Connection Between a Country’s Evolution and Parity Conditions
The parity conditions within a given country can be eventually linked to different manifestations of currency or a country’s evolution. In the course of international trade, the constant exchange of currencies may give rise to various discrepancies. The parities are often more pronounced when the disparities between the two exchanged currencies are substantial. However, if the economic trajectories of any two countries remain constant, the parity conditions do not have any significant impact. The problem arises when one of the trading countries experiences an economic evolution that is accompanied by a significant shift in currency status.
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For instance, parity conditions are most noticeable when “economic conditions and changes in economic conditions in different countries take effect on the value of goods measured in different currencies and the relative values and opportunity costs of these currencies” (Bhatti and Moosa 49). Therefore, if a country is experiencing rapid changes in its economic outlook, the sudden jolts in valuation can be linked to parity conditions. It might take some time for arising parities to be noticed and realigned in cases of currency evolution. Furthermore, the fast-changing nature of a country’s economic landscape makes it difficult for stakeholders to keep up with rapid changes in parity conditions.
Most currencies derive their value from international parities. However, the factors of currency evolution are also an important consideration when determining parity conditions that touch on a country’s economic circumstances and other arbitrage factors. Interestingly, a currency or country evolution might trigger distortions in parity conditions. On the other hand, parity conditions can trigger a currency or country evolution, albeit in a smaller scope. Some of the most prominent parity conditions include interest rate parity (IRP), purchasing power parity (PPP), and the international fisher effect (IFE) (Gandolfo 56). All these parities determine the growth patterns of any currency that features in the international market.
In extreme cases, it is not possible to curb the evolution of any currency using international settlements. For instance, in the past few decades, the United States has unsuccessfully tried to affect the evolution of the Chinese currency. After assuming office, President Trump sought to address the parities that offer China an advantage when it comes to currency policies. According to the President, China’s currency evolution makes the country a ‘currency manipulator’ owing to the pre-existing parity conditions (Dorn 1).
In an attempt to address this problem, the country has eventually turned to the assistance of the National Trade Council (NTC), a body that reports directly to the White House. According to the NTC, all countries that are guilty of lowering their foreign exchange values should be subjected to financial penalties. For a long time, China has been accused of manipulating its IRP because it does not match the country’s PPP. The US considers currency manipulation as an unfair subsidy to countries that practice it, and economic experts have proposed anti-subsidy countermeasures to deal with these undue parity conditions. However, the World Trade organization is yet to classify currency manipulation as a punishable practice in the context of international trade (Cox 1).
It is estimated that some of the most established economies in the world, such as that of the US lose up to five million jobs through undervalued currencies. The US also reports lost GDP to the value of $720 billion annually. Countries that have issues with artificial currency parity include Japan, Switzerland, and other rapidly evolving economies such as Malaysia, Russia, and Singapore. Parity issues are also common among countries that are net exporters of commodities such as oil. To contravene common parity conditions, countries often rely on central banks, mostly in a bid to make their exports cheap. South-East Asia is the region where parity conditions are manifested in an unusual manner (Johnson 1).
Difference Between the Interest Rate Parity (IRP) and the Rest of the Parity Conditions
The standard definition of IRP is that it is “a theory in which the interest rate differential between two countries is equal to the differential between the forward exchange rate and the spot exchange rate” (Jung 2). However, in my opinion, IRP is most relevant as a tool for regulating foreign exchange markets and their accompanying factors, which include exchange rates and interest rates. It is important to note that all parity conditions are interrelated in one way or another.
However, each condition has a defining factor that makes is different from the rest. The main difference between IRP and the rest of the factors is that it is the only condition that can shift markets on its own without the input of the other factors. While the other parity conditions have a mostly theoretical aspect, IRP’s impact is mostly practical. Therefore, IRP stands out because it is the universal parity condition in regards to money markets. In this regard, most of the other parity conditions contribute to the functionality of IRP. For example, changes in PPP will affect the commodity markets, which will, in turn, raise interest rates, and eventually, the rates will influence the future spot rate (IFE). Eventually, this chain of events will contribute towards market shocks through IRP.
Cox, Ryan. “Chinese Yuan Still Undervalued According to Purchasing Power Parity Purchasing Power Parity.” DailyFX. 2015. Web.
Dorn, James. “Trump’s New Currency Plan a Flimsy Attempt to Confront China.” The Hill News. 2017. Thehill.com. Web.
Bhatti, Razzaque H., and Imad A. Moosa. International Parity Conditions: Theory, Econometric Testing and Empirical Evidence. Springer, 2016.
Gandolfo, Giancarlo. “International Interest-Rate Parity Conditions.” International Finance and Open-Economy Macroeconomics, Springer Berlin Heidelberg, 2016, pp. 53-66.
Johnson, Dave. “What is Currency Manipulation”. Our Future. 2014. OurFuture.org. Web.
Jung, Minje. “Relationship between the Market Deviation from the Interest Rate Parity and the Net Working Capital Decision of the US Multinational Corporations.” International Journal of Business, Accounting, & Finance vol. 7, no. 2, 2013, pp. 1-9.