Thailand's economic and political dilemmas

¶ … inflation has a direct impact on exchange rates because it has a direct impact on the purchasing power of both (or all) currencies involved in a comparison of inflation rates. That is, inflation by definition reduces the purchasing power of a currency, and thus if two currencies have different rates of inflation (as they almost always will, on some level or another) they will have different rates of purchasing power reduction. These differing rates of purchasing power reduction lead to different and constantly changing exchange rates, and in fact are a major driver of fluctuations in exchange rates. For example, if the inflation rate is higher in country A than in country B, country A's currency is experiencing a faster reduction in its purchasing power than is country B. This means that the currency in country B. can buy more than the currency in country A, unit for unit and all else being equal, and thus it will take more of currency A to buy some of currency B -- a greater amount of A is needed in order to reach the same purchasing power as B.

A company with a foreign investment in production and/or retail sales is also directly impacted by such fluctuations, especially when a currency is free-floating such as the baht in this case. If the company's home country experiences a faster rate of inflation, its costs in the foreign country will increase, while at the same time the revenue brought in will increase in value as well -- the baht can be traded in for a larger amount of the home country's currency. In the reverse situation, i.e. rapid inflation of the baht, the company would experience an initial cost savings in production (though wages would eventually need to rise to keep up with inflation) and a reduction in revenue value (that would also be offset by price changes).

2)

Purchasing power parity is impossible to achieve in the short run due to a variety of factors, including the individual changes in demand amongst various markets, political situations that have nation-specific economic impacts, and the trade barriers that exist in the real world: tariffs, shipping costs, differences in regulations, etc. If countries were to commit themselves to more long-term and concrete trade arrangements with specific purchase agreements, rather than letting markets (for the most part) dictate when, what, and how much gets traded, purchasing power parity might hold better in the short-term as expectations and evidence of purchasing power would be more certain. Should this occur on any meaningful scale, however, the inefficiencies and economic upheaval that such a planned economic system would create would eventually lead to a complete disruption of currency markets and potentially of international trade altogether, and simply wouldn't be sustainable.

3)

Changes in the exchange rate between two currencies can also affect interest rates, especially in countries with smaller economies and less of an international economic footprint. If investors and banks expected the baht to begin losing ground against the dollar, for instance, they would demand a higher rate of return on their baht investments in order to make up for this expected change in the exchange rate. This would lead to the charging of higher interest rates in order to maintain the same purchasing power parity when it comes to money itself -- that is, just as goods should (in an ideal world) cost the same in all markets, investments should earn the same rate of return, and this rate of return is affected by exchange rates.

4)

If a company plans on expanding its operations in a foreign country, the issue of purchasing power parity is one that definitely needs to be considered. Because purchasing power parity is an ideal economic concept, and is never actually achieved on a short-term or ongoing basis, there is the potential for either losses or profits to mount up much faster than expected if changes in the purchasing power parity were to occur. At the same time, there is very little that a single small company can do to affect purchasing power parity, and without a sudden and major change in the exchange rates/currency situations of the two countries fluctuations in parity are not likely to make a formerly profitable venture a loser or vice versa. While the purchasing power parity between the two countries should thus be closely monitored, expectations of changes should not make or break any foreign investment plan.