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    Meaningless fuss

    Fatih Özatay, PhD14 September 2010 - Okunma Sayısı: 897

     

    It is exporters in general who mention a certain level for exchange rate. This is 'understandable' considering only the exports. After all, exchange rate affects the profitability of exporters. Lower the exchange rate, lower the profits.

    But on the other hand, exchange rate is a cost item for those who use imported inputs in production. For them, higher the exchange rate, higher the costs and lower the profits since rise in costs translate into rise in prices and thus inflation.

    So, exporter circles, when demanding a certain level of exchange rate, they talk about the level that will be profitable and advantageous for themselves. This is a natural wish provided that they voice their demand without damaging the prestige of the Central Bank, one of the most important institutions of the country. Nonetheless, that a demand is natural does not necessarily mean that it is righteous. Because, exports and imports are not the main determinants of the exchange rate. It is enough to take a look at the academic research on exchange rate to understand this. The reason simply goes as follows:

    Before 1990's the main factor that determined the exchange rate movements between countries was exports and imports. The mentality was like this: If exports exceeded imports, domestic demand for foreign exchange would rise which will increase the price of the foreign exchange as well as the exchange rate. This will discourage imports and encourage exports. Therefore, exchange rate will reach equilibrium alone as a result of these movements.

    However, this is not the case now. In fact, compared to other sources, the amount of foreign exchange movement caused by exports and imports is just a drop in the ocean, let alone being the main determinants of the exchange rate. So what are these other 'sources'?

    At the beginning of this week, BIS published an important report which is prepared on the basis of the info collected from a number of central banks. The report mainly aims to identify the monetary value of the transactions in international FX market, sort of transactions and the foreign currencies used in such transactions. Purchase and sale of several currencies are generally made in large centers such as London, New York, Tokyo, Singapore and Zurich. As the BIS report states, daily transaction volume of the FX market transactions exceeded $4 trillion as of 2010. This figure was $1.5 trillion in 1998. So we are talking about $4 trillion daily FX transaction volume. On the other hand, total annual world trade volume in 2009 was $12.5 trillion. I should underline once again that the former is a daily figure and the latter is an annual figure.

    Therefore, the main important factor for exchange rate is the reasons behind the FX purchase and sales in the international FX market. It is quite obvious that there are not the requirements stemming from exportation and importation.

    In that case, there is no scientific point in wishing a certain level of exchange rate just looking at the exports, imports, or more broadly the current accounts. Of course this does not prevent the fuss. I will continue with this subject.

     

    This commentary was published in Radikal daily on 14.09.2010.

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