The Implications For An Economy Of A Rising Exchange Rate - Essay Example

? EXAMINE THE IMPLICATIONS FOR AN ECONOMY OF A RISING EXCHANGE RATE Introduction The exchange rate of a currency is defined as the price of that currency in relation to other currencies. The major currencies of the world such as the US dollar and the Euro act as a standard for evaluation of the performance of a country’s currency. The performance of a specific currency is determined by the demand for the currency and the investments on the economy. An increased exchange rate of a country’s currency in relation to world currencies such as the dollar influences negatively on the export of the country’s products. On the other hand, the cost of imports is decreased by a strengthening currency and therefore more goods and services are imported. However, a strong currency discourages foreign investment and as a result, central banks use various strategies to ensure that currencies are regulated. This acts to protect the manufacturing industries from business failure due to reduced exportation of goods and competition. This paper gives a critical analysis on the impact of the rising exchange rate on world economies such as Australia, China, and Switzerland. The Australia’s steel export industry was impacted negatively by the rising exchange rate in July 2011 when the Australian dollar hit the highest point ever recorded in thirty years. This means that the value of the Australian dollar in relation to other currencies increased steadily. The demonstration for the negative impact of the rising exchange rate of the Australian dollar on the economy is seen in the increases in the cost of the raw materials for the industry in addition to the decreasing prices of steel1. Moreover, the strength of the Australian dollar led to the reduction of the export of goods and services from the agricultural, retail, tourism, and manufacturing sectors of the country’s economy. Foreign countries reduced their import of agricultural products from Australia due to the strength of its currency. The importance of agriculture and manufacturing industry in Australia shows the extent to which reduced exports of goods from these sectors affected the economy. Figure 1 Foreign Exchange Rate Australia/US Because of a rising exchange rate, the manufacturing industry of countries incurs big losses. For example, the Australian steel industry incurred a net loss of about US$1.1bn as a result of the appreciation of the Australian dollar2. The loss was due to asset write downs and reduction of the export activities. The impact of a rising exchange rate leads to the involvement of governments in an attempt to revive the failing economies. For example, the Australian government channeled funds to the steel industry to enable it to recover from the losses incurred due to the reduction of the country’s steel exports. The impact of the government involvement on the economy is twofold: the funds channeled to the industries for their recovery would lead to the improvement of the economy or reduce economic performance due to inappropriate prioritization of funds. The government involvement in the improving its manufacturing industries should therefore consider other sectors of the economy so that realistic distribution of funds is made possible. The exportation of a country’s products reduces when the currency strengthens because the prize of the exports and the costs associated with the shipments of the exports rise when the currency becomes strong. As a result, foreign importers from a country with a strong currency may reduce or terminate their imports from that country. As a result, the sectors of the economy, which export goods, are impacted negatively3. A rising exchange rate also affects the job market4. Because of the loss of revenue, which results from reduction of exports, a company is likely to reduce its workforce as a way of minimizing expenses. Blue scope, which is the largest producer of steel in Australia, for example reduced its work force by retrenchment following the reduction of its exports. The company cut its workforce by 400 so that it could reduce its expenses. It is estimated that when the Australian dollar hit its highest exchange rate, about 7000 workers lost their jobs in Australia’s industrial, agricultural and tourism industries. Australian BlueScope was described by its CEO are unlikely to sustain the export business anymore as the Australian dollar became even stronger. This illustrates the chances of increased loss of jobs of the company’s workforce. The loss of jobs is not only related to the reduction of exports but to the general poor performance of the economy. The production in agricultural and manufacturing sectors contributes to the majority of the workforce in many economies. Poor performance of these sectors thus leads to the loss of jobs, which translates, into low productivity and a weakening economy. Loss of the competitive advantage also results from a rising exchange rate5. This is illustrated by the Australian steel industry, which was unable to compete favorably with the Chinese steel producers. China regulated its currency so that it did not appreciate as a way of protecting its export industry. As a result, the countries, which compete with China in the export of various goods, have failed to sustain the competition. This is a clear demonstration on the negative impact of the rising exchange rate of a currency on the manufacturing sectors of an economy. Competition acts as a facilitator of growth of various industries hence when an economy fails to compete with producers of the same product, monopoly is likely to occur. However, the strategies of depreciation the Chinese Yuan as a way of promoting the country’s exports has caused economic controversies among the developed economies. China also regulates the exchange rate of its currency as a way of ensuring cheap importation of foodstuffs to feed its large population. Local production is therefore not prioritized and hence a self-sustaining economy is not made possible by the Chinese strategies of exchange rate regulation. A rising exchange rate promotes the import industry of various goods and services6. This is due to the reduction of price of imported goods. The manufacturing industry is the major benefactor of reduced price of imports because the expenses of production of goods are generally reduced due to the lowered purchase price of imported raw materials. A poor capital economy usually benefits when its currency strengthens because the capital required in importation of raw materials reduces. As a result, a rising exchange rate may lead to overall growth of a poor capital economy. The reduced cost of imports therefore illustrates a positive effect of a rising exchange rate of a country’s currency. Overvaluation of a currency poses a big threat to a country’s economy. The strengthening of the Swiss Franc against the Euro and the Dollar in September 2011 for example affected the country’s economy negatively. There were fears that the Swiss exporters would run out of business because of the strengthening currency. Because of a rising exchange rate of a currency, central banks apply various strategies to enable the countries steady their currencies. The Swiss central bank made a bold move in September 2011 by buying foreign currencies as a way of stabilizing its currency7. This was because of the looming collapse of the economy, which was likely to be caused by the strengthening currency. It is notable that a decrease in prize of imports because of a rising exchange rate leads to burdening debtors within an economy. This could justify the economic actions of various banks in protecting trade within various economies in both the developing and the developed worlds. Furthermore, consumers are likely to guard their money because a rising exchange rate is anticipated to cause lowering of prices of goods and services8. Due to such economic fluctuations and determinants, central banks act as a regulator of foreign exchange of various currencies. If the central bank of a country does not put regulatory measures against rising exchange rate, the economy of a country is thus likely to be paralyzed9. Figure 2 Foreign Exchange Rate: Switzerland/US The exchange rate of a currency against the US dollar varies with the performance of the world economy. The strengthening of the Swiss Franc is therefore a demonstration of unsteady performance of the world economy. The impact of a rising exchange rate of a currency therefore causes reduction in investment inflow into a country. Switzerland, which received billions of US dollar annually in form of investment, was impacted negatively through the rising exchange rate of its currency. Foreign investment in a country is thus reduced when the exchange rate of a country’s currency improves and a result, a negative effect on the economic performance becomes inevitable. Japanese investment in Switzerland reduced because of the high cost associated with starting businesses in a country with a strong currency. On the other hand, the increased foreign investment in developing countries is because the exchange rate of these economies is relatively low. Therefore, investors get more value of their capital in economies with weak currencies10. Oil, which acts as a major contributor to the world economies, is affected by rising exchange rates of currencies. The falling of oil prizes, which result from a strong currency, would lead to reduced imports of oil. The economic performance of a country is facilitated by oil which is used across manufacturing industries. Lack of oil causes a fall in a country’s economy because of the reduction in the productivity of industries. Moreover, a strengthening currency would eventually cause an increase of oil prices because of its reduced imports. This will lead to increase of prizes of many commodities and services. Therefore, a country should use various economic strategies to stabilize its currency because of the negative impacts it could cause on its economy11. The China dollar dilemma is a result of the efforts of the China to depreciate its currency so that its exports would increase. Furthermore, china aims at increasing foreign investment into its housing industry. As a result, housing has become expensive for local buyers. This demonstrates that regulation of the rising exchange rate by a country has negative implications of housing. The housing industry is significant in China due to its large population. The pushing up of the local housing prizes in China due to the control of the Yen’s exchange rate has thus negatively affected the Chinese people even though foreign investment is considered as a positive contribution to the growth of the economy12. Figure 3 Foreign Exchange Rate: China/US The retail market of various economies is affected by a rise in the exchange rate13. Currency exchanges are necessary in many retail transactions and hence the exchange rate of a currency determines the performance of its retail business and the economy in a larger scope. Travelers for example are affected by a currency’s exchange rate because it would make travel expenses either cheap or expensive depending on the performance of the currency against the standard currencies such as the US dollar. A rising exchange rate is likely to promote the transport industry because more travelling to foreign countries is likely to result. On the other hand, the tourism sector is affected negatively by an increase in the exchange rate of a country. This is because of the increased cost of travel and accommodation within a country with a strong currency. The number of tourists therefore is likely to decline when a country’s currency becomes stronger. Transport and tourism are sectors, which play major roles in the development of world economies. The impact of an increasing exchange rate on these sectors thus determines the overall performance of the economy. Demand and supply are the forces, which determine the development of the economy of a country. An increase or speculated rise in the strength of a currency usually leads to more demand for the currency14. This affects the transaction activity of the economy. The expenditure on goods and services is also affected by the fluctuations in the exchange rate of a currency. The role of the central banks therefore is to regulate demand and supply within the economy so that the impact of a rising exchange rate on the economy does not lead to failure of a country’s manufacturing and agricultural industries, which act as a backbone of the economies of most economies15. The distribution of wealth in a nation is affected by the exchange rate of its currency against the major world currencies. The strategies of the central banks used in regulation of exchange rate may include increase of the interest rate for loans. As a result, conflict among wealthy regions result while the poorer regions are left in debt. The economy of a country is determined by both local and foreign investment. Local investors obtain credit from banks and hence the interest rate of the credit given influences the extent of local investment in the economy. This demonstrates how the regulation mechanisms of an increasing exchange rate affect the economy of a state. In small and open economies, a rising exchange rate may act as a tool for absorbing the shocks which the economy experiences16. In developing countries, a rise in the exchange rate of their currencies positively affects the economy. This is because the developing economies usually import a large share of its consumer products. When the exchange rate of currencies in the developing nations is high, the cost of oil imports for example reduces. This affects the prices of goods since oil boosts the transport and manufacturing industries of these countries. The importation of raw materials at a cheaper cost by developing economies is made possible through increases in the exchange rate of their currencies. As a result, the cost of production is reduced and thus increasing production and lowering the prices of various goods and services. The government of a country has a significant implication on the economic growth. Governments are also influenced by the exchange rates of their currencies. This is in form of the large amount of funding used in government operations. In addition, the government policies are affected by the exchange rate of the currency. Economic regulation of the currency through various political economies determines the economic performance of a country. This shows that exchange rate of currencies, governments and economic performance are interdependent. The political economies such as budgetary allocation and policies on taxation and foreign investment affect the economy of a country. The political economies on the other hand are affected by the exchange rate of the currency at a specific time. Furthermore, governments are actively involved in the regulation of imports and exports of various goods and services. As a result, governments affect the economy. The laws on trade, which are provided by governments, affect the economic performance of a country. Laws on economy are usually affected by the performance of world economies, which is illustrated by diversity in the exchange rates of a country. Conclusion The exchange rate of various currencies has major implications on the performance of economies. This is through the negative impact on exportation of goods and services which is caused by a rising exchange rate. Some countries such as China have laid strategies of ensuring that the exchange rate of the currency does not rise as a way of promoting exportation and gaining from reduced importation costs. A strengthening currency also affects the job market, distribution of wealth, foreign investment, and political economies especially in major sectors of an economy such as manufacturing, agriculture, and tourism. 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