Reference no: EM13223964

Describe briefly the advantages and disadvantages of both floating and fixed exchange-rate systems. Which do you think the world will move toward in the future?

The advantages of a floating exchange rate can allow governments freedom to pursue their own internal policy objectives and goals. This can benefit governments in areas such as growth and full employment without external input. Another advantage is with a floating rate; such changes should remove the element of crisis from international relations and business. The floating rate also allows a country to be more flexibly to external shocks, while also having lower foreign exchange reserves. The disadvantages of a floating exchange rate include instability and uncertainty, Lack of investment, Lack of discipline in economic management and inflation. This can cause inflation by allowing import prices to rise as the exchange rate decreases.

The advantages of a fixed exchange rate is international trade does not create a great risk. By having a fixed rate buyers and sellers of international goods can agree on one price. Also another advantage can contribute to discipline in economic management and leadership. A disadvantage includes no balance of payment adjustments, loss of free choice in internal policy, large holdings of foreign exchange reserves and fixed rates can be unstable.

In the future the world will move towards a fixed exchange rate system. I believe that this could be a maybe since a lot of countries are conducting business and trade internationally. With a fixed exchange rate system, it can allow effective communication and necessary agreements to take place. Basically with fixed exchange rate "everyone will be on the same Page".

With China manipulating its currency over other nations, China is gaining a trade advantage over the U.S. Through this China is not only making more money, but is taking and creating more jobs as well. I also believe that if the American market was not so quick to operate on Chinese soil or sell into the Chinese market, we would have more of an advantage. For China their main concern should not only be their currency, but also inflation as well.

International Business: The Challenges of Globalization, Sixth Edition. John J. Wild; Kenneth L. Wild,print.

1.There are some advantages of the fixed rate system. These include fixed rates reduces speculation. The fixed rate encourages the government not to go in for inflationary policies. Also the fixed rate reduces risk in foreign trade and this encourages exports.
The disadvantages of fixed rate system include the following. The internal fiscal/monetary policy gets constrained. This also requires large foreign exchange holdings, the balance of payment and adjustment is not automatic. Finally, inflationary pressures often compel countries with fixed rates to devalue their currency(a).

2.The advantages of floating rate are the country requires relatively lower foreign exchange reserves. There is flexibility in floating exchange rates. Strong pressure to devaluate or revalue are not there. The floating rate gives greater flexibility to the government to pursue their fiscal and monetary policies. There is automatic adjustment of balance of payments. If there is surplus then there is appreciation of the rate and if there is a deficit there is a decline in the rate (a).
The disadvantages of floating rate are that it leads to inflation. There are doubts that balance of payment deficit is wiped out by floating rates at all times. The governments with floating rates often lead to inflationary policies. Floating rates lead to uncertainties and low FDI. Speculation leads to fluctuation in foreign exchange rates and this harms the interest of exporters and importers.

3.Fixed rate helps China in several ways. An undervalued renminbi means that Chinese exports to the US less expensive. The Chinese exports then successfully compete on price with US products. This reduces the sale of US products in the domestic market. At the same time an undervalued renminbi means that US exports to China become relatively expensive in China. This decreases their demand in China and the exports of US to China suffer. Thus an undervalued renminbi means lower home sales for US products as well as lower exports to China for US firms (b). Similarly, US firms have to pay higher price in dollars for buying assets in China and Chinese investors have to pay a lower price in renminbi for assets in the US.

References:

(a)Floating Exchange Rates, Ronald MacDonald, E2, Routledge, 2013

(b)International Financial Management, Jeff Madura, E10, Cengage Learning, 2010