Exchange rates indicate the the quantities of one product that need to be exchanged for the quantity of another so that the value of each quantity is the same (similar or higher) in the minds of the trading parties. When we talk about exchange rate we are normally referring to national currencies - as opposed to exchanging a good for a particular amount of money - there we we refer to the exchange rate as the price of the product. Essentially exchange rate is the the price of one currency in terms of another.
Let us look at the exchange rate between the dollar ($) and the Rand (R). At the time of writing (July 2012) one could exchange one dollar for R 7,00. This also means that for one Rand one could purchase 14 American Cents.
Let us now have a look at what it means for trading by individuals between these two countries and how shifts in the value and relationships of currencies affect trade. Let us say that you are and exporter of wine from South Africa to the US. You sell a bottle of wine for R70 in SA - so if you export it you have to sell it in the US for $10 to earn the equivalent in Rands (assuming no other costs). So when you bring back the money to SA and you convert the $ 10 back to Rand at the reigning exchange rate and you would have earned yourself your R 70.
Similarly if an exporter from the US was selling memory sicks in the US at $ 10 and now exported these for sale to SA he will have to sell it at R70 to earn an equivalent of $10 to earn the same.
Now, let us say the exchange rate changes - the Rand weakens in relation to the dollar. One now needs R 10,00 to purchase a dollar. In other words a rand can only purchase 10 American Cents.
The exporter of wine from South Africa to the US still sells a bottle of wine for R70 in SA - so if you export it you have to sell it in the US for only $ 7 to earn the equivalent in Rands (assuming no other costs). So when he brings back the money to SA and he converts the $ 7 back to Rand at the reigning exchange rate and he would have earned himself his R 70. Or, If the price remained the same as it was before on the American market ie.$ 10 he would be able to exchange it for R 100 SA Rands now. Clearly a weakening of the Rand would favour exporters since more rands would be earned by the same bottle of wine..
Let us look and see how this weakening of the rand (it can also be seen as a strengthening of the dollar) affects our American counterpart - the exporter of memory sticks from the US to SA. Remember he was selling memory sicks in the US at $ 10 and now these memory sticks exported for sale to SA he will have to be sold sell it at R 100 to earn an equivalent of $10 for him earn the same. If he kept the price the same as previously namely R 70 he would only earn $7 after the conversion. Clearly a weakening of the Rand (or strengthening of the dollar does not favour the American exporter to South Africa.
The barter value relationship was unchanged. One Bottle of wine was exchanged for one memory stick - the value in currencies do however have a profound effect of the money values exchanged. This is one reason why some economists are proposing an international currency - similar to the role that gold played in the past. It will reduce the effect of changing exchange rates on international trade.
In a future handout we will look at what Governments do to reduce the effect of their internal monetary policies on their exchange rates.
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Charl Heydenrych
July 2010