Exchange Rates as Prices

Foreign exchange rates may be defined as prices at which foreign exchange is bought and sold. They are the prices which indicate how many dollars an American importer will have to pay his bank for a £1,500 sight draft to settle his account in England; or the number of dollars an American cotton exporter will receive for the Euro 2,000 draft he has drawn on his French customer. Just as is the case with commodity prices, foreign exchange rates are to varying degrees competitively determined--or, more accurately, competition in the determination of foreign exchange rates approximates "perfection," as conceived by the Marshallian economist, in varying degrees. The pound sterling-dollar rate is highly competitive, although among the supply or demand factors will appear, from time to time, the exchange stabilization funds of the two countries concerned. At the other extreme, a government may monopolize the supply of foreign exchange and more or less arbitrarily fix the price at which it will be sold or allotted to buyers.

We are justified in concluding that between countries not on a common metallic standard in which the treasuries stand ever ready as buyers and sellers of gold, the par of exchange is merely a reminder of an earlier period of more "orthodox" international monetary policy. It has no other significance unless one or both of the governments intend ultimately to return to an international metallic standard at that par. In that case the par becomes a point of stability toward which, under the guidance of the monetary authorities, the exchange rates tend to return.

The exporters in each country would draw drafts in the foreign importer's currency. Thus the English exporter finds himself loaded with dollar exchange and the American exporter with sterling exchange. Under such circumstances the exchange rate would result from operations between the two groups of exporters or the persons or institutions to whom they may sell the exchange. If some of the export drafts are drawn in the exporter's currency, the process, but not the principle, is somewhat changed. Now those importers who are drawees under foreign currency drafts must enter the market to purchase that foreign currency or exchange. What we are saying here is this: An export by an American to an Englishman may result in (1) a supply of sterling exchange in the United States (transaction in sterling), or (2) a demand for dollar exchange in England (transaction in dollars). In the determination of the exchange rate it is a matter of indifference which occurs.