Foreign Exchange : Too expensive or too cheap?

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One of the major adjustments that one has to make while visiting a new country is to get accustomed to the new currency. Depending on the exchange rate that your currency has with respect to the currency of the country you are visiting, you might end up spending too much or too little. If you are an Indian visiting Japan, you might spend less than usual because one Japanese yen equals half a rupee. So, one has to pay larger sums for the same item and this makes one more conscious of the money being spent. The same person might end up spending too much in the USA since one US Dollar equals 60 INR. Or you might be a broke summer intern in Germany who converts the price of everything into rupees in his head instantly and on realizing how expensive that 2 Euros ice cream is, you just decide to drink some cold water and wait for 2 months to have an ice cream. Its too cold anyway.

So, why does this happen and what are the forces that guide the exchange rate? The primary force that drives the exchange rate of a country is its “balance of trade” which is simply the sum of the total imports and exports of a country. If the total value of a country’s exports exceeds the total value of its imports, the country is said to have a trade surplus. A country is said to have a trace deficit if the total value of the country’s imports exceeds the total value of its exports.

Lets the take the example of two countries, UK and Japan. I chose these two nations to address a very popular myth according to which a country is deemed developed only if it has a trade surplus, that is, if it exports more. A country importing more than it exports is dependent on other countries and hence, is underdeveloped. This idea is flawed and completely disregards the nuances of international trade. Both UK and Japan are highly developed nations yet, while Japan is primarily an exporter, UK is a major importer (even USA has a trade deficit). However, it is true that a country’s trade tells a lot about its prosperity. Its not the value but the kind of traded goods that determines whether a country is developed or not. While, underdeveloped and developing nations chiefly export cheap mass produced goods like clothes, cheap electronics etc. that require cheap uneducated labor, rich developed nations usually export goods requiring highly skilled workforce like jet engines, pharmaceuticals, new technology etc. Consequently, developed nations, with high minimum labor wages, are the markets for the goods produced by the cheap labor in the developing nations.

Trade deficit in the UK

Trade surplus in Japan

Now, Japan has traditionally had a trade surplus (more export) while UK has always had a trade deficit (more import). Since Japan’s economy is dependent on other countries buying its goods, it would try to makes its goods available at a cheaper rate to attract prospective buyers. One way Japan can do that is by depreciating its currency. that is, by ensuring that the 1 unit of any foreign currency buys more of Japanese Yen. For example, lets consider an American businessman who wants to buy a Japanese sex doll that costs 5000 Yen in Japan. If 1 US dollar converts to 100 Yen, then he would have to pay just 50$. However, if 1 US Dollar converts to 50 Yen, then he would have to pay 100$. Its clear that the businessman is more likely to make the transaction in the earlier case (Though in this case, I think he’s gonna buy the doll anyway). On the other hand, UK, that predominantly buys foreign goods would want the opposite so that it has to spend fewer GBP while importing stuff.

In truth, Japan and UK do not actively control their exchange rates (come countries like China do). The exchange rates are free floating and hence, they keep changing depending on international trade. The result. The same sex doll costs 50$ dollars in US, and 5000 Yen in Japan.

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Foreign Exchange : Too expensive or too cheap?

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