20 November 2010

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

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

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

Part Two -

After World War II –
Everything regarding international business changed and very slow America became the No.1 in everything, a Global leader with perfect policies and great intelligence of their politicians.

Bretton Woods system -

Bretton Woods system – regarding international trade and currency,

Bretton Woods system came into existence in year 1944.

This fixed rate system is also known as ‘Bretton Woods system’ or ‘pegged currency’

India also abandoned Fixed Rate system’ in 1975 and moved to the floating rate system.

British proposal of introducing a supranational currency
named as Bancor could not prevail against the interests of the United States, which then at the Bretton Woods conference established the U.S. dollars as world key currency.

That time U.S. dollar was the currency with the most purchasing power and it was the only currency that was backed by gold
Fixed Rate was –
Dollar to gold at the rate of $35 per ounce of gold.

After World war II European nations and United Kingdom required help and American government provided it.
When we take loan or benefits from other nation , we have to indirectly accept the wish of giver.
The government can not go against the wishes of loan giver country.

United States signed an agreement on December 6, 1945 to grant Britain aid of $4.4 billion after that British Parliament ratified the Bretton Woods Agreements (which occurred later in December 1945)

1945 – France took loan from the USA.

730 delegates from all 44 Allied nations gathered at the Mount Washington Hotel in Bretton Woods, New Hampshire, United States, for the United Nations Monetary and Financial Conference.

The delegates deliberated upon and signed the Bretton Woods Agreements during the first three weeks of July 1944.

Why the Bretton woods system was created ?
What was the Role of the Bretton woods system in world trade ?

To regulate the international monetary system, the planners at Bretton Woods established the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD), which today is part of the World Bank Group.

Under this system each country adopted a monetary policy that maintained the exchange rate of its currency within a fixed value—plus or minus one percent—in terms of gold and the ability of the IMF to bridge temporary imbalances of payments.

To promote the growth of world trade and to finance the postwar reconstruction of Europe, the planners at Bretton Woods created another institution, the International Bank for Reconstruction and Development (IBRD), World Bank

After this dollar American Dollar became trustworthy like the Gold, and dollar gave interest also.
So majority countries started to keep reserve of American dollar, dollar became the international trade currency.

Power of USA – and Problems of USA - Up to year 1970
Gold was guaranteed in exchange of dollar by government of America.

U.S. produced half of the world's manufactured goods and holding half its reserves but later this became problematic for USA as gold was guaranteed in exchange of dollar .

After world war two honest nations started to work hard towards developing their nations and very slowly japan, France and Russia started to compete with America

But after 1970 other nations started to lose the faith in the Dollar and started to demand gold in exchange of dollar.

U.S. President Richard Nixon changed the History – for the Benefit of America and to save American economy -

Today India needs a leader and Prime Minister like American President Richard Nixon who can take strict policy changing decisions for the benefit of India.

We can say that policies of President Richard Nixon took the world towards floating currency exchange

On 9 August 1971, as the dollar dropped in value against European currencies, Switzerland withdrew the Swiss franc from the Bretton Woods system.

On August 15, 1971, the United States declared that dollar will not be directly converted into Gold.
Will be available in open market only and thus Floating exchange rate system started.
1971 it reached $44.20/ounce,
1972 $70.30/ounce
1973 $44/ounce

Special Drawing Rights (SDRs) are international foreign exchange reserve assets created in year 1969 by IMF
SDR is used as a unit of account and is sometimes referred to as a "quasi currency".

Special Drawing Rights are allocated to nations by the IMF.
The SDR interest rate is determined weekly and is related with debt also.

In 1969 one SDR was defined as having a value of 0.888671 grams of gold, the value of one US dollar

Today SDR is a basket of Japanese Yen, US Dollars, British Pounds and Euro
And the proportion each of these four currencies contributes to the nominal value of a SDR
SDR is reevaluated every five years.

The IMF fixes daily the value of one SDR in terms of US dollars

March 2009 Zhou Xiaochuan, governor of the People's Bank of China, proposed using Special Drawing Rights as a worldwide reserve currency in place of the US dollar

In India currently we are using demand and supply based system as well as our central bank RBI also controls the price.This depends on our SDR and gold stock also.

Currently demand and supply is also decided by foreign exchange market –
That is also known as or called as FX market or currency market.

I am sure you know about the share market –
Share market is a place where we sell and buy shares of the companies.

Same way in short currency or FX, Currency market is the place where currencies of the nations are bought, sold and speculated.

When we buy oil from Iran or Iraq what happens?
They demand payment in Dollars, so we need to give those dollars or gold.
Or go to forex, currency market and purchase the dollars or get the loan from America or world bank or from other nation to pay for the goods which India imports from other nations.

This is reason each nation has to keep the stock of gold as well as dollars,
More the stock of gold and American dollar,
More the respect that nation enjoys.

Thus currency keeps changing as per the demand and supply and trade in currency market.

Currently china has saved, purchased lot of American dollars by purchasing American government bonds
this is reason America has to respect china and their leaders talk one to one.

Regarding our Indian currency value one has to consider Indian loans, Spending, RBI policies , government policies and spending.
Only after we can understand how the rate is fixed.

In short we must understand nothing comes free, our politicians do the corruption and become rich, our rich people do the corruption and become rich and
we lower class Indians pay all those debt and loans by staying and living life in a gutter.

Demand and supply, loans, debt = equal currency rate.

The topic is very difficult to explain hope you got the idea regarding how the currency exchange rate is fixed.

Reality views by sm –

20th November 2010


SG November 20, 2010  

Very detailed and informative. Thanks.

Sathish Chandrasekaran (சதீஷ் சந்திரசேகரன்) November 20, 2010  

very very informative :)
These days finance & taxes are so confusing that it surpasses rocket science :D

sm,  November 20, 2010  


sm,  November 20, 2010  

thanks for requesting me topic.

Amrit November 21, 2010  


As usual well researched, detailed and informative post. Pleasure to read your posts.

bhagyareema November 21, 2010  

Thanks SM, this is better than what they teach in classroom, have to read it 2 more times to fully grasp it

sm,  November 21, 2010  


Kavita Saharia November 22, 2010  

As i said earlier - very informative and easy to understand.Thanks.

sm,  November 22, 2010  


Kirtivasan Ganesan November 22, 2010  

Excellent work.

I can now do away with reading most of the editorials.

A complex topic easily explained.

sm,  November 22, 2010  


Gold rates December 21, 2010  

A whole lot of details helped me to understand with ease that how currency rates fluctuate and what are the reasons behind them.

sm,  December 22, 2010  

gold rates

Destination Infinity May 17, 2011  

Nice explanation. Keep it up!

Destination Infinity