THE FIXING and formation of foreign exchange rates in operation at the beginning of 1970 display a great heterogeneity, reflecting countries’ monetary systems, the degree of freedom, and the manner in which international trade and settlements are carried out, and the institutions, habits, and techniques which have been developed in the past.1
Unitary Exchange Rates
Exchange rates can be divided into three broad groups: unitary exchange rates, single fluctuating exchange rates, and multiple rates. The first group includes the United States, countries which adhere to the European Monetary Agreement (EMA), countries in which quotations are based on the rates of the leading foreign exchange markets, and countries in which exchange rates are technically (although not economically) independent of the quotations outside.
Exchange Rates in the United States
Exchange rates in the United States fluctuate within narrow limits around a parity determined by arrangements about the convertibility of the U.S. dollar in respect of gold. The U.S. Treasury buys gold only from official sources and sells it only to governments and central banks, and under certain conditions, to international institutions for the settlement of international balances and other monetary purposes at the fixed par value of the U.S. dollar.
The spot and forward foreign exchange market and exchange arbitrage operations in the United States are free for residents and nonresidents. No restrictions on foreign payments exist except those imposed for reasons other than economic ones on transactions involving the authorities or nationals of mainland China, Cuba, North Korea, North Viet-Nam, and Rhodesia. Residents and nonresidents are not restricted in their exchange operations by any specific requirements or limitations such as those related to prescription of currency, repatriation, and surrender of exchange earnings or holdings.
Exchange Rates Under the European Monetary Agreement
Exchange rates vis-à-vis the U.S. dollar of currencies of countries of the European Monetary Agreement fluctuate within limits determined by the convertibility mechanism functioning in accordance with the provisions of the European Monetary Agreement of August 1, 1955.2 The Agreement came into effect on August 27, 1958, i.e., at the time of the termination of the European Payments Union. Exchange rates for currencies of nonmembers are freely fluctuating on foreign exchange markets of many EMA countries.
Under the Multilateral System of Settlements of the EMA, each member country’s central bank is assured of obtaining settlements in U.S. dollars, at an exchange rate known in advance, of its holdings in other members’ currencies. In accordance with the provisions of the Agreement, each member country fixes the parity, buying and selling rates for gold, the U.S. dollar, and other members’ currencies, and notifies the other members of the EMA of the fixed rates, which must be used as a basis for the calculation and settlements provided for in the Agreement. Spreads (in percentage terms) between the buying and selling rates for the U.S. dollar in terms of EMA currencies 3 and their respective par values or parity rates are between 0.7 per cent and 0.9 per cent except the following: about 0.1 per cent for the Icelandic krónur and 0.3 per cent for Greek drachmas, 1.14 per cent for Portuguese escudos, and 1.17 per cent for Swiss francs. Fixed buying and selling rates for the U.S. dollar in terms of EMA currencies determine rates for EMA currencies in terms of one another. These official rates, which make up a range within which exchange rates can fluctuate, are called limits or intervention points; they indicate that central banks are ready to intervene on exchange markets at these rates, when freely fluctuating rates for EMA currencies are quoted beyond these limits. The percentage spread between fixed buying (or selling) rates for EMA currencies in terms of their respective parities (calculated on the basis of their par values or parity rates in respect of the U.S. dollar) is the sum of the spread between the buying (or selling) rate for the U.S. dollar in terms of one EMA currency and the selling (or buying) rate of the other EMA currency. Thus, the spread is over 0.4 per cent between the currencies of Iceland and Greece (the smallest spread), and over 3.9 per cent for the currencies of Switzerland and Portugal (the biggest spread).
Exchange rate mechanisms in 5 EMA countries do not work as fully as those in the remaining EMA countries. One of these countries maintains multiple rates. Exchange rates in Belgium and Luxembourg may become multiple rates from time to time because of the operation of their free foreign exchange market in addition to the official foreign exchange market.
In 56 countries, quotations are based on the quotations in various leading foreign exchange markets, the main reason for this being that their own exchange markets are too small. Countries that continue to maintain close banking, financial, and exchange relations with the foreign exchange and financial markets of one or more countries are often reluctant to switch to independent quotations, fearing such a change would be misinterpreted as a weakening of old ties.
London quotations are closely followed by 28 countries in establishing their exchange rates. Practically all of these countries are tied to the United Kingdom by their participation in the sterling area; those outside the sterling area follow London quotations because of the importance of London as a financial center. Several countries in this group apply only one rate to all exchange transactions involving the pound sterling. In 3 countries, London quotations are used indirectly; they follow the quotations of a country in the sterling area which uses London quotations.
In 16 countries, exchange rates for foreign currencies are based on Paris quotations; 14 of these have very close financial and economic relations with France; 1 of these countries maintains multiple rates as specified exchange transactions are subject to an exchange tax of 2½ per cent.
Six countries base their rates for foreign currencies on New York quotations. In 4 countries in this group, official buying and selling rates for the U.S. dollar are fixed, while in the fifth country, exchange transactions in the U. S. dollar are carried out at a parity rate. In one of these countries, minimum and maximum buying and selling rates are prescribed for exchange transactions between authorized banks and their customers; the minimum buying rate of authorized banks for the U.S. dollar is slightly below the official buying rate of the central bank, while the maximum selling rate of authorized banks for the U.S. dollar is slightly above the official selling rate of the central bank. In another country in this group, all exchange transactions in pounds sterling are carried out at dollar parity rates.
In the sixth country basing its rate on New York quotations, the unit of currency is equal to the U.S. dollar, and its official accounts are kept in dollars. In addition, U.S. currency is in circulation along with the country’s coins. There are no restrictions in this country on foreign exchange transactions.
In two countries, rates for foreign currencies are based on Brussels quotations. In both of them, the parity rates for national currencies are expressed in terms of the Belgian franc. In one of them, official buying and selling rates for the U.S. dollar are established by the central bank. In addition, the central bank bases its quotations for the other 14 foreign currencies on the rates of these currencies against the Belgian franc in Brussels. Authorized banks in this country are required to carry out permitted exchange transactions at rates between the buying and selling rates fixed by the central bank for currencies quoted by that bank and at rates fixed freely with their customers for certain other currencies.
In another country in this group, the buying and selling rates for currencies other than the Belgian franc are based on the fixed rate for the Belgian franc and the official market rates for these other currencies in Brussels. However, the central bank of the country buys and sells most foreign currencies against the country’s currencies at rates differing by not more than 0.75 per cent from the cross rates resulting from the official par values or parities.
In one country quotations are based on those quoted in the Madrid exchange market.
Four countries belong to a group in which rates are based on quotations of several foreign exchange markets. In one country, the central bank deals with commercial banks only in pounds sterling and U.S. dollars at rates fixed daily, while the commercial banks deal in other currencies at rates based on quotations in London, New York, and other foreign exchange markets. In another country, transactions in French francs are carried out at the parity rate; buying and selling by the central bank for convertible currencies are based on quotations in the leading foreign exchange markets.
In the third country, exchange transactions between commercial banks and the public take place at fixed buying and selling rates for the U.S. dollar. While the buying rate differs from the par value by less than 1 per cent, the selling rate (including a tax) differs by slightly more than 1 per cent from the par value.
In the fourth country, both official buying and selling rates for the U.S. dollar are below the par value rate. Exchange rates for ten specified currencies quoted by the central bank are based on official buying and selling rates for the U.S. dollar, taking into account the exchange rates of these currencies on the international exchange markets. The authorized banks are permitted to quote rates for the U.S. dollar within the limits of the official buying rate and the par value increased by almost 1 per cent. Rates for other currencies are determined by the authorized banks in a similar way to that used for rates for quoted currencies.
Independent Fixed Rates
In 23 countries, official buying and selling rates for the U.S. dollar and specified other currencies, the lists of which are different in various countries, are fixed independently of the quotations of the leading foreign exchange markets, although the quotations of these markets seem to be taken into consideration in a number of countries. The rates are either fixed for a relatively long period of time or altered relatively frequently.
Rates for the U.S. dollar, which plays a predominant role in exchange systems of most of these countries, are fixed in the following way. In 6 countries, the same rates (mostly par value or parity rates) are applied to purchases and sales of U.S. currency; in some of these countries, however, small taxes—not considered as giving rise to multiple rates—are applicable to exchange operations involving the U.S. dollar. In 12 other countries, buying and selling rates are officially fixed; authorized banks in eight of these countries carry out exchange transactions at rates within or at official rates. In 1 country, U.S. dollars are purchased at the parity rate, but the selling rate differs from the parity rate by 1 per cent.
Single Fluctuating Rates
Single fluctuating exchange rates (without being combined with multiple currency arrangements) are maintained in only 3 countries. In 1 country, a fluctuating exchange rate is not permitted to appreciate beyond a certain limit. In another country, all exchange transactions take place at a free market rate. In the third country, where a single fluctuating rate exists, all sales of foreign exchange are subject to a tax of 1.6 per cent and a 2 per mill stamp tax. The total spread (including taxes) between the buying and selling rates of the monetary authority is about 1.8 per cent.
The Pattern of Exchange Rates in 119 Countries
A 16th century woodcut of a foreign exchange dealer by Hans Baldung: “An exchange rate should be simply the price at which international exchange transactions and operations are made.”
Broadly speaking, five main arrangements can give rise to multiple rates: 1) those that provide for two or more explicitly established exchange rates; 2) those that provide for taxes and charges of an exchange nature; 3) those that provide for bonuses, premiums, subsidies, etc., of an exchange nature;4 4) those that provide for selling to, or buying by, the monetary authorities at different rates various portions of exchange accruing from or needed for the same operation or transaction; and 5) those that provide for the retention of foreign currency proceeds accruing to residents on account of exports or services rendered to nonresidents.
Nineteen countries maintain multiple rates arising from the application of one or more arrangements mentioned above; one of these countries belongs to the EMA group, and another to the group of countries in which exchange rates for foreign currencies are based on Paris quotations. Spreads between the highest and lowest multiple rates vary widely in these countries. In 5 countries, they do not exceed 10 per cent; in other countries the spreads are higher and in some much higher—even up to 300 per cent. Spreads between the highest and the lowest multiple rates do not, however, reflect the full economic impact of multiple rates, as in many countries only one rate out of various multiple rates is of primary importance.
Moreover, multiple rates can arise in one country from the arrangement under which specified exporters may retain and use on preferential terms a part of their export proceeds. In addition, some 10 other countries are (or can be) involved in multiple currency practices mainly in connection with specified capital transactions involving nonresident interests. These countries which apply unitary rates to most exchange transactions are included in the unitary rate group.
Unitary rates maintained in various countries present considerable differences as to the manner of their fixing and as to the part that free market forces play in influencing their daily fluctuations within established limits of official buying and selling rates.
Various obstacles make uniformity in the field of exchange rates difficult if not impossible. Habits, tradition, and inertia still play a great role in preventing the introduction of uniformity in this field. Potent economic groups and even individuals exert strong effective pressure upon the maintenance of arrangements that permit them to realize advantages through preferential multiple buying or selling exchange rates. What if an international agreement were to provide for larger spreads between official buying and selling rates, or for freedom to alter exchange rates within relatively wide limits, thus allowing adjustment processes to be carried out through the exchange rate mechanism to a greater or smaller extent? Several countries would still probably prefer to rely on multiple exchange rates or on relatively unlimited freedom to change foreign exchange rates. They would thereby avoid adjustment processes through changes in domestic price and income levels needed to maintain or re-establish external equilibrium.
Is it desirable that monetary authorities may regard the fixing of quotations for foreign currencies as a source of additional income to the Treasury, the banks, or governmental agencies? Should exchange rates be used as instruments for cost control? An exchange rate should be simply the price at which international exchange transactions and operations are made. It should not be distorted by the application of exchange measures for purposes which have little—if anything—in common with the real nature of the exchange rate mechanism.
The study deals exclusively with spot quotations and is primarily based on information about exchange rates in 119 countries included in the Fund’s 21st Annual Report on Exchange Restrictions.
The following 17 countries signed the Agreement: Austria, Belgium, Denmark, France, the Federal Republic of Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom.
The U.S. dollar is quoted in terms of EMA currencies with the exception of the pound sterling, which is quoted in terms of the U.S. dollar.
Such bonuses, premiums, etc., are extended to residents through various devices including so-called exchange certificates (known also under other names) which are given to residents surrendering their exchange earnings; they must be submitted to buyers of exchange from official sources. Supply of, and demand for, exchange certificates determine their market value.