Business review; Currency exchange rates

From the national educational radio network here is a Business Review ASSOCIATE PROFESSOR ROSS Wilhelm of the University of Michigan Graduate School of Business Administration presents his views and comments of business and economic activity at the recent international monetary crisis demonstrated again the weakness of the dollar franc and pound in the world's money markets. The retirement of General de Gaulle led to a flurry of buying of West German marks and gold with dollars pounds and francs during the recent crisis the price of gold reached extremely high levels and the interest rate to borrow American dollars held by European banks reached the 12 percent level. It's ridiculous that events such as the replacement of General de Gaulle should cause such difficulties in the world currency markets. This is simply another piece of evidence that indicates that the West German market is undervalued while the dollar franc and pound are overvalued. What is needed is to abandon the idea that the dollar franc or pound should exchange for some given ratio which is fixed and unchanging for all times. Each of the major world's currencies exchange for a fixed rate of exchange for today. For

Mark's exchange for one dollar five francs for a dollar two dollars and forty cents or equal to one pound these at fixed exchange rates were established many years ago and at a time when they said roughly when they at the time when they were set they roughly represented the relative purchasing power of each currency for one dollar you could buy roughly the same amount of goods in the United States for marks would buy in West Germany or five francs admi in France are eight point three shillings would buy in Great Britain. However during the period since the fixed exchange rates were set the purchasing power of the various currencies of the world have changed. Inflation has been much more severe in the United States Britain and France than in West Germany. This means that for Marx today will buy significantly more in West Germany than one dollar I'll buy here. Thus the market is undervalued while the dollar is overvalued. There are two possible ways of solving this problem if we stay with fixed exchange rates the first is the method the method which was seriously considered during the most recent crisis. Increase the value of the market instead of having a

market exchange for four for a dollar. Allow them to exchange for 3 for a dollar or some similar ratio. This would reduce the amount of goods that could be bought in West Germany for the equivalent of a dollar and would ensure that both the mark and dollar would exchange at roughly the same purchasing power. A second possible way of achieving the same end would be for the United States Great Britain and France to de-value the West Germans are reluctant to see either change occur because of the effect of a change in the exchange rate would be to raise the prices of the things that West Germany sells to the rest of the world. Suppose for instance the value of the mark were increased by either method by say 10 percent. This would mean that the price of a Volkswagen would rise in the United States from 2000 to twenty two hundred dollars of the things being given. This would mean that fewer Americans would buy votes vog and unemployment would probably rise in West Germany. The Germans obviously don't want to see this happen and as a result it's most unlikely that they'll do it voluntarily. More importantly however no fixed exchange rate will ever solve the world's monetary problems. Let's suppose for instance that the exchange ratio between the mark and the

dollar were changed so the dollar were equal to say three point six marks instead of for this new fixed exchange ratio would probably come closer than the present one to reflecting the relative purchasing power of each of these currencies. But would this be true over the future. Probably not. If past experience is a guide as long as prices in the United States continue to rise faster than prices in West Germany we can be certain that the exchange any exchange rate set today will not reflect the proper. Purchasing power ratio of each currency over the future. If we simply moved to new fixed exchange rates now these exchange rates will become out of date over time and we will again face monetary crises. Well what is the alternative. The alternative is to move to some form of the free flow free or flexible exchange rate that will change automatically with changes in the purchasing power of the currencies. This could be done simply by allowing the importers and export ER's in West Germany and the United States to buy or sell marks or dollars for every whatever ratio they can obtain from the market. Thus if we were to have more inflation here than in

there in West Germany the exchange ratios of the currency would change to reflect these relative purchasing power changes. The principal objection to flexible or free floating exchange rates is that this would add an additional risk for anyone seeking to buy or sell goods overseas the risk of a change in the exchange rate. This objection does not seem to be well-founded however a first experience indicates that even where the where there are free floating exchange rates the rates do not change rapidly. More importantly it's most likely that if we were to move to free floating rates we would see a futures market for money developed just as we have a futures market in commodities and the importers and exporters would hedge this risk in that market. That was Associate Professor Ross Wilhelm of the University of Michigan Graduate School of Business Administration. With his views and comments on business and economic activity Business Review is recorded by the University of Michigan Broadcasting Service. This is the national educational

radio network.