Twin Cities Business Daily

What is the effect of freezing an exchange rate?

Would someone be kind enough to explain (in layman terms please), what freezing an exchange rate means as well as what the implications are. Many thanks.

Public Comments

1. You can't freeze an exchange rate, but you can tie it to the value of another currency (in the way that the Chinese Yuan is tied to the US$). It means that your economy is to some extent at the mercy of the other country's economy, as you are not able to use some fiscal means to regulate your own economy.
2. This is only possible in a 'controlled economy' (typically only Communist / Soviet system) with a 'non-convertible' currency. It is sometimes a response to the mass export of wealth that follows a change in Government that abandons basic property rights and thus a total collapse of 'in-country' asset values (see Financial Rand), although most countries (including UK - from WW2 until abolished by Thatcher in 1979) adopt 'exchange controls' instead .. The result is an artificial 'official' exchange rate (eg 1 Rouble = $1) that is totally out-of-step with the real world market rates (eg. 100 Rouble = $1). Visitors are forced to exchange all their non-native currency at port of entry at the official rate .. and on leaving they are paid the official rate on any remaining native currency .. whilst foreign investors are forced to deal in the native currency and can only 'export' their profits at the official exchange rate. Needless to say, very soon a thriving 'black-market' arises in which every official who can, swaps their native currency for (usually) $ at the 'official rate' and then uses the $ to buy more native currency at the black-market rate ... which they then swap at the official rate again, thereby multiplying their gain by 10x to 100x on each swap .... Visitors quickly learn to conceal their $ at entry or bring in goods the can sell (at one time visitors were being offered 1,000 Roubles for a pair of Jeans in Red Square) .. needless to say, eventually the officials stop converting native currency back to $ on exit (thereby driving one more nail into the coffin of international trade and tourism ..) In the meanwhile, importers discover that foreign suppliers either refuse to deal at all or adopt a 'barter' approach i.e. they agree commodity 'swaps' (eg "Vodka - Cola" deal, "Oil for Wheat", in fact, anything at all instead of the debased native currency). If this persists for long enough, the entire country descends into a 'barter economy' as those with goods refuse to accept anything other than $$'s or some 'swap' ... whilst the state as a whole ends up 'exporting' all it's wealth in raw materials .. Eventually with all their foreign currency exchanged at the artificial rate the state has to start borrowing on the international money markets .. this soon leads to debt defaults and collapse of your financial system as no-one will lend to you at any rate .. See links ...