Exchange rate

I came across a very interesting piece about exchange rates in the book "Lords of finance". Setting Exchange rate rather than being a technical exercise is more of a political one where decision has to be made on which group has to be favored. Normally it is exporter vs importers which comes down to producer vs consumer. The producers being small in number and organized does lead to moving the rate in their favor. Another decision has to be made is on the amount of inflation invariably linked to exchange rate. A high inflation transfers wealth from savers to debtors while protecting the people who own means of production while deflation does favor the other way around.

After the first world war, all the three European countries Britain, Germany and France were riddled with large monetary expansion and foreign debt. The value of exchange rates would determine the inflation and total national debt.

Britain chose the conservative approach to get the exchange rate back to its pre-war level thus protecting the creditors and savers but causing a recession and later stagnation due to required deflation. Germany took the opposite path leading to a period of hyper-inflation and hence destroying the wealth of savers in this case the whole middle class. France took the medium path and in short term was the most successful economy, growing at a good rate.

Setting the exchange rate is always a political decision.

Next step: Look at the political economy behind China's current exchange rate dilemma.