Forex: Changes in Monetary Value
A change in the value of one currency relative to that of another may be large or small, but both possibilities must be considered. The currencies of countries that are members of the International Monetary Fund (IMF) fluctuate within set percentages of a parity expressed in gold and dollars.
Certain countries, such as Switzerland, that are not members of the IMF also control their currency within equivalent limits. Other countries have more than one set of equivalent values and frequently change the limits.
The decision by the United States in August 1971 to stop selling gold at $35 an ounce resulted in a floating of almost all major currencies against the dollar outside the parities and limits called for by the IMF. New parities were agreed upon in December 1971. The wider limits or the elimination of a fixed parity make the management of foreign exchange more difficult and the risk greater.
In general, regardless of how parity is set, devaluation or a revaluation occurs when the parity is changed. Fluctuations on either side of parity had the same effect, but of course, generally did not persist and could not exceed set limits. They should, however, be taken into consideration.
After all, a ½ percent change over a period of one month amounts to 6 percent on a per annum basis, which can be significant.
Second, changes in currency values affect the translation of accounts abroad even when no transfer of funds is immediately involved. As pointed out previously, a multinational business generally uses a common denominator in evaluating results whether or not those results are reported on a consolidated basis.
For instance, if a businessman in the United States were using dollars as his base currency, he would not say he made p in dollars, q in francs, and r in pounds. He would report, 'We made p dollars in the United States, y dollars in France, and z dollars in United Kingdom'. He would generally receive reports in dollars so that he could evaluate and compare the results and might very well give a total dollar figure for the business as a whole.
However, there is a pitfall for management in doing that; the tendency is to forget everything is not actually in dollars, but only expressed that way. Based on the example that was described, total cash is not dollars alone, but dollars, francs, and pounds.
A change in the value of a currency other than that being used for a common denominator results in a change in the value placed upon assets and liabilities in the country that of that currency, and the net worth of the foreign entity. In turn, that change has an effect on operating results and decisions.