The Levels of Foreign Exchange Rates
FOREIGN exchange rates express the rate at which one currency may be exchanged for another. In terms of international economic arrangements, it is the connecting link between the price levels of two countries or of one country and the rest of the world, and therefore is an important factor in encouraging or discouraging exports or imports as well as influencing other items in the balance of payments such as tourism and investment.
In the nineteenth century, exchange rates were fixed by the fact that currencies could be converted into gold and gold could be used as payment. Therefore, the exchange rate approximated the relative gold content of the currencies and did not fluctuate beyond the costs of gold shipment. The system of unrestricted currency interchangeability at fixed rates existed until 1914 and for a few years in the 1920's.
It came to an end with the introduction of foreign exchange controls in many countries, beginning in central Europe in 1931. The depression years before the second World War were marked by a series of more or less competitive and retaliatory exchange depreciations in the attempt to protect reserves and export unemployment, with Germany in particular demonstrating that exchange machinery might be used as a foreign policy instrument.
During the war and immediately thereafter, a good deal of thinking, planning, and negotiating was devoted to the purpose