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Foreign Exchange Rates
One of the major complaints companies and individuals have with foreign exchange rates and flexible exchange rates is that they are too volatile because they float. Several factors contribute to the volatility of the rate of exchange. These include the balance of trade, currency substitution, the differential speed of adjustment of asset markets vs. goods markets, and the news. The balance of trade affects the exchange rate because countries are always shipping goods back and forth (O'Sullivan & Sheffrin, 2003). If a country really needs a particular good, it will be willing to pay more for that good than it would if it did not need the good as strongly. Countries that have more leverage from a trade standpoint can also affect the exchange rates, because the balance of trade is very different for countries that are strong than for countries that are weak when it comes to trading (Sanger & Wines, 2010). With there being so many issues affecting trade, companies can become very confused about the best way to handle their finances.
Currency...
The more foreign currency that is being used, the lower the level of control that is seen and the higher the trade imbalance might be. In some cases it can work out very well when a country uses foreign currency, but there are many cases of currency substitution that have not worked out well. Companies should generally avoid substitution of currency when they can use their home currency instead (O'Sullivan & Sheffrin, 2003). Flexible exchange rates and currency substitution rarely work out well for a company that is attempting to work with companies in another country. For companies that are highly skilled - and a bit lucky - however, it is possible to use flexible exchange rates and currency substitution to improve their financial position.
The differential speed of adjustment of asset markets vs. goods markets is another area that is highly significant. When…
References
O'Sullivan, A. & Sheffrin, S.M. (2003). Economics: Principles in action. Upper Saddle River, NJ: Pearson Prentice Hall.
Sanger, D.E. & Wines, M. (2010). More countries adopt China's tactics on currency. The New York Times.
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