EXCHANGE RATE. - By foreign exchange rate, or simply by exchange rate, is meant the price in national currency at which a certain quantity of foreign currency is purchased. The exchange rate therefore expresses the ratio between the value of two currencies. The set of variations of this ratio, that is, the different quotations over time, is called the course of the exchange rate or also, concisely, the exchange rate.
The exchange rate can be expressed technically in two ways. When in a given country the value of a fixed quantity of foreign currency is calculated against a variable quantity of national currency - this being the system adopted by Italy and by most countries - the country in question is said to give the uncertain; in the opposite case, in which a fixed quantity of national currency is compared against a variable quantity of foreign currency, that country is said to give the certain for the exchange rate. The exchange rate can be established both between the currencies of different countries - manual exchange rate - and between a currency and securities representing the currency of other countries - draft exchange rate. Besides banks, the economic agents most interested in exchange-rate operations are importers and exporters, and since international exchanges of goods and services are regulated essentially by credit instruments, such as bills on abroad, checks, telegraphic transfers, letters of credit, etc., it follows that the most significant exchange rate is the draft exchange rate.
In the case of credit instruments on abroad, the exchange rate is at sight when the instruments themselves are payable at the moment of their presentation, whereas it is forward or on delivery when payment occurs after a predetermined period of time. Forward exchange rates, which are the object of particular negotiations and quotations, have an important economic function; by means of them foreign currency, although available only in the future, comes to have a price determined already at the present moment in which it can be bought or sold, removing importers and exporters from the risk of subsequent fluctuations of the exchange rate.
The exchange rate of a given currency A can be expressed in terms of all the other currencies B, C, etc., with which currency A is exchanged. Given the exchange rate of A with B and of A with C, an exchange rate between B and C will also come to be created. In order that possible divergences between the different exchange rates may not be established, or may be eliminated as soon as they are established, arbitrage operations exist. If, for example, the exchange rate of A in terms of B allows one to obtain a greater quantity of currency B, while the exchange rate between A and C and that between B and C have remained unchanged, it will be convenient to buy with currency A the currency B to be converted in turn into currency C with which to repurchase currency A. The profit possibilities offered by this maneuver, by accentuating the demand for currency B, tend to increase its value and finally to bring the exchange rate between A and B back to equilibrium. Other simpler or more complex arbitrage operations are also possible.
The meaning and nature of exchange-rate variations differ according to whether one considers the exchange rate between gold currencies or between paper currencies inconvertible into gold. In the first case the exchange rate is in equilibrium when it realizes the monetary parity between the given currencies, that is, when it is such as to make the exchange ratio between them coincide with the ratio between the weight of fine metal contained in both; it will then be said that the exchange rate is at par. Since its quotations depend on the demand for and supply of the relevant foreign currency - demand and supply connected in turn to the trend of the balance of payments - there may be divergences from parity, with movements of the exchange rate above par and below par. Assuming the freedom of international transfer of gold, the movements of the exchange rate from parity cannot exceed the gold points - gold points - marking the limits beyond which it is convenient to ship gold, rather than make payments in foreign currency. The breadth of the two gold points, upper and lower, is delimited by the costs of transport and insurance for sending the metal from one country to another, as well as by the loss of interest for the time of transport. The transfers of gold, acting in a deflationary sense on the price level of the country that loses it and in an inflationary sense on the price level of the country that receives it, tend to modify the trend of the trade balance and thus to remedy the causes of the exchange-rate disequilibrium.
In the case of the exchange rate between a paper currency with forced circulation and a gold currency, when gold can still be used for international payments, the equilibrium exchange rate is represented by the ratio between the metallic content of the gold currency and the old metallic parity multiplied by the level of the premium.
In recent decades the exchange rate between inconvertible paper currencies has acquired importance, while the possibility of international gold transfers has ceased. In this case, to define the equilibrium position of the exchange rate, the principle of purchasing power parity has been formulated, according to which the exchange rate is stable only when it is able to guarantee an equal purchasing capacity of each currency at home and abroad. To the causes of exchange-rate variation dependent on the oscillations of the balance of payments, in this case are added the relative movements of the price levels of the countries considered. If the price level in one country M increases fourfold and in another country N merely doubles, the new exchange rate of the currency of M in terms of that of N will be exactly double the previous one.
However, the principle of purchasing power parity has proved anything but acceptable both from the scientific and from the practical point of view, so that the problem remains open.
The freedom of the exchange-rate market, which was the typical situation until 1914, has gradually come to be restricted for a series of different reasons that have often accompanied the causes leading to limitations on the international movements of goods, men and capital.
In general there is a tendency to reduce exchange-rate operations to those that respond to real needs of the country's economic life. Sometimes the obligation has been reached of the total surrender of foreign currencies obtained by exporters to a special body that pays them at an official exchange rate, usually rigid and rather low. At other times the obligation of surrender concerns only a percentage share of the currencies, while the remaining part can be freely traded on a free market. Many countries then prohibit the export of monetary tokens and of every sort of security denominated in national currency, in order to avoid possible harmful speculation.
In a matter so complex and delicate as the currency matter, direct or indirect control by the organs of the State is necessary, precisely in order to prevent operations carried out by individuals from compromising the country's economic life and from adversely affecting the social well-being of the population. Therefore the provisions issued in this matter by the competent authority bind in conscience, unless in concrete cases submitting to them brings evident offense to justice and good sense.
Bibliography5 works
Ercole Calcaterra