2The global factors4
3Changes in the world economy6
5Types of costs8
The global economy has increased the interdependence of national economies. Multinational companies dominate the international economy. The integration of the financial markets and the internet technology give access to investments in foreign countries.
As investors increasingly buy assets in a high yield foreign currency the exchange rates in this specific currency rises. This leads to a reduction in exported and an increase in imported goods. The balance is easily disturbed and governments find it increasingly difficult to control rising inflation. The economic relations between countries are very complex as each country has its monetary policy. Japan for example exerts a strong control on the exchange rates due to a high export percentage, whereas the U.S. does not use the currency operations as a tool of monetary policy.
Companies are confronted with different cultures and markets and have to differentiate their products in order to maximize their profit in clearly separated market segments. Investments in foreign countries have become easier, and multinational companies benefit from economy of scales and low cost production using the cheapest resources available. 2The global factors In a global economy, multinational companies independent of national government, dominate the international economy. This increases the interdependence of nations as each multinational company invests their assets in several countries. Those companies respond effectively to differing regional demand. Furthermore, they benefit from economy of scales and low cost production using the cheapest resources available. The global economy has opened the market boundaries to foreign capital, making investment in a foreign currency accessible.
The exchange rate is determined by the demand in a currency (export) and the supply of currency (import) as companies need currencies to trade on the open market. The exchange rate fluctuates linked to the interest rate. Furthermore, technology has made the access to investment opportunities in foreign countries easier as investors can now trade directly at foreign stock markets. The integration of financial markets allows investors to hold their money in a foreign currency.
Demand of currency and exchange rate (Siilats, 2002)
Foreign investors, who want to hold their assets in a high-yielding currency with a strong growth potential, will invest into a currency with a high exchange rate. Therefore, the demand in this currency will increase and because of the increase in demand, the currency will be appreciated. Additionally, the appreciation of the currency linked to an increase of the interest rate will trigger inflation.
A high exchange rate in a country’s currency will boost imports as goods and services in foreign countries are cheaper. However, it will lessen exports, which will affect the Gross Domestic Product (GDP). In particular the tourism and retail industries will benefit from a high exchange rate in another currency. This will have an effect on the demand in foreign countries and an increase in GDP for the affected countries.
However, there are differences in the way governments deal with exchange rates fluctuations. Since 1992, the UK has adopted a monetary policy strategy of floating exchange rates and inflation forecast targeting (Bank of England, 2008). The U.S. monetary policy does not have targets for the exchange rate. In case the dollar depreciates the Fed will sell foreign currency to absorb some of the dollars selling pressure (Federal Reserve Bank, 2004). The European monetary policy is similar to the U.S. policy, but transactions in Euro...