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Causes Of Variations In The Exchange Rate

 Causes of variations in the Conversion Rate

Description

    Based on these postulates the conversion rate under the gold standard is ascertained by the forces of demand and supply among the gold points and is banned from moving exterior the gold points by shipping the gold.

   The below diagram represents the determination of the conversion rate under the gold measure.

  1. The conversion rate OR is fixed up at E point where the demand and supply curves DD1 and SS1 intersect.
  1. The conversion rate need not be at the mint equality. It can be anywhere among the gold points based on the shape of demand and supply curves.
  1. The mint parity is simply meant to define the US gold export points ($5.06) and the US gold import point ($4.94).
  1. As the US treasury is ready to sell any quantity of gold at a price of $40 per ounce, no US citizen would pay more than $5.06 per pound for the reason that he can get any amount of pounds at that price by exporting gold.
  1. That is the reason that the US supply curve of pound becomes perfectly elastic or horizontal export point.
  1. This is represented by the horizontal portion S1 of the SS1 supply curve.
  1. Likewise, as the US treasury is ready to purchase any amount of gold at $40 per ounce, no US citizen would sell pounds less than $4.94 for the reason that he can sell any amount of pounds at the price by gold imports.
  1. Therefore the US demand curve for pounds becomes perfectly elastic at the US gold importation place. This is presented by the horizontal portion D1 of the demand curve DD1.

Criticisms

The mint equality thesis has been criticised on the succeeding causes:

  1. The international gold standard does not persist now ever since it broke down after the Depression of the 1930s.
  1. The thesis is based on the presumption of free buying and selling of gold and its movement among countries. However governments do not permit such sales, purchases and movements.
  1. The Thesis is unsuccessful to describe the ascertainment of exchange rates as many nations are on inconvertible paper standard.
  1. This thesis presumes sophistication of internal prices. However modern governments follow at liberty domestic price policy not related to changes in conversion rate.

Conclusion

The mint parity thesis has long been rejected ever since the gold measure broke down. No nation is on the gold norms now. There are neither free movement of gold nor gold parities. So this thesis has only an intellectual interest.

Causes of variations in the Conversion Rate

  1. Variations in Price – It is variations in the associate price levels that cause variations in the exchange rate. Presume the price level in Britain rises associative to the US price level. This will tend to the hike in the prices the prices of British goods in terms of pound.
  2. Then British commodities will become favourable in US and this will tend to deduction in British exports to the US. Hence the supply of dollars to will lessen.

  1. Variation in Interest Rates – Variations in interest rates also tends to variations in the conversion rate. If interest rate rises in the domestic nations, there is a large inflow of capital from overseas nations. Consequently, the exchange rate of the home nation will appreciate relative to the overseas currencies. The contra will be the crate if interest rates drop in the domestic nation.
  1. Variations in Exports and Imports – The demand and supply of overseas conversion are also over powered by variations in the exports and imports. If exports of the nation are more than imports, the demand for its currency hikes so that the rate of conversion shifts in its favour.
  2. Alternatively, if imports are more than exports the demand for the foreign currency hikes and the rate of exchange will move contra to the nation.

  1. Capital Movements – short term or long term capital movements also over power the conversion rate. Capital flows is likely to enhance the value of currency of the capital exporting nation. The conversion rate will shift in favour of the capital importing nation and against the capital exporting nation.
  2. The demand for the currency of the capital importing nation will hike and its demand curve will move upward to the right and the conversion rate will be ascertained at a larger level given the supply curve of overseas exchange.

  1. Influence of Banks – Banks also affect the conversion rate through their operation. They comprise of the purchase and sale of bank drafts, letters of credit, arbitrage etc. These banking functions affect the demand for and supply of foreign conversion. If the commercial banks issue a large number of drafts and letter of credit on overseas banks, the demand for overseas currency hikes.

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