The foreign exchange rate is a term used to describe how a specific currency is traded or exchanged for another currency. An essential indicator in a country's economy, exchange rate motion, influences the rate of inflation and the export-import equilibrium (Alotaibi, 2016). In general terms, it is regarded as a ratio between two currencies. The level of a currency's exchange rate indicates its purchasing power in the international market. Theoretically, two general methods exist to determine currency exchange rate; the first is the use of the gold standard system, which is technically obsolete since gold is not a common currency used by any country presently. The second method refers to the use of the paper currency model, a standard money system for most countries. In this mode, the most used foreign exchange determination mechanism is the demand and supply theory, also known as the balance of payment approach.
In general terms, the demand and supply of a currency to another is determinant of that currency's price or value, which is essentially the rate of exchange. Demand and supply forces determining exchange rates are often affected by inflation, real GDP, government regulation, and interest rate factors (Maurya, 2017). For example, when the inflation rate in Thailand is higher than that of the U.S, products from America become cheaper to Thais, which makes them more likely to sell the Thai baht in exchange for the dollar to purchase American products. This change causes an increase in the supply of the baht in the money market. Similarly, government regulations, such as reducing tariffs on products from the U.S by Thailand, causes an increase in the baht supply. Both circumstances result in the appreciation of the baht and fall in the dollar.
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Interest rates also affect the demand and supply of a currency. When Thai baht-dominated interest rates are higher than that of the dollar, the demand for the dollar declines due to investors' tendency to sell the U.S dollar for the baht to purchase baht-dominated assets. The change in GDP of two countries with different currencies affects the forces of demand and supply on their currencies that determine the exchange rates between the currencies (Šimáková, 2017). Conversely, a higher increase in Thailand's growth rate compared to the United States will lead to Thai investors and consumers purchasing more American assets and goods. This projection will lead to Thai consumers preferring to sell the baht in exchange for the U.S dollar to have a trade advantage causing the dollar to appreciate. Therefore, it can be stated that the decline in the supply of a currency leads to the rise of the currency.
In a business involved in the export or import of raw materials, specifically Thai silk, changes in exchange rate causes changes in the price of the goods involved. In exchange rate between Thailand and the United States, a fall in the Thai baht value causes silk imports from Thailand to the U.S to become cheaper as exports to Thailand become expensive. Cheaper silk imports will increase demand for them in the U.S market. The level of increase in demand will vary with the price elasticity of demand. Therefore, a higher exchange rate will make the silk importation business pay lower prices, whereas a lower exchange rate will cause higher prices. The increase in domestic currency also increases its people's purchasing power, and their appetite for luxury goods can be met easily (Azimi, 2016). Silk is used to make luxury products with more demand from the consumers and businesses with an increase in the value of the dollar against the baht. The silk import business will likely boom at these times whereas, a decline in the dollar exchange value will lead to the industry experiencing a slump.
At a higher exchange rate, the supply of silk will also be increased since, on the other hand, the deprecation of Thai baht will lead to higher importation and lower exports. The exporters of silk in Thailand will trade more of the product since the demand for it will be higher in the United States, causing a higher aggregate demand. Therefore, a desirable scenario for this business is a stronger dollar against the baht on a long-term basis, which will improve the demand for the commodity. The reverse would be a worst-case scenario since the business will struggle with both the decreased domestic demand caused by a weaker dollar and an unfavorable export-import equilibrium for the United States.
The exchange rate is a crucial concept in a country's investment portfolio, which is considered in determining if the investment will be profitable or not. Besides international security investment, international trade relies mostly on the exchange rate, with a stable equilibrium being favorable to both countries involved in the business. A decline in currency causes is good for exports but bad for imports and vice versa. Exchange rates between two currencies are mostly influenced by their demand and supply forces. An increase in the supply equilibrium of a currency caused by relatable factors makes a currency depreciate. For a silk import business, the most favorable exchange rate is an appreciating rate that causes the importation of the silk raw material to increase.
References
Alotaibi, K. (2016). How Exchange Rate Influence a Country’s Import and Export. International Journal of Scientific & Engineering Research , 7 (5), 131–139.
Azimi, M. N. (2016). Exchange rate re-examined: The varying impact of import and export on exchange rate volatility. International Journal of Management Excellence , 7 (1), 716. https://doi.org/10.17722/ijme.v7i1.230
Maurya, S. (2017, January). Factors affecting Exchange Rate and its Impact on Economy. ResearchGate. https://www.researchgate.net/publication/319216390_Factors_affecting_Exchange_Rate_and_its_Impact_on_Economy_of_India.
Šimáková, J. (2017, December 7). The Impact of Exchange Rate Movements on Firm Value in Visegrad Countries . Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis. https://doi.org/10.11118/actaun201765062105.
