshire: Palgrave Macmillan.
Manzur, M. (2002). Exchange rates, interest rates, and commodity prices. Cheltenham, UK: Edward Elgar.
Streissler, E. W. (2002). Exchange rates and international finance markets: An asset-theoretic perspective with Schumpeterian innovation. London: Routledge.
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