Forex Prevention of Speculation

Stable exchange rates avoid the dangerous possibilities of speculation and thus help in orderly growth of international markets. The claim that stable exchange rates prevent speculation is not correct. By keeping the value of the currency at an artificial level. It encourages speculation of devaluation of the currency. The suspicion of devolution will ultimately make devaluation inevitable and result in the destruction of the stability of the currency.

Small Open Economies

It is destruction of the stability of the currency small open economies i.e., a country which trades extensively with others. Such economies may be depending upon imports to a large extent for many of its to deprecation of the currency of the country. This is opposed to stimulate exports due to reeducation in the price of domestic products and thus adjust the deficit in the balance of payments. But depreciation of the currency will raise the price of imports. If the import is inelastic, it will raise the cost of living leading to rise in wages. The prices of domestic products increase offsetting of the benefit of depreciation. Thus the increase in exports may not realize. It would be better for such economics to fix the value of their currencies to the currency of the country which supplies most of their imports.

Inflation under the fixed rate, system where rates are strictly on gold or dollar standard, there was need for the central bank to keep a close watch on the money supply and keep the inflation under control. Poor performance on this front was immediately reflected in the dwindling of foreign exchange reserves. This provided a good reason for taking strong remedial measures by the central bank. Under flexible exchange rates, the foreign exchange reserves are not affected and therefore no evidence of the deterioration in the situation is available. This may allow inflation to creep in. however, it should be noted that under flexible rates, the change in exchange rate itself provides the needed evidence. Therefore, it may not be say that flexible rates are more inflationary than fixed rates.

Terms of trade many countries maintain their currencies pegged through trade and exchange controls at a level higher than that would prevail in a free market. The introduction of flexible rate system would far exceed gain, if any, that accrues from introduction of flexible exchange rates.

Competitive exchange depreciation under the flexible exchange rate system there is a possibility of countries engaging in competitive depreciation of their currencies in order to capture would markets. Such unhealthy practices are eliminated in the case of stable exchange rates.