ZICw2w

ance (capital plus current account) is guaranteed by a residual balancingitem, formerly gold under the gold standard, but is now guaranteed bychanges in a nation’s foreign exchange reserves, short-term IMF credits(special drawing rights or SDRs), and IOUs from deficit countries calledshort-term capital flows.Chapter 20 Financial Globalization • 391■ Exchange Rate RegimesAn exchange rate is the amount of one currency you would have to payto receive one unit of another. For example, in September 2009, one U.S.dollar could purchase about 6.8 Chinese renminbi. Any international exchangeof goods, services, or assets requires an exchange of currencies, asthose who sell generally want to be paid in their own currency. How theexchange of currency takes place depends on the exchange rate regimeused by a particular country. The regime influences not only current andcapital account balances but also economic stability and the effectivenessof domestic economic policy. There are two basic types of regime: fixedand flexible. When discussing exchange rates, floating is synonymous withflexible.In a fixed exchange rate regime, the value of one country’s currency ispegged (sometimes loosely) to that of another country. For example, from1994 to 2004, the Chinese renminbi was pegged to the U.S. dollar at aboutan 8.3:1 ratio; that is, the People’s Bank of China would sell as many dollarsas anyone wanted for 8.3 renminbi each. Obviously, the central bankneeded to have foreign currency on hand to make this exchange. Ideally,this currency would come from demand for Chinese products. When anAmerican wanted to buy consumer goods from China, the central bankwould also sell the required renminbi for $0.12 each. In reality, China andmany other developing countries have some exchange rate controls, sopeople can’t necessarily buy or sell as much of a given currency as theymight like, but the general concepts described here still apply.A problem can occur under a fixed rate regime when nationals of afixed rate country consistently want to buy more (or fewer) goods, services,and assets from other countries than other countries want to purchasefrom them, that is, when the fixed rate country is running a BOPsurplus (or deficit). If the fixed rate country runs a BOP surplus, as Chinadoes, it will accumulate excess reserves of foreign currency for whichthere is insufficient demand. In July 2009, China had over $2 trillion inforeign exchange reserves. 5 This will put pressure on the country to5 Bloomberg News, July 15, 2009, China’s Foreign-Exchange Reserves Surge, Exceeding $2Trillion. Online: http://www.bloomberg.com/apps/news?pid=20601087&sid=alZgI4B1lt3s.