Government intervention methods in foreign exchange markets

¶ … country can interfere in the foreign exchange markets. In many cases, the motivation for doing so lies with propping up exporters, by lowering the value of the domestic currency. While this is the most common reason for currency manipulation, it is not the only one. In some cases, currency manipulation aids in the cause of making debt disappear, lowering the value of that debt in order that it might be paid back early. This paper will discuss some of the different ways that countries can affect their exchange rates.

A freely-traded currency should reflect the economic strength of a nation, in particular the expectations for future interest rates. Where expectations for future rates are relatively low, that means that the economy is expected to perform worse. This is the case for Japan. The country has adopted a policy recently of a low yen, in order to provide some spark to its export-driven economy. When currency is affected in this way, it is usually the result of monetary policy and is done out in the open. Monetary policy to enact foreign exchange rate policy can take a couple of different forms. The first form is that interest rates are going to be kept low. Rates in Japan are low, for example, which is pushing down the yen. This also reflects, however, sluggishness in the Japanese economy, which in turn is a function of an aging, stable population and flatlining per capita consumption. There is little doubt that Japan wants to keep its rates low to suppress the yen, but this is probably still reflective of the yen's intrinsic value, given that it trades freely and the economy really is going nowhere fast (Wernie, 2014). Just the statement from the government alone was enough to move the markets.

Other monetary policy is the result of open market transactions. China is famous for using open market transactions to suppress the value of the yuan, a practice frequently derided for artificially suppressing the value of its currency for the benefit of its exporters (Staiger & Sykes, 2008). But there are other means by which a country can affect the exchange rate of its currency. China does another -- it allows the yuan to trade only within a given band. The open market supports this, but ultimately the Chinese government sets the official exchange rate for the currency (Palmer, 2012).

Usually, when a country sets an official exchange rate, it pegs that currency to a more significant currency, often a leading global currency like the USD or the Euro, but sometimes to a regional reference currency -- there are examples of ZAR, RUB and SGD all used for this purpose. The official peg will often create a situation where there is an official exchange rate and an unofficial one. Or in the case of Venezuela, four different rates depending on how important you are to the government three official rates and the (black) market rate (The Economist, 2014).