How does a country controls its foreign exchange?

Paul Einzig is his book exchange controls has mentioned as many as 41 different methods of exchange control. They can be categorized as

1. Direct Method
2. Indirect Method

They are discussed here as under.

1. DIRECT METHOD

The direct method is further classified as:

Intervention

For an effective control of foreign exchange rates and the foreign exchange market the government usually has a central authority i.e. the Central Bank that has the complete power to control and regulate the foreign exchange market. Under this method any body who either wants to purchase or sell foreign exchange he has to deal with the central bank. All the selling and purchasing transactions of foreign exchange is controlled by the central bank which helps it to adjust demand and supply of foreign exchange according to the need of the country.

Restriction

Exchange restriction is another powerful weapon of exchange control. It refers to the policy by which the government restricts the supply of its currencies coming into the exchange market. It is achieved either by one of the following methods.

1. By centralizing all trading in foreign exchange with central bank of the country.
2. To prevent the exchange of national currency against foreign currency with the permission of the government.
3. By making all foreign exchange transactions through the agency of the government.

Exchange Clearing Agreement

Under this method the countries engaged in trade pay to their respective central bank the amounts payable to their respective foreign creditors. The central banks they use the money in off setting the corresponding claims after fixing the value of the foreign currencies by common agreement. The basic principle is to offset international payments so that they have not to be settled through the medium of the foreign exchange market.

INDIRECT METHODS

The most commonly used direct method or tool of exchange control is the use of tariff duties and quotes and other quantitative restrictions on the volume of international trade. By imposing tariff and quotes the demand for the foreign currency falls down in the case of restricting the imports.

Rate of Interest

Another method of indirect exchange is the rate interest. The rate of exchange is the result of demand and supply of each other currencies arising out of trade and capital movement. A high rate of interest in a country attracts short term capital from other countries that leads to a exchange rate for the currency in terms of other currencies goes up.

How does a bill of exchange is drafted?

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While drafting a bill of exchange the following are necessary.

1. STAMP

To prepare a bill of exchange in the form of a legal document, the drawer of the bill has to pay a tax to the Government which is accepted by issuing a stamp. The value of the stamp depends upon the amount for which the bill has been drawn.

2. AMOUNT PAYABLE

The amount payable should be written clearly. It is necessary that the amount should be written in words and figures.

3. DATE

The date on which the bill is being drawn or prepare should be posted accurately. The date is usually written on the upper side of the bill.

4. NAME OF THE DRAWEE

It is necessary that the name of the drawee should be mentioned in the bill. The words ‘’OR ORDER OR BEARER’’’ indicate the persons to whom the bill has to be paid.

5. FOR VALUE RECEIVED

A bill of exchange is always drawn against a certain amount or value. Therefore the words ‘’For Value Received’’’ should always be written on the bill.

6. SIGNATURE OF THE DRAWEE

A bill lacking the signature of the drawer is unacceptable and unlawful. Such type of a bill can be dishonored. That is why the structure of the drawer are essential.

7. NAME & ADDRESS OF THE DRAWEE

The closing of the bill includes the name and address of the drawee. It is written on the left side corner of the bill.

INTRODUCTION

INTRODUCTION

The classical theory of International trade commonly known as the principle of comparative cost was first enunciated by David Ricardo. The theory went through many additions improvements and refinements at the hands of economists like Mill, Cairns & Bastable.

An individual is able to perform many tasks but he does not perform them all. He selects that work which pays him the most. A doctor can also do the work of a dispenser but he does not do it. The same principle works in international trade. Considering the climatic conditions, distribution of material resources, geographical concern etc. Every country seems to be better suited for the production of certain articles rather than for others to employ its resources more remuneratively it will be to the advantages of each country as well as to the world.

THEORY

In its simplest form the theory may be stated as, ‘’It pays countries to specialize in the production of those goods in which they possess the greatest comparative disadvantage.’’

EXPLANATION

Ricardo argued that two countries can gain very well by trading even if one the countries is having an absolute advantage in the production of both the commodities over the country. The condition is ‘’Provided the extent of absolute advantage is different in the two commodities in question’’ i.e. the comparative advantage is greater or comparative is lesser in respect of one good than in that of the other. In this connection we compare not the cost of production of one commodity with the other rather we compare the ratio between the cost of production of the two commodities concerned in one country with the ratio of their cost of production in the other country.

EXAMPLE

Suppose there are two countries A and B and there are two commodities wheat and rice. Suppose a unit of labour produces 10 tons of wheat or 20 tons of rice in country A. The same unit can produce 6 tons of wheat and 18 tons of rice in country B. According to this situation country A is having an absolute advantage in the production of both commodities over B. But she is at a greater comparative advantage in the production of wheat country B is at a disadvantage in both. Commodities the comparative disadvantage is less than case of rice. Hence the ratio would be

In A it is 10 : 20 i.e. 1 : 2

In B it is 06 : 18 i.e. 1 : 3

Therefore, A will specialize in wheat and B in rice and international trade will become possible and profitable. This is the law of comparative advantage or costs.

Determination of Rate of Exchange

RATE OF EXCHANGE

The rate at which the currency or monetary unit of one country can be exchanged with the monetary unit of other country is called the rate of exchange. In other words, the rate at which a unit of one country exchanges for the currency of another is the rate of exchange between them. It may be used to denote the system whereby the trading nations pay off their debts.

Determination of Rate of Exchange

The rate of exchange is determined under the following under the following money systems as:

Under Gold Standard

If two currencies are on gold standard and if their currencies are expressed in terms of gold i.e. a certain weight of gold then the rate of exchange is determined by reference to the gold contents of the two currencies. Suppose Pakistan and United States are on gold standard the rupee being equal to 10 grams of gold and dollar consisting of 50 grams of gold. The rate of exchange between the two countries will be

1 Rupee = 10/50 = 1/5 $ or 0.20 cents

1 Dollar = 50/10 = 5 Rupees.

Thus the rate of exchange is determined in a direct manner by comparison between the gold contents of the two countries. This rate of exchange is also known as Mint Par of Exchange. The actual rate in the foreign exchange market will be slightly different from the mint par to allow for certain expenses. However the actual rate of exchange between currencies will not depart much from the mint par and will move between the two points of export and import of gold. These points are called Gold Points.

Under Paper Currency Method

This phenomenon of exchange rates determination is also called Purchasing Power Parity Theory. No country in the world is rich enough to have a free gold standard. All countries nowadays have paper currencies. According to this theory the rate of exchange between two countries depend upon the relative purchasing powers of their respective currencies. Such will be the rate which will equate the two purchasing powers.

For example if a certain assortment of goods can be purchased for £ 1 in Britain and a Similar assortment of goods with Rs. 16 in Pakistan then the purchasing power of £ 1 is equal to the purchasing power of Rs. 16. Thus the rate of exchange according to purchasing power parity theory will be

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