Question

Critical Thinking: Most of the world has floating exchange rates, but the Euro Zone combined the currencies of 17 countries to in effect, create a fixed exchange rate between them. China has a fixed exchange rate with the US dollar, and under values their exchange rate by 17% - 19%, thus giving them an unfair advantage in international exchange. Should the world governments get together and set up a common rule for currency exchange? Discuss.

Answer 1

The common currency has certain benefits which are the elimination of transaction cost while converting currency. The benefits are mainly situated at the micro level but the cost of common currency deals on the macro level. There will be gains in economic efficiency as the cost of transaction gets eliminated and risk of tentative future movements will not be there. There will not be only direct gains but some indirect gains also like decrease of the possibility of price discrimination between national markets. The cost of the transaction is something like a tax paid by the individuals. This will benefit the individual as he was only getting worse off after paying tax. The transaction would likely to occur smoothly in a common currency rule. European Community Commission saved around 20 billion ECUs per year by the elimination of the transaction costs. So, it would be good if there will be a common currency but some economies who benefits from the future movements in the exchange rate will eventually worse off. So, governments should set the common currency rule in order to get the direct and indirect gains associated with it.