I dont know much about Economics,please enlighten me.
I know i might sound Naive,but how:
How is the currency Exchange rate decided?
What is Fiscal Deficit and Fiscal Year?
thanks in advance...
06-25-04, 05:48 PM
I'll start with the easiest first.
What is Fiscal Year?Every business and every government has to do bookkeeping -- or accounting, as it's more formally called. In order to tell whether it is financially successful, it must periodically take totals and perform other calculations, including statistical ones. That way it can compare its performance against past periods and predict its performance in future periods. The most logical time period to use is one year. The problem with that is that the year ends in the middle of a big season of holidays -- at least in the U.S. and most Western nations. The time around Christmas and New Years Day is one in which it's very difficult to get much work done. In addition to the holidays themselves, many employees take vacations, and even when their bodies are at work their minds are elsewhere. Furthermore, most of the population of the Western nations lives at a sufficiently northern latitude that the weather at that time of year can be terrible and cause even more trouble for business. Try balancing your checkbook to the bank statement on January 2!
Therefore, the concept of the fiscal year was created. A year only has to be a twelve month period in order to be useful for accounting and economic purposes. It doesn't have to be the twelve month period starting January 1 and ending December 31. So each business and agency chooses its own "fiscal year." The most common choice is July 1 through June 30. Personally I think this leaves a lot to be desired because the children are out of school and most families take vacations in the summertime. In addition, the summer weather can be just as miserable as the winter weather in all but the northernmost regions. That's why people take vacations and leave home! But anyway, some companies and agencies choose other time periods. Some start on March 1, some on October 1. I'm sure somewhere there's somebody who picked April 12th just to be different.
It doesn't matter as long as it's twelve months. In some businesses, there are good reasons to pick a certain date. For example, in the retail industry in the USA, the biggest shopping season starts before Thanksgiving (the fourth Thursday in November) when people begin buying Christmas presents and holiday decorations, and ends in the middle of January when everyone has spent the money they got as Christmas gifts. So retail companies start their fiscal year at some other time of year so the entire Christmas season gets counted in one year.
What is Fiscal Deficit?If a person, business, or government takes in more money than it spends, the positive difference is called a "surplus." If it takes in less money than it spends, the negative difference is called a "deficit." If it "runs a deficit," it has to spend any extra money it has left over from prior years. If it continues to run a deficit for many years, it will have to borrow money. Eventually no one will want to loan it any more money and it won't be able to pay back the loans it has already made. Then it will go bankrupt. A business will be closed down. A person will have to go through a legal process; most of his possessions will be taken away, and sold to give part payment to his creditors; no one will be willing to loan him more money for a long time. The U.S. government, unfortunately, has the ability to continue "running a deficit" indefinitely. It is currently $ 4,000,000,000,000 in debt. (Four trillion dollars the way we count in the U.S., in some countries they call it four billion.) It is difficult for many of us Americans to understand why banks continue to loan money to the U.S. government when it has proven that it is incapable of paying back the loans it already has. This is just one of the many perplexing aspects of American politics.
How is the currency Exchange rate decided?That depends on the country. The short answer is that ultimately it is decided by the entire human race. If the price of a gallon of milk is one dollar in the USA and 40 pesos in Mexico, then any American who wants to buy pesos in order to travel easily in Mexico will be given no more than 40 pesos for each dollar. If he stupidly gives one dollar for 35 pesos, hundreds of Mexicans will quickly line up at his door and buy all of his dollars until he doesn't have any more. People aren't usually that stupid.
However, the system is not that simple. If someone in Brazil wants to exchange some of his cruzados for some of my dollars, it's difficult. He has to send me the money and trust me to send him my money in return. That's a lot of trust. Furthermore, I can't walk across the border to Brazil the way I can to Mexico, so it's not easy for me to spend cruzados. I don't have any good reason to want his cruzados, so I won't offer him what he thinks is a "fair" exchange rate for them.
So the banks, since they have most of the money, end up being the institutions that set the exchange rate. In practice, if I want to exchange my dollars for anything except Mexican pesos or Canadian dollars, I'll probably have to go to a bank that does business with other banks all over the world. They keep track of prices and set a more-or-less fair exchange rate. Of course they take a profit. If I give them a dollar they will only give me 39 pesos, but if I give them 40 pesos they will only give me 0.98 dollar.
In some countries the government makes it difficult or even illegal for people to exchange money personally, they are forced to do it at a government bank. In those countries the government can artificially set the exchange rates and attempt to enforce them. This doesn't work very well. For example, in the years before Perestroika, the USSR generally set the exchange rate at one ruble for one dollar (or more than one dollar!). In reality it required as many as ten or twenty rubles to buy as much as one dollar, so no Americans were willing to exchange their dollars for rubles. It was very difficult for Russian people to acquire dollars. They had to use illegal methods, and the people who helped them took a huge profit.
Some governments just try to adjust their exchange rates a little bit. If the dollar starts to lose value, the U.S. government will simply start buying dollars with the pesos, cruzados, and rubles it has in its own treasury. This will cause the exchange rate to increase slightly. This can only be done in a narrow range, obviously, or the government will run out of foreign currency.
Another thing that happens is that foreign governments may have reasons to artificially "prop up" the value of U.S. currency. (This can work in the opposite direction, I'm just using this example to avoid confusing myself.) In fact, many governments are doing that right now. China, India, South Korea, Indonesia, and many other governments have a lot of dollars in their treasuries, yet they continue to buy more. One reason is that they want their currencies to maintain a low value so that foreigners will buy a lot of their products and services, and thereby keep their people employed. They are gambling that eventually the world economy as a whole will normalize itself, and they will be able to sell back their dollars without causing a recession in their own country.
I hope this has been helpful!
06-25-04, 11:41 PM
there is more witchcraft in the currency exchange rate than anything else. Price of the same commodity (expressed in $, for example) may vary quite a lot from country to country (see MacDonald's index). Governments have a lot of controls over exchange rates, they may buy/sell a currency just to maintain an exchange rate of their choice, they may tie national currency's value to that of $, euro, etc. I doubt that entire human race determines exchange rate. Traders/governments do. The rest follows. They have little choice but follow. It appears that saying "idle hands are devil's workshop" is guiding currency exchange policies of many governments. Economics is frequently irrational thing from the common sense stand point. Working for green paper instead of working for yourself, what could be more irrational?
Kudos to Fraggle Rocker. You should be a proffessor. Kids would love you. Great explanation.
Excellent Explaination Fraggle Rocker...Many Thanks.
07-04-04, 09:56 AM
Fraggle's always awesome. I got a lot out of that post too.