represents the demands of U.S. buyers of British goods, U.S. travelers to

Britain, currency speculators, and those who wish to purchase British

stocks and securities. It slopes downward because the dollar price to U.S.

residents of British goods and services declines as the exchange rate

declines. An item selling for Ј1 in Britain would cost $2.00 in the U.S. if

the exchange rate were Ј1/$2.00 U.S. If this exchange rate declined to

Ј1/$1.50 U.S., the same item is $.50 cheaper in the United States,

increasing the demand for British goods and thus the demand for pounds. The

supply schedule of pounds represents the pounds supplied by British buyers

of U.S. goods, British travelers, currency speculators, and those who wish

to purchase U.S. stocks and securities. It slopes upward because the pound

price to British residents of U.S. goods and services rises as the $ price

of the Ј falls. Assuming an exchange rate of Ј1 /$2.00 U.S., a $2.00 item

in the U.S. costs Ј1 in Britain. If this exchange rate declined to Ј1/$1.50

U.S., the same item is 33 percent more expensive in Britain, decreasing the

demand for dollars to buy U.S. goods and thus reducing the supply of

pounds. The equilibrium exchange rate in Figure 1 is Ј1/$2.00 U.S. The

amounts supplied and demanded by the market participants are in balance.

Figure 2

[pic]

To understand better the schedules, several of the factors that might

cause these curves to shift are discussed next. If there is a decrease in

national income and output in one country relative to others, that nation's

currency tends to appreciate relative to others. The domestic income level

of any country is a major determinant of the demand for imported goods in

that country (and hence a determinant of the demand for foreign

currencies). Figure 2 shows the effects of a decline in national income in

Britain (assuming all other factors remain constant). The decrease in

British income implies a decrease in demand for goods and services (both

domestic and foreign) by British people. This reduction in demand for

imported goods leads to a reduction in the supply of pounds, which is shown

by a leftward shift of the supply curve in Figure 2 (from S[pic] to

S[pic]). If the exchange rate floats freely, the British pound appreciates

against the U.S. dollar. If the exchange rate is artificially maintained at

the old equilibrium of Ј1/$2.00 U.S., however, a balance-of-payments

surplus (for Britain) likely results.

Figure 3

[pic]

In Figure 3, an initial exchange-rate equilibrium of Ј1/$2.00 U.S. is

assumed. Now presume the rate of price inflation in Britain is higher than

in the United States. British products become less attractive to U.S.

buyers (because their prices are increasing faster), which causes the

demand schedule for pounds to shift leftward (D[pic] to D[pic]). On the

other hand, because prices in Britain are rising faster than prices in the

U.S., U.S. products become more attractive to British buyers, which causes

the supply schedule of pounds to shift to the right (S[pic] to S[pic]). In

other words, there is an increased demand for U.S. dollars in Britain. The

reduced demand for pounds and the increased supply (resulting from British

purchases of U.S. goods) mandates a newer, lower, equilibrium exchange

rate. Furthermore, as long as the inflation rate in Britain exceeded that

in the United States, the British pound would continually depreciate

against the U.S. dollar.

Differences in yields on various short-term and long-term securities

can influence portfolio investments among different countries and also the

flow of funds of large banks and multinational corporations. If British

yields rise relative to others, an investor wishing to take advantage of

these higher interest rates must first obtain British pounds to buy the

securities. This increases the demand for British pounds shift the demand

schedule in Figure 4 to the right (D[pic] to D[pic]). British investors are

also less inclined to purchase U.S. securities, moving the supply schedule

of pounds to the left (S[pic] to S[pic]). Both activities raise the

equilibrium exchange rate of the British pound in terms of U.S. dollars.

Figure 4

[pic]

3. Factors affecting foreign exchange rates

. Balance-of-Payments Position

The exchange rate for any foreign currency depends on a multitude of

factors reflecting economic and financial conditions in the country issuing

the currency. One of the most important factors is the status of a nation's

balance-of-payments position. When a country experiences a deficit in its

balance of payments, it becomes a net demander of foreign currencies and is

forced to sell substantial amounts of its own currency to pay for imports

of goods and services. Therefore, balance-of-payments deficits often lead

to price depreciation of a nation's currency relative to the prices of

other currencies. For example, during most of the 1970s, 1980s, and into

the 1990s, when the United States was experiencing deep balance-of-payments

deficits and owed substantial amounts abroad for imported oil, the value of

the dollar fell.

. Speculation

Exchange rates also are profoundly affected by speculation over future

currency values. Dealers and investors in foreign exchange monitor the

currency markets daily, looking for profitable trading opportunities. A

currency viewed as temporarily undervalued quickly brings forth buy orders,

driving its price higher vis-a-vis other currencies. A currency considered

to be overvalued is greeted by a rash of sell orders, depressing its price.

Today, the international financial system is so efficient and finely tuned

that billions of dollars can flow across national boundaries in a matter of

hours in response to speculative fever. These massive unregulated flows can

wreak havoc with the plans of policymakers because currency trading affects

interest rates and ultimately the entire economy.

. Domestic Economic and Political Conditions

The market for a national currency is, of course, influenced by

domestic conditions. Wars, revolutions, the death of a political leader,

inflation, recession, and labor strikes have all been observed to have

adverse effects on the currency of a nation experiencing these problems. On

the other hand, signs of rapid economic growth, improving government

finances, rising stock and bond prices, and successful economic policies to

control inflation and unemployment usually lead to a stronger currency in

the exchange markets.

Inflation has a particularly potent impact on exchange rates, as do

differences in real interest rates between nations. When one nation's

inflation rate rises relative to others, its currency tends to fall in

value. Similarly, a nation that reduces its inflation rate usually

experiences a rise in the value of its currency. Moreover, countries with

higher real interest rates generally experience an increase in the exchange

value of their currencies, and countries with low real interest rates

usually face relatively low currency prices.

. Government Intervention

It is known that each national government has its own system or policy

of exchange-rate changes. Two of the most important are floating and fixed

exchange-rate systems. In the floating system, a nation's monetary

authorities, usually the central bank, do not attempt to prevent

fundamental changes in the rate of exchange between its own currency and

any other currency. In the fixed-rate system, a currency is kept fixed

within a narrow range of values relative to some reference (or key)

currency by governmental action.

National policymakers can influence exchange rates directly by buying

or selling foreign currency in the market, and indirectly with policy

actions that influence the volume of private transactions. A third method

of influencing exchange rates is exchange control—i.e., direct control of

foreign-exchange transactions.

Intervention of a central bank involves purchases or sales of the

national money against a foreign money, most frequently the U.S. dollar. A

central bank is obliged to prevent its currency from depreciating below its

lower support limit. The central bank should buy its own currency from

commercial banks operating in the exchange market and sell them dollars in

exchange. These transactions are effectively an open-market sale using

dollar demand deposits rather than domestic bonds. Such transactions reduce

the central bank's domestic liabilities in the hands of the public. The

ability of a foreign central bank to prevent its currency from depreciating

depends upon its holdings of dollars, together with dollars that might be

obtained by borrowing. Even if a national monetary authority has the

foreign exchange necessary for intervention, its need to support its

currency in the exchange market might be inconsistent with its efforts to

undertake a more expansive monetary policy to achieve its domestic economic

objectives.

Also I’d like to say a few words about currency sterilization. A

decision by a central bank to intervene in the foreign currency markets

will have both currency market and money supply effects unless an operation

known as currency sterilization is carried out. Any increase in reserves

and deposits that results from a central bank currency purchase can be

"sterilized" by using monetary policy tools that absorb reserves. There is

currently a great debate among economists as to whether sterilized central

bank intervention can significantly affect exchange rates, in either the

short term or the long term, with most research studies finding little

impact on relative currency prices.

Conclusion

A market in national monies is a necessity in a world of national

currencies; this market is the foreign-exchange market. The assets traded

in this market are demand deposits denominated in the different currencies.

Individuals who wish to buy goods or securities in a foreign country must

first obtain that country's currency in the foreign-exchange market. If

these individuals pay in their own currency, then the sellers of the goods

or securities, use the foreign-exchange market to convert receipts into

their own currency.

One from the most important participants of an exchange market is a

business bank, which act as the intermediaries between the buyers and

sellers. As already it is known they can execute a role speculators and

arbitragers.

Most foreign-exchange transactions entail trades involving the U.S.

dollar and individual foreign currencies. The exchange rate between any two

foreign currencies can be inferred as the ratio of the price of the U.S.

dollar in terms of each of their currencies.

The exchange rates are prices that equalize the demand and supply of

foreign exchange. In recent years, exchange rates have moved sharply, more

sharply than is suggested by the change in the relationship between

domestic price level and foreign price level. Exchange rates do not

accurately reflect the relationship between the domestic price level and

foreign price levels. Rather, exchange rates change so that the anticipated

rates of return from holding domestic securities and foreign securities are

the same after adjustment for any anticipated change in the exchange rate.

The major factor influencing to the rate of exchange, is interference

of government in the person of central bank in currency policy of the

country. The value of a nation's currency in the international markets has

long been a source of concern to governments around the world. National

pride plays a significant role in this case because a strong currency,

avidly sought by traders and investors in the international marketplace,

implies the existence of a vigorous and well-managed economy at home. A

strong and stable currency encourages investment in the home country,

stimulating its economic development. Moreover, changes in currency values

affect a nation's balance-of-payments position. A weak and declining

currency makes foreign imports more expensive, lowering the standard of

living at home. And a nation whose currency is not well regarded in the

international marketplace will have difficulty selling its goods and

services abroad, giving rise to unemployment at home. This explains why

Russia made such strenuous efforts in the early 1990s to make the Russian

ruble fully convertible into other global currencies, hoping that ruble

convertibility will attract large-scale foreign investment.

Recommendations

The problem of “laundering” money is essential with regard to the

exchange market. I’d like to add that the Russian exchange market comes

first in this respect.

The origin of this problem directly is connected with activity of the

organized crime: funds obtained in a criminal way are presented as legal

capital to introduce them in economic and financial structures of the

state. Therefore struggle against “laundering” money is recognized in all

countries as one from major means of a counteraction of the organized

crime. The sources of “dirty” money are as follows:

international drugs traffic;

mafia’s activity;

illegal trade of weapon.

The use of exchange markets for “laundering” money is not a

contingency. This process is promoted by absence of restrictions concerning

foreign exchange.

Unfortunately today participation of Russia in international struggle

against outline problem is limited by signing of the Viennese convention on

struggle against an international drugs trafficking and entering Interpol.

The work on struggle against “laundering” money in Russia should start from

the very beginning. The process of developing legislation and mechanisms of

its application is supposed to give instructions aimed at lawful struggle

against “laundering” money, developing bilateral cooperation with

countries of European Union, USA and Japan.

Literature used

1. “Money, banking and the economy” T. Mayer, J.S. Duesenberry, R.Z.

Aliber

W.W. Norton & company New York, London 1981

2. “Principles of international finance” Daniel R. Kane

Croom Helm 1988

3. “Money and banking” David R. Kamerschen

College Division South-western Publishing Co. 1992

4. “Money and capital markets: the financial system in a increasingly

global economy” fifth edition Peter S. Rose

IRWIN 1994

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