O 41 A Successful Foreign Exchange System

A multinational company's access to international capital markets and its freedom to move funds across national boundaries are subject to a variety of national constraints. These constraints are frequently imposed to meet international monetary agreements on determining exchange rates. Constraints may also be imposed to correct the balance-of-payments deficit or to promote national economic goals.

A successful exchange system is necessary to stabilize the international payment system. To be successful, an exchange system should meet three conditions:

1 Balance-of-payments deficits or surpluses by individual countries should not be too large or prolonged.

2 Such deficits or surpluses should be corrected in ways that do not cause unacceptable inflation or physical restrictions on trade and payments for either individual countries or the whole world.

3 The maximum sustainable expansion of trade and other international economic activities should be facilitated.

Theoretically, continuous balance-of-payments deficits and surpluses cannot exist around the world. Under a system of freely flexible exchange rates, a foreign-exchange market clears itself in the same way a competitive market for goods does. Just like every commodity price, each exchange rate moves to a level at which demand and supply are equal. Under a system of fixed exchange rates, central banks or other designated agencies buy and sell on the open market to absorb surpluses and to eliminate deficiencies of foreign currencies at the fixed exchange rates.

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