THEINTERNATIONAL MONETARY SYSTEM facilitates the settlement of international balance of payments between countries1. Its connection is its impact upon exchange rates that in turn impacts currency values2. The global economy has become reliant upon fluid international currency exchange rate expectations, as sovereign activity has accelerated dramatically. The risk associated with international sovereigns has increased as well. Market risk is the focus in this respect to enhance the understanding of the exposure. To adequately lay a foundation for market risk requires establishing the fundamentals. At the core of the international monetary system is currency.
Basically the balance of payment account is the standard of one side of the equation of a T account in which there is a credit entry and the other a debit entry. Those totals theoretically are to be balanced. The debit and credit of that account comprises the current account3 side of the accounting equation. All indebtedness reflected necessitates the need to finance the short fall. In the alternative if there is a surplus within this accounting measure, an exporting of capital adjusts the imbalance.
In concept, international economics is geared to a mercantile system. The mercantile concept is an economic system of political and economic policy, evolving with the modern national state in its rivalry with other nations. This system regards money as a store of wealth and the objective of the state is the importation of currency by the act of exporting the utmost possible quantity of its products. It seeks in theory to import as little as possible, thereby establishing a favorable balance of trade.4
There are two dominant themes that are enshrined in international economics that influence currency exchange rate movement. One factor, trade balance, is considered by traditional concept to influence exchange rate expectations. The other significant economic influence upon the exchange rate equilibrium is capital movement between global financial markets. It has taken on a much greater importance in recent years with innovation and technology.
Trade is without question a vital component. There is an absolute linkage between trade and a country’s currency exchange rate. That effect can drive the economy or have a degenerative result. The effects are two fold. A country that is afflicted with persistent trade deficits will encounter a loss of purchasing power parity of its currency as a general thesis. The effects of a loss of purchasing power parity will likely cause a downward pressure upon its exchange rate. The debilitating affect results because an inflationary environment is created.
Imports place in to motion a demand for higher prices. The imports necessary to the economy and production such as commodities, materials, and agriculture products result in a rise in the cost of production, along with the cost of consumer goods. This differs from a surplus economy.
A surplus economy will experience a persistent upward pressure upon its exchange rate. A rising exchange rate economy w
