International Financial Systems
International Financial Systems
1. The country selected for this assignment is China. The official currency in China is known as a Yuan (CNY). As at November 6, 2012, $1 was equivalent to 6.28925 CNY. Thus, an investment of $202,995 will be equivalent to 1,276,690 CNY.
2. Countries used varied exchange rate systems. The main exchange rates systems include; free floating or flexible exchange systems, managed floating systems and fixed/ pegged exchange rate systems (Buckley, 2009). A free floating system is whereby the value of the currency is determined by the market. The government does little in order to influence the rate at which the currency is exchanged.
A managed floating system is whereby the currency is left to trade freely in the market, but the government intervenes when there are market instabilities. The government set certain benchmarks for the currency and intervenes when these benchmarks are not attained. Most countries control their currency through monetary policies such as interest rates and foreign exchange reserves. A Fixed or pegged exchange system is whereby exchange rate of a country is fixed to another currency such as Dollar (Buckley, 2009).
This makes home currency stable against the currency on which it is pegged. However, the value of the home currency fluctuates in line with the fluctuation of the currency on which it is pegged. Since 2005, China has been using the managed floating system. The country allows it currency to trade freely in the market but the government intervenes in order to control fluctuations. Chinese government uses, among other policies, its vast foreign reserves to control the exchange rates of the Yuan.
3. If my salary in China is paid in USD and is fixed for the next two years, I think would be better off in terms of spending power at the end of the second year. Several considerations can be used in order to arrive at this conclusion. The current exchange rate between the local and USD is one of these considerations (Buckley, 2009). Currently, the US dollar has a greater value that the Chinese Yuan. One USD is exchanging at the rate of 6.28925 CNY. This means that I would have a large sum of money when I change my salary into the local currency.
The second consideration is the likelihood of significant fluctuations in the exchange rates between the USD and CNY within the next two years (Buckley, 2009). Since the salary would remain constant, a significant fluctuation in the exchange rate would result in a significant impact to the purchasing power. On one hand, the purchasing power would improve if the exchange rate fluctuates in support of a stronger dollar. This implies that there would be additional Yuans for every dollar received. On the other hand, if the exchange rate fluctuates in favor of a stronger Yuan, then the purchasing power would decrease.
However, current trends indicate that there can hardly be a significant variation in the rate of exchange involving the Yuan and the USD. The Chinese government has been extremely efficient in managing fluctuation of the Yuan in order to protect its export oriented economy. There are minimal chances of seeing the Chinese government relent its effort to protect the Yuan from appreciation. Thus, the value of the salary is likely to remain relatively constant over the next two years.
Cost of living was also a key consideration when arriving at this conclusion (Buckley, 2009). Cost of living refers to the amount of money required in order to obtain goods and services within a given setting. Cost of living has a substantial impact on the purchasing power of individual. When the cost of living is high, an individual has to pay high amount in order to receive goods and services. This restricts the quantity of services and goods that an individual can purchase using a similar amount of money.
The cost of living in China is significantly lower than the cost of living in the US (Buckley, 2009). The prices of essential goods and services such as fuel, food, housing and health care are relatively cheaper in China than in the US. This implies that, with my salary, I would be able to purchase more goods and services in China.
Rate of inflation is also an essential consideration. Inflation rate influences the pace at which the cost of living increases within a given setting (Buckley, 2009). Higher inflation rates mean that, in two years time, prices of goods and services will be substantially higher than the current prices. This means that with the salary remaining constant, I will not be in a position to afford as many goods and services as I am able to afford right now. However, the inflation rate in China is still low, and there is least likelihood that the rate could increase significantly in the next two years.
4. I would not recommend to the international currency market investors to trade the Chinese Yuan. This is because the value of the Yuan is still largely controlled by the government rather than the market. International market investors earn revenues by trading currencies. In this trade, money is treated as a commodity and is sold to markets where it is needed (Buckley, 2009).
However, in order to make this trade sustainable the currencies need to be controlled by the market system. In the free floating system, the value of the market is controlled by forces of demand and supply. When the demand of a currency is high, and the supply is low, the value of that currency appreciates (Buckley, 2009). Though China has made a substantial progress in terms of deregulating it currency, the Yuan is still largely influence by the government.
For instance, when the demand of Yuan appreciates as a result of export trade, the Chinese government responds by printing additional currency instead of allowing the market to address the shortage. This has made the banking and the monetary market in China less competitive and thus, making it difficult for the international currency market investors to make returns within this market.
5. I have learnt various elements concerning the international financial system through this assignment. Through this assignment, I have enhanced my understanding of the three main currency exchange systems. These systems include; the fixed exchange; managed float exchange systems and free float exchange system (Buckley, 2009). I have also learnt that currency exchange rate has a substantial effect on the international and domestic economies. The currency affects the value of imports and that of exports within a country.
It also affects the rates of inflation and purchasing power of individuals within a country. I have also learnt how exchange rates are determined. Exchange rates are primarily determined by the market forces. In situations where the demand for a certain currency within the market is high and the supply is low, the value of that currency appreciates. On the other hand, if the demand for the currency is low and supply is high, the value of that currency depreciates. However, governments often intervene when the market forces drive the value of currency into positions that make the countries less competitive, in terms of trade.
Reference
Buckley R. (2009). International Financial System: Policy and Regulation. USA. Kluwer Law International
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