Housefull Economics

Be Still, My Floating Exchange Rate

Our weekly explainer on economics using lessons from popular culture. In Installment 46, Selina Meyer loses out because of Exchange Rate Fluctuation.

In an episode of the Emmy award-winning political satire VEEP, the ex-POTUS Selina Meyer is assigned to monitor the first democratic election of the Republic of Georgia, where a battle rages between a reigning tyrant and a seemingly virtuous up-and-comer. Both the candidates offer competing thinly-veiled bribes in the disguise of donations to Meyer’s presidential library in exchange for victory in the election.

Selina accepts the bribes but due to a coup and unexpected electoral outcomes, the exchange rate fluctuates in a way that makes her $20m bribe dwindle to a mere shoddy $389,000: a cheap price for tampering with a nation’s presidency.

Apart from all the Public Choice Theory lessons that the show brims with, this particular episode also highlights the many factors that can alter a nation’s currency exchange rate. But it wasn’t always this erratic or complex.

The exchange rate of a country is simply the price or value of its currency in terms of another country’s currency. For example, if you have your eyes set on the iPhone X, buying it in India will set you back by Rs 89,000, while asking a friend/relative/acquaintance/cousin twice removed (gotta tap into those relations for a cheaper iPhone) to get it from the US will cost you about Rs 66,603 at the current exchange rate (1USD=66.67INR). However, if the exchange rate were to change in America’s favour i.e. the Indian Rupee depreciates to, market-gods forbid, 1USD=69INR, you’re now paying Rs 68,931. The exchange rate isn’t just relevant for tech-arbitrage-deals-scouring opportunists like this author, but also for large-scale international trade, jet-setting travellers and tourists, as well as those who invest in foreign currencies as an asset class.

Some countries “float” their exchange rate, which means that this price is determined by supply and demand — for the nation’s currency internationally for trading purposes, or even as an asset. Some nations also “fix” their exchange rate, at least for periods of time, which means that the country’s central bank (or monetary authority) trades actively in the foreign exchange market and buys or sells foreign currency, whichever may be required in order to keep the rate fixed at the predefined value with the chosen foreign currency. Most countries follow an intermediate regime between pure fixing and pure floating (target zones, bands, basket pegs, crawling pegs etc) with the central banks intervening in the foreign exchange market in order to reduce the variability in the exchange rate.

At the time of independence, the Indian rupee was at par with the American dollar (were those the OG Acche Din?). In order to maintain some semblance of trade stability at a chaotic time, we adopted a fixed-rate currency regime which pegged the rupee at 4.70 against a dollar. This lasted from 1948 to 1966. The currency was devalued a couple of times, but then kept fixed until the next devaluation. In 1993, the currency was liberated from the clutches of one fixed rate and allowed to swing freely with market sentiments. The exchange rate was to be now determined by the market, with certain provisions for intervention by the RBI in case of extreme volatility.

Before the havoc caused by the World Wars, the extant international monetary system was the international gold standard, which is to say that money was backed by gold reserves. All the participating countries fixed the values of their domestic currencies in terms of a specified amount of gold. The period from 1880 to 1914 is known as the classical gold standard. During that time, the majority of countries adhered (in varying degrees) to gold as a reserve asset, and there was a global fixed exchange rate.

Towards the end of World War II in 1944, there was a seminal conference at Bretton Woods, and the International Monetary Fund was established to promote foreign trade and maintain monetary stability of the global economy. The consensus was reached that every country would peg its currency to the US dollar which would in turn be pegged to gold at the rate of $35 per ounce. Eventually, this arrangement wasn’t tenable due to the limited reserves of gold and the oversupply of paper money in the US in order to cover internal deficits. By 1973, major countries began adopting a floating system and never looked back.

At the time of writing, 1 INR was 0.015 USD. This means that in order to buy 1 USD, 66.67 INR will be required. The American Dollar is generally used as a base currency to express the value of the Indian Rupee. The current exchange rate of 66.67 against the dollar means that the Indian currency has depreciated by almost 67 times against the dollar in the last 71 years. It is seductive to plainly state that our currency depreciating is a bad  thing and the contrary is good, but the exchange rate and all that it signifies is much more nuanced. A sharp appreciation in a country’s currency would lead to its wares becoming costlier for other nations and thereby reduce export, which doesn’t bode too well for a country like ours that is aiming to accelerate its employment rate and economic growth, on the back of producing more products and services and sending them the way of exports.

Since our exchange rate is now majorly a floating one, what are the factors that determine its value at any given point? The rates are determined by the buying and selling activities in the foreign-exchange markets, akin to any stock’s valuation in the stock market. The buying and selling are dependent on such a vast amalgamation of factors that its virtually impossible to pinpoint them all. As Selina learned the hard way, anything from election surprises to local festivals to release of global macroeconomic reports to trading patterns to mere sentiment can bring a currency crashing down or send it soaring higher.

As with any fixture of our world, there are winners and losers with differential exchange rates as well. Now, one can only hope that their country’s currency is ever able to enjoy a Bitcoin-like surge. Or not.

Don't miss anything
Once a week. Just 5 minutes.
Get Pragati in your inbox.
Don't miss anything
Once a week. Just 5 minutes.
Get Pragati in your inbox.
Zero spam. 1-click unsubscribe.
Please share

About the author

Reshu Natani

Reshu Natani is a former social entrepreneur who studied economics and public policy at Meghnad Desai Academy of Economics. She now uses Keynes’s aphorism about being dead in the long run to justify her nihilistic hedonism.