For foreign monies automatically corrects balance of payments deficits and surpluses

Though freely fluctuating exchange rates automatically tend to eliminate payments imbalances,

they may entail several significant problems; the main ones are:

Uncertainty and diminished trade. The risks and uncertainties associated with flexible exchange

rates may discourage the flow of trade. To illustrate: Suppose an American automobile dealer contracts

to purchase ten Toyota cars for 18 billion yen. At the current exchange rate of, say, $1 for

100 yen, the American importer expects to pay $180,000 for these automobiles. But if in the threemonth

delivery period the rate of exchange shifts to $1 for 90 yen, the 18 billion yen payment

contracted by the American importer will now amount to $198,000, i.e. 10 percent increase. This

unheralded increase in the dollar price of yen may easily turn the potential American importer’s

Anticipated profits into substantial losses.

The same rationale applies to investment. Investment is inherently risky. The added risk posed

By adverse changes in exchange rates may persuade the potential investor to shy away from overseas

Ventures.

Terms of trade. A nation’s terms of trade will tend to be worsened by a decline in the international

Value of its currency. For example, an increase in the dollar price of yen will mean that the United States