Chris Rudy Issue analysis 4/29/20710 The global economy has expanded exponentially since the beginning of the 20th century. A very important issue that has come to develop in the last thirty years is the global economy more or less abandoned a fixed currency system and using the modern floating currency/exchange model in an attempt to regulate markets in the newly developed foreign market economy. But what effects, both positive and negative have there been in the adoption of a floating model compared to a fixed model?Is the global economy better off or worse off by this implementation? To really be able to analyze the issue it is important to know the background of this switch from a fixed to floating currency system, who are the big players in the floating currency system, the challenges or benefits that this system provides and what needs to be done to correct problems arising out of the use of floating currencies.
To understand why the world uses a floating currency it is important to understand the history behind the issue. After World War II the leaders of the world’s industrialized nations met at a hotel in Bretton Woods, New Hampshire (Mingst 2008) and established a fixed currency rate that these industrialized nations would adhere to.There are a couple of reasons why the delegates that met at this time wanted a fixed international monetary system: one, the global depression was fresh on all the delegates’ minds, believing that a fixed currency rate would not only prohibit another global depression but as well be establishing global economic security; and two, the established international economic security would also provide a strong foundation for world peace (Hudson 2003). The fixed rate they agreed on would be set on a gold standard of 35 US dollars per ounce. that would have to be met by plus or minus one percent.
The idea was that the gold standard would be adhered to easily by the developed, industrialized nations, and that the established bretton woods institutions such as the IMF would then be able to help lesser developed countries in helping their currencies live up to the international standard by giving the countries short term loans to decrease the deficit in the gap of their currency (Hudson 2003). This exchange rate regime lasted the better part of forty years until the early 1970’s when the United States took away the ability away for the dollar to be converted into gold.It was not soon after that other countries followed suit, which in effect made the US dollar the reserve currency of the global economy. As a result in modern times, the currencies that are the most traded on the global market place are not the pegged or fixed currencies of the past but are floating or flocculating currencies which allow a national currency to fluctuate instead on the foreign exchange market (Galvo and Rienhart 2002). Now that the background of the issue of floating currencies has been addressed, who are the key players in this economic regime of floating currency?The key players in this system are the countries whose currencies are exchanged the most on the international system, as well as various Intergovernmental Organizations. The currencies that are most traded in the international economic community are the US dollar comprising 71% of forex trade, the Euro consisting of about 41%, the Great Britain Pound at 18% and the Japanese Yen at around 16%.
Seeing that most trade is done in the US dollar, and that the reserve currency is also the US dollar, the United States the biggest player of the four on the field that is the global marketplace.This virtually makes all countries with the biggest trade surpluses, such as China, to have to buy US dollars. This is important because, from lecture, it is known that the fed does indeed buy up US dollars when it seems the value will decrease and can then sell that money at a rate that is more beneficial to the current rate of the dollar.
The second big player being the European Union currency of the Euro which is used in multiple countries such as Germany, the third largest economy in the word (Nationmaster. om). The Euro is listed as the second largest player due to the fact that the Euro is being traded on an ever increasing basis and is starting to give the dollar a run for its money on which currency might be seen as the next reserve currency.
The GPB has always been a force in the world economy due to the fact that London itself is one of the largest international banking hubs in the global community and exchange wise, the GBP has always been relatively good when compared to the US dollar or the Euro.It is interesting to note however that Japans currency is listed as the safest currency to invest in with the second largest economy next to the United States, making it the last of the four key players in the floating market economy. It will be very exciting to watch and see how much of a player Japan will become in the global market place in the coming years. Now for the benefits and negative consequences of floating markets, first the benefits: with floating currency it enables countries to revalue or devalue their currency in terms of the international market.Nations that are involved in floating currencies also have the ability to pursue public policy as it relates to the economy (growth, employment) without outside constraints (Levy-Yeyati and Sturzenegger 2005). Usually a fixed economy is a pre-cursor to importance of a nation to devalue or revalue its currency in a time of crises.
A floating currency system in theory automatically adjusts for this and is a way to avoid conflict in international relations (Levy-Yeyati and Sturzenegger 2005).A floating currency has the chance to adapt in types of external shock as well as internal. Take for example the oil crisis of the 1970’s, if the US and global markets weren’t able to fluctuate in accordance to the OPEC shock that resounded globally, other markets could not have been destroyed due to the inability to adjust their currencies to the external shock. There are however some disadvantages of floating currency as well. A floating currency market regime inherently creates instability.When the currencies float the seller of a particular good is never sure exactly how much they are going to get for their product domestically or abroad, this uncertainty can also lead to a lack of investment domestically and internationally (Galvo and Rienhart 2002). Speculation is another problem that arises out of floating currencies. If there is not a set value it makes that possibility of speculation much more possible which can damage the economy due the fact that more often than not speculation trends do not match up with actual trade trends (Galvo and Rienhart 2002).
One of the biggest problems with floating currencies is inflation. Inflation can come from speculation or governments falsely inflating their own currencies to keep up with the global market. Inflation also happens in poorer countries that continuously need to take out loans from organizations like the IMF to stabilize their own currencies when the currencies of those key players mentioned above inflate. So then what is the solution? There are definite downfalls to a floating currency and a pegged currency.On one hand it seems that a pegged currency, economically speaking, is a economic variation of natural selection.
The strongest economies will prevail, and the weak ones will wither off and die. At the same time floating currencies seem only to prolong the natural selection by propping up economies with money that really isn’t worth anymore than the people handing it over say its worth, with interest of course. While there is probably no best answer, one way to regulate the global economy and help stabilize currency is brought forward in the book “Fear of Floating” is to peg the price of resources.
This already takes place to some extent on the global market, oil for example, is a virtually set price, but not very person selling the oil is getting the same amount of profit from their sales, Alberta gets more for their oil from the US then they do domestically. This is a great solution. If we could keep these prices pegged so all sellers are getting a fair and equal price, and the products are sold globally at a uniform and similar price it would do good in stabilizing currencies as well.Well what about states that lack resources? Instead of organizations like the IMF and World Bank giving loans to stabilize currency, use those funds to develop some sort of domestically viable resource, industrial centers for finishing raw goods, textile assembly plants..
. even stitching together soccer balls, just get something going. If we used a combination of these two aspects it would more than likely help regulate and stabilize currency on its own.However in theory things work out great, there is still the underlying problem of how to fix a price on a commodity when the currency its based on is itself floating, no one’s perfect.
What seems to work the best is the situation that gets us by. Bretton Woods institutions and pegged currency did okay for a while, now economic liberalism seems to be getting us by, but there are inherent problems with both market regimes. With the ever expanding global economy more and more players such as the BRIC (Brazil, Russia, India and China) countries ever merging on the world stage and the emergence of currencies that incorporate many nations states (euro) it still remains to be seen the effects of this floating currency global economy is going to play out. While we do see definite results in the global community from converting from a fixed market to a floating market we undoubtedly have not yet experienced or witness that conversions full effects.