Today’s lecture will describe the exchange of one currency for another, buying Mexican
pesos or Japanese yen or Euros with dollars or the other way round.
There are two main kinds of currencies. First, there are widely
recognized currencies which are considered reasonably stable because they’re issued by
governments that are stable and that represent big economies to which not much is going to happen
—at least we all hope not. These currencies are the Japanese yen, the US dollar, the Euro, and the
English pound. Second, there are local currencies do not have this kind of strong backing behind
them and are not internationally traded. They’re money inside their own country, but not outside it.
The Lao kip is only recognized outside Laos with huge discounts.
Price relationships among different currencies fluctuate, as described in Reading 12.1
other words, the number of Euros, yen or whatever you can get for $ 100 can increase or decrease
over time. Lately, the dollar has been weakening or depreciating; in other words, the number of
Euros, pesos or yen you get for $ 100 has been decreasing. Before discussing why currencies
appreciate or depreciate, I am going to ask what the effects of currency fluctuations are, under two
main headings, the effect of fluctuation on investments and the effect on the underlying economy.
Effects on investments
. The relationship between the internationally traded currencies
and the others—suppose I call them the local currencies—matters a lot if you’re in international
finance, whether it’s FDI, FPI, loans or bonds. If you’re a US investor and you want to buy and
operate a factory in Thailand, you start out by turning dollars into the Thai currency, the baht, and
using the baht to buy the factory, pay the workers and run the business. Your profits will be in
baht, and if you resell the business the sale price you get will also be in baht. Then you’ll turn the
baht back into dollars and bring the dollars home. But what if the value of the baht in terms of
dollars has changed between the time you make the investment and the time you liquidate it?
Suppose when you made the investment the exchange rate was 25 to 1—it took 25 baht to buy a
dollar. You took $ 1 million, exchanged it for 25 million baht and used the baht to buy a rubber
plantation in southern Thailand, say in 1995. After a few years, say in 1999, you sell the plantation.
Let’s say the rubber business has done well and you sell the plantation for 32 million baht. But in