Flexible Exchange Rates
This is not about group yoga.
Instead, in the years that followed the collapse of Bretton Woods, nations shifted from fixed exchange rates to flexible exchange rates. Their currencies were no longer pegged to the dollar; instead they rose and fell in value relative to other currencies based on simple laws of supply and demand.
Think about what would happen if the Brazilian health ministry reported that Brazilian bananas magically increased your IQ. Foreigners would race to get Brazil’s currency (the real) so they could buy the miracle fruit. In fact, they would frantically compete with one another by offering to pay more and more for the limited supply of reals. If it was later discovered that the earlier reports were fake, people would rush to unload the Brazilian currency that no longer had any real value to them. For a while Brazil’s real would be very strong—non-Brazilians would have to pay a lot of their currency to get a little Brazilian currency. But when the hoax was revealed, the real would become weak—non-Brazilians would have to pay less for the real.
In the real international market, the factors affecting the value of foreign currencies are more complex—how anxious are foreigners to buy a nation’s goods, invest in their industries, or buy their government’s bonds. Is the country’s government stable? Will any dollars I invest there be safe? Are there better opportunities in other foreign nations?
What this all means is that international trade involves more than a simple transaction between buyers and sellers. You may think that when you click your mouse to buy that discount Ukrainian lifejacket you are making a private, isolated purchase. But in reality, since you have to complete the purchase with hryvnias, not dollars, and the value of the hryvnia is affected by a long list of economic, social, and political factors, your private act is actually part of a much more complex web. Your purchase of the lifejacket is actually playing a tiny part in setting the value of the hryvnia itself.
Why It Matters Today
It's all about China, baby.
China, the world's largest country and one of its fastest-growing economies, is emerging as the major player in 21st century world trade. In the recent economic crisis, with demand for goods depressed in the United States in Europe, one path to recover could lie in Chinese consumers buying up more of the world's production. But the Chinese government has refused to adopt flexible exchange rates for the nation's currency, the yuan, instead using fixed exchange rates to keep the yuan's value artificially low. This boosts China's export industry by making Chinese goods cheaper overseas, but limits the Chinese people's ability to consume goods from elsewhere by making comparatively more costly. A move to a flexible exchange of the yuan, something frequently demanded by central bankers from the rest of the world, would help to open up the Chinese market to free trade.
In June 2010, China announced that it would allow some appreciation of the yuan; it remains unclear exactly how much the Chinese government will allow its currency to rise in value.
Expect this to continue to be an issue of serious controversy. The shape of the future world economy depends on it! And if you end up working in an industry that makes things for export, your future job probably depends on it too.
Sometimes, a Song Says it Better: Open Up the Border, by Clutch
Clutch sings of opening up the border (for pumpkins, Spam and unfortunately some illegal activities as well).