This paper examines whether foreign exchange market intervention is a worthwhile strategy for international businesses or an unnecessary financial risk. Drawing on the theory of Purchasing Power Parity, the paper argues that market prices between trading nations tend to equalize over time, rendering active intervention largely ineffective. Japan's experience between 1991 and 2000 — during which the Bank of Japan bought and sold $304 billion in U.S. dollars yet still suffered substantial losses — is presented as a cautionary example. The paper also considers alternative risk-management approaches, such as hedging and same-day payment contracts, concluding that businesses generally fare better by allowing markets to operate naturally rather than attempting to profit from exchange rate fluctuations.
Foreign exchange markets are one avenue that international businesses use to avoid losses during purchases and shipments. While some argue that knowing the market and selecting the right technique saves a company money, others contend that the specialized calculations required for such transactions can actually cost companies as much as simply letting the market run its course (Giddy, 2003). This theory, known as Purchasing Power Parity, has shown that between the purchase and exchange of goods, market prices between two countries tend to even out, resulting in little to no difference in exchange. The overall notion of manipulating foreign exchange markets can therefore be seen as wasteful and often does not result in a positive shareholder outlook. One example of the futility of market manipulation is that of Japan.
In the 1970s, Japan changed its currency exchange rate away from the Bretton Woods Exchange Rate System (Taylor, 2001). The result was Japan taking an active role in intervening in the foreign exchange market. In just nine years, between 1991 and 2000, the Bank of Japan purchased and sold $304 billion U.S. dollars. While these figures may sound large, this amount is actually very small compared to the total volume of foreign exchange activity. Moreover, even with these interventions, the Bank of Japan experienced periods of substantial loss in value due to market fluctuations. The intentional purchase of currency in an attempt to impact the market thus resulted in losses that otherwise would not have occurred — actions that could nearly be compared to gambling or investing in highly risky assets.
"Arguments for passive strategies over active intervention"
As can be seen, there is justification in being aware of the market and acting prudently as a business person. However, attempting to manipulate or otherwise benefit from changing foreign exchange market prices can result in losses rather than gains for a company. Simply purchasing goods and allowing the market to ebb and flow naturally maintains a positive shareholder outlook and ensures minimal unexpected gains or losses, keeping the final cost at the contractually agreed-upon price.
You’re 58% through this paper. Sign up to read the remaining 1 section.
Sign Up Now — Instant Access Already a member? Log inAlways verify citation format against your institution’s current style guide requirements.