20 November 2010

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Part One - How Currency Exchange Rate is decided? How Currency exchange rate of Indian Rupee and Dollar is decided?

Part One - How Currency Exchange Rate is decided?
How Currency exchange rate of Indian Rupee and Dollar is decided?

Currently One American Dollar is equal to 40 to 44 Indian Rupees.
This exchange rate keeps changing daily; this exchange rate is not fixed.

How this ratio is fixed. How the value of the currency is decided.
Why Currency rate keeps changing ?

To understand this one has to understand how the dollar became important in world trade?
History of world trade after World War II and international market and financial markets system.

This is decided as per the rule of demand and supply and which currency is trustworthy and which currency is globally accepted by everyone.

The Indian rupee has a market determined exchange rate.
However, the RBI trades actively in the USD/INR currency market to impact effective exchange rates.

The rupee currency is not pegged to any particular foreign currency at a specific exchange rate.
The RBI intervenes in the currency markets to maintain low volatility in exchange rates and remove excess liquidity from the economy.

As per my Reading and Understanding RBI or government of India is not trying and is not interested in making 1 dollar = 1 Indian Rupee and 1 Euro = 1 Pound = 1 Indian Rupee.

Because of corruption, war and wrong policies of our Indian government,
Indian currency was devalued few times between 1960 and 1990.

In International Market when business is done
in advance it is fixed that how one nation will pay the another nation
example - payments will be done in American dollar or gold or currency of one nation.

Thus the demand for currency is created.

All the countries do business with each other, thus every country has to think about future payments while doing business, and how and which which form of currency will be required to do future business

This way the demand for particular currency is created and that currency rules ,
one has to pay more to get that currency as that currency is more trustworthy, has more demand.

If more countries want to use the Indian Rupee when they sell something to other nations
then value of the Indian Rupee will increase and value of the Dollar will decrease.

This is the principal of demand and supply, more the demand for currency more the value for currency.

Now a days majority nations follow the principal of demand and supply based exchange rate system.

Only few nations like china fix there own rate,
showing that china is the next super power, a country which is challenging the global position of America as the No. 1 country in the world.
Somewhat china got success also and is moving towards to become No.1 , it will all depend on American politicians and their intelligence.

History of Exchange Rate in Short -

In following ways from ancient times the payment system kept changing.
Methods of Buying and selling of Goods , services National as well as international

Barter system
Barter system and silver-based
Barter system, silver-based and gold based
silver-based and gold based,
silver-based , gold based and introduction of paper notes,
gold based and paper notes

In beginning international business was done using silver coins or we can say silver-based. But later on Gold became the standard.

Gold exchange standard –

Historically, the Indian rupee was a silver-based currency, while the major economies of the world were following the gold standard.

In the 19th and early 20th centuries gold played a key role in international monetary transactions.

In this system government of one nation agrees with the government of other nations to give gold, paper notes are convertible into pre-set, fixed quantities of gold.

Simple example - is giving for understanding the concept.
34 American dollar equal to 1 kilo gold.
Like this it is fix in advance.

Under this Governments can not pump unlimited money in the hands of citizens.
It all depends on how much gold is in the possession of the nation.
Number or quantity of Printing of notes is decided on
how much gold is possessed by that nation.
Thus central bank has limited function, can not help much to anyone.

But Gold is not available in unlimited quantity.

in 18th and 19th century European, British and American government started to fix standard currency exchange rate regarding international business.

Thus Gold became the standard. As gold is not available unlimited.

Benefit of gold standard is
if any nation has more gold , then that nation dominated the international business.
But this is not good for inventions, without money spending inventions are not possible.

Under this standard the power of politicians and government is limited as everything depends on how much gold is in the possession of nation.
So it becomes very difficult for any nation to take risks regarding any business or spending towards research and finding new medicines or innovations.
Thus in one way we can say politicians as well as government becomes somewhat powerless.

The current global monetary system relies on the U.S. dollar as a reserve currency by which major transactions, such as the price of gold itself, are measured

Every nation keeps reserve currency.
A reserve currency, or anchor currency is a currency which is used by the government for the international transactions that is business related activities.
For doing international business this reserve currency is used by the government, not their own currency.

Example –
When India purchases Oil from Arab Nations India pays them in American dollar.
When India purchase arms from other nations we pay them in dollars and not in Indian currency.

As Indian currency is not globally accepted.

What is devaluation?

Devaluation means -

1 dollar = 4 Indian Rupees

When Indian rupee gets devalued this ratio changes and

1 Dollar equals to 7 Indian Rupees
with wrong policies of politicians this ratio and gap keeps increasing.

Effect of devaluation-
Devaluation means value of currency is decreased comparing to other currency or say gold.

When devaluation of currency happens -
country can sell more but the purchasing capacity is reduced ,is less,
this is reason government needs to keep the policy of never to devalue the currency without proper planning and intelligence.

Export Business = Selling goods or something to other nations
Import Business = Purchasing goods from other nations by paying cash or gold.

Which class of people benefit in export and import business ?
only rich people of the nation benefit in the export and import business.

Fix rate system is good for everyone; even in this global world the time has come to introduce the global one currency.

Continued -

Suggested Reading -

Part Two - How Currency Exchange Rate is decided? How Currency exchange rate of Indian Rupee and Dollar is decided?

Reality views by sm -

20 Saturday 2010


Cildemer November 20, 2010  

Thanks for visiting my place and taking the time to comment!

Have a nice weekend****

sm,  November 20, 2010  


SG November 20, 2010  

Nice post. Enjoyed reading it. In 1971, Richard Nixon ended the direct convertibility of dollar to gold. It is the root cause of all future problems.

Kavita Saharia November 20, 2010  

Thanks for such an informative post.Loved reading it because it was very easy to understand.

kiran sawhney November 20, 2010  

Very Nice and informative. have to read again to understand it better.

sm,  November 20, 2010  


sm,  November 20, 2010  


sm,  November 20, 2010  

Kiran Bajaj Sawhney,,

sm,  November 20, 2010  


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