DAILY TURNOVER IN THE FOREIGN EXCHANGE MARKETS UK $637b USA 350 Japan 149 Singapore 139 Germany 94 Switzerland

zerland 82 Hong Kong 79

The Nominal and the Real Exchange Rate Foreign competitiveness is affected not only by the exchange rate but also by price fluctuations. For example, even when the nominal effective exchange rate of the sterling remains unchanged, the relative competitiveness of British goods increases when the rate of price increases of the trading partner surpasses that of Britain. Taking this into account, prices are adjusted for the nominal effective exchange rate and this rate is called the "real effective exchange rate." The nominal and real exchange rate index for the UK is shown in the chart below

A rise in the value of the exchange rate is called an appreciation of a currency meaning that more of another foreign currency can be bought with one pound. A fall in the market value of a currency is called a depreciation.

Currency War The Clash of Two Economic Superpowers

Overview Since March 2010, there is a buzz in the global economic environment about currency manipulation. The situation has given rise to a Currency War scenario as termed by the International Monetary Fund during its annual meetings held in Washington, D.C between October 8 and 10, 2010. The two economic superpowers, China and United States are posed against each other as a result of this situation. United States claims that China is purposely manipulating its currency by holding the value of yuan down against the US dollar in order to keep its exports competitive and on target. On the other hand US Federal Reserve is printing money with a view to tackle the financial crisis by infusing more liquidity in the market. This led to the appreciation of many currencies around the world including China against the US dollar. Thus, for dealing with this problem, economies like China, South Korea and Brazil intervened in the foreign currency markets and artificially held down their currency rates. How is Chinas currency depreciating? Chinas yuan policy is to keep the value of its currency low against other foreign currencies like the euro and US dollar. It does this by creating an artificial demand of other currencies in the market. Basically, if the demand of

US dollar rises in the market, the currency appreciates against the yuan. China, being a huge economy, can afford to buy US dollars in the open market and increase its demand as a result. The dollar appreciates and naturally the yuan is undervalued. This increases the US trade deficit with China because the lower value of yuan gives an edge to Chinese exporters and manufacturers against their competitors. Solution The situation where the two largest economies of the world are fighting each other is not healthy for the global market environment. Both the countries should make some efforts to sort out this problem. The currency rates on foreign exchanges should be left on the market forces instead of intervention from governments so that the global imbalances are eliminated and developing nations are not pressurized with undue currency exchange rates. After all, the growth potential of emerging economies can assist the world to enter an era of sustained prosperity which is in the interests of all economies including the United States and China.