Chapter 16

The foreign sector

Exchange rates
Presented by Dr GG van Gend

OBJECTIVES OF THIS PRESENTATION

What is an exchange rate
What factors influences the exchange
rate
Why do we have different currencies in
different countries
Buying and selling goods across borders
Explain how the exchange rate is
determined between the US dollar and
the SA rand
Explain a depreciation and appreciation
of a currency.
Explain the concept Manage Floating

16.4

E XC H A N G E R AT E S

D E F IN E E XCH A N G E R ATE

The exchange rate is the prices of one

currency quoted in terms of another
currency. It is thus an exchange ratio
between the two currencies.
Direct quoting
R10 = $1. Ratio
Indirect quoting

10 : 1

R 1 = 10 USA cents
The market where currencies are traded (bought
and sold) is called the foreign exchange market.

1. Unified monetary policy - a difference in currency allows each individual

country to have independent monetary policies. Take Japan for example:
Japan's economy depends on exports, so Bank of Japan has an incentive to
devaluate their currency to boost the economy through exports. If Japan uses
the US Dollar, the value of their exports will be dictated by the importing
country; which is not good.
2. Spending habits - each individual country differs in culture, as well as
spending habits. Take Greece for example: they love discretionary spending
(Government spending). If they use the same currency as their trade partners
(and they do) all users of that currency will have to adjust the monetary policy to
cater for all. The extreme opposite of Greece would be Germany. German
economy does not do much discretionary spending. So since they share the
same currency, one monetary policy won't fit them both.
3. Macroeconomic events - Imagine if all of us uses the US Dollar, and then
9/11 happened. The events on one country will have a much, much larger
ripple effect than what it usually experiences. There would also be no idea of
an "emerging market", since all countries will be using the same currency and

WHY DO I WANT TO BUY OTHER COUNTRIES

CURRENCY
If you want to buy a product in the USA, you will firstly have to
obtain (BUY) $ to pay for the good as seller in the USA do not
accept Rand as payment. You will have to convert Rand to $
through the foreign exchange market of which the major traders
are BANKS.
On your request to transfer the amount of $ to USA the bank will
deduct from your account the amount of Rand that will buy the
correct amount of $. Your imports generated a demand for $.
The opposite holds. If a person in the USA want to buy a product
in the SA, he/she will firstly have to obtain (BUY) Rand to pay for
the good as the in the SA do not accept $ as payment. He/she
will have to convert $ to Rand. His/her imports (our exports) has
generated a supply of $
The sum of the of the demand for $ and supply of $ will
determine the exchange rate.

 FACTORS INFLUENCING THE EXCHANGE RATE

1. Differentials in Inflation in countries
2. Differentials in Interest Rates offered by
countries
3. Current-Account Deficits
4. Public Debt (government borrowing)
5. Terms of Trade (export prices: import
prices)
6. Political Stability and Economic
Performance
Policy makers should note the possible impact of
any changes in the determinants of the exchange
rates on economic activity

WHO IS THE DEMANDERS AND SUPPLIERS OF

CURRENCIES THAT NEED TO EXCHANGE
THEIR DOMESTIC CURRENCY FOR THE
CURRENCY OF A FOREIGN COUNTRY?

Demander for $:
SA importers from, and investors in the
USA need $ to make payment in the USA
Suppliers of $
USA importers and investors in SA needs
Rand to make payments in SA.
Through exports (USA imports) the flow of
dollar to SA accumulates to form part of
our foreign reserve holdings at the SARB.
These reserves serves as source for funds
for SA importers of goods and services

EXCHANGE RATES
DEMAND FOR DOLLARS

SA importing from USA. (Exports by

USA)
SA citizens buying shares aboard.
SA tourists to the US
Speculators anticipating the rand to
depreciate

EXCHANGE RATES
SUPPLY FOR DOLLARS

USA importing from SA (SA

exports)
Foreigners buying shares in JSE
(SA).
Foreign tourists
Speculators who anticipate the
rand to appreciate

FIGURE 16.2
T H E F O R E I G N E XC H A N G E
MARKET
E XC E SS D E M A N D / E XC E SS
S U P P LY

At R8 we have
equilibrium in the
foreign exchange
market
At R10 per $ we have
an excess supply of $
At R6 per $ we have
an excess demand
for $

FIG 16.3

A DEPRECIATION OF THE

RAND
WHEN HOUSEHOLDS,
GOEVERMENT AND FIRMS
FROM THE USA IMPORTS
LESS FROM SA, THEY
SUPPLY LESS DOLLARS
EXAMPLE: A FALL IN THE
GOLD PRICE MEANS THAT
BUYERS OF GOLD OFFER
SA LESS DOLLAR FOR
SAME QUANTITY OF GOLD
THE RAND WILL
DEPRECIATE, ASSUME
FROM R8 TO R9 PER
DOLLAR

DEPRECIATION OF THE RAND

THROUGH INCREASED IMPORTS
R/$

D1
S

E1

8,00
7,50

10

Rand depreciates
Dollar
appreciates

12

Quantity of
Dollars

APPRECIATION OF THE RAND

THROUGH INCREASED EXPORTS
R/$

D
S
S1

8,00
7,50

E
E1

12 14

Rand
appreciates
Dollar
depreciates
Quantity of
Dollars

TABLE 16.1 CHANGES IN THE SUPPLY AND

DEMAND FOR DOLL AR

TABLE16.1
CHANGES IN SUPPLY OF DOLLARS
Change

The supply curve

shifts

Impact on
Rand/Dollar
Exchange rate
Rand

Dollar

SA exporters of goods to USA

increase

Supply curve shifts

rightwards

Appreciates

Depreciates

Foreigners buying shares on JSE (SA).

Supply curve shifts

rightwards

Appreciates

Depreciates

Foreign tourists visiting SA increase

Supply curve shifts

rightwards

Appreciates

Depreciates

Gold price increase

Supply curve shifts

rightwards

Appreciates

Depreciates

USA firms buy more South African

minerals

Supply curve shifts

rightwards

Appreciates

Depreciates

Southern Business School

USA citizensstop
investing in South
Africa

Supply curve shifts leftwards

Depreciates

15
Appreciates

CHANGES IN DEMAND FOR DOLLARS

Change

Demand curve
shift

Impact on Rand/Dollar
Exchange rate
Rand

Dollar

SA imports increase

Demand curve
shifts rightwards

Depreciate

Appreciate

SA citizens buying shares

aboard.

Demand curve
shifts rightwards

Depreciate

Appreciate

SA tourists to the US

Demand curve
shifts rightwards

Depreciate

Appreciate

Appreciate

Depreciate

Recession in SA causing
Demand curve
a decrease in demand for shifts leftwards
Southern Business School
USA goods

16

EXCHANGE RATES

The interaction between A CHANGE IN DEMAND

and A CHANGE IN SUPPLY determines the
exchange rate.
Not a change in QUANTITY DEMANDED OR
QUANTITY SUPPLIED
Therefore, we will always have a shift of the
demand or supply curve..
NEVER A MOVEMENT ALONG THE CURVE

QUESTIONS

Explain why the South African Clothing and

Textile Workers Union would tend to
support a call for an increase in the tariffs
on imported clothing.
.

ANSWER

Domestic supply increase due to

higher price and higher profits
Demand for workers increases
Domestic demand increases
Government revenue increases
Balance of payments improve less
imports

Demand for dollars increase

Rand currency depreciates sell rands
US Dollar appreciates due to demand for dollars that
increases

Supply of dollars increase

Rand currency appreciates Demand for rands by US firms and
households
US Dollar depreciates due to supply of dollars that
increases
Table 17-4 and Table 17-5 important.

E X A M I N AT I O N E X A M P L E

EXAMPLE

More capital
goods are
imported from
China
Foreign
Investment in
SA increases
Speculators
expect the rand
to depreciate
SA interest rates
are lower than

DEMAND/SUPPLY
FOR DOLLAR

RAND
DEPRECIATE/APPRECIA
TE

29

EXAMINATION EXAMPLE
EXAMPLE

DEMAND/SUPPLY FOR
DOLLAR

RAND
DEPRECIATE/APPRECI
ATE

Demand for Dollars

increases

Depreciation of Rand

Foreign Investment in
SA increases

Supply for Dollar

increases

Appreciation of the
Rand

Speculators expect
the rand to depreciate

Demand for Dollars

increases

Depreciation of Rand

SA interest rates are

lower than foreign
interest rates

Demand for Dollars

increases

Depreciation of the
Rand

SA experiences a high
rate of inflation

Demand for Dollars

increases

Depreciation of30the
Rand

More capital goods

are imported from
China

QUESTIONS

1.Use a diagram to explain how an

increase in interest rate in South
Africa would affect the foreign
exchange market.
2.What would happen to the value
of the rand as interest rate
increases?