She holds the Certified Financial Education Instructor (CFEI) certification issued by the National Financial Educators Council. So when the U.S raised red flags, Vietnam’s central bank agreed to “improve exchange rate flexibility over time” so that Dong reflects the real-world economy and the markets.Libby Kane, CFEI, is the Executive Editor for Personal Finance Insider, Insider's personal finance section that incorporates affiliate and commerce partnerships into the news, insights, and advice about money Insider readers already know and love. Now, if Vietnam manipulates the exchange rate, by buying or selling USD it will have an unfair competitive advantage. Its goods’ trade surplus with the United States jumped 25% in 2020 to $69.7 billion. And that’s exactly how Vietnam had been benefitting.īecause of the trade wars between China and the U.S, Vietnam had been taking away a significant chunk of the exports to the U.S. You see? If Dongs become cheaper, for the same pen, a foreigner will have to pay fewer Dollars to buy it. On the other hand, if the exchange rate were Dongs 25,000/USD (which means Dongs becomes cheaper), then the cost of the pen would be USD 1.428. If the exchange rate were Dongs 23,000/USD, the cost of the pen would be USD 2. They have their own tools).īut why would Vietnam undervalue its currency and why will the US have a problem with that? By as much as 47%!Īmerica’s Treasury department also realized this (though, they don’t use the Big Mac Index to measure such discrepancies. So if you can get more dongs for the same dollar, it means Dong is undervalued. Currently, $1 can fetch you 23,000 dongs. So, if you get a Big Mac for $5.65 in the U.S and you get the same burger for 69,000 dong in Vietnam, then it means,Īnd if that does not happen, it means that this could be a sign that something or the other is going wrong. Right? And if the costs are the same, then the price of the burger should also be the same? So ideally the cost of making a burger across all the nations should be the same. And uniformity is something that you can definitely trust McDonald’s with. McDonald’s serves Big Macs in nearly 120 nations.
Whatever you would have thought, a McDonald’s burger would definitely not have crossed your mind. What is that one thing that is uniform all across the world? Fluctuations then became a function of mere demand and supply. With the US as the superpower, the currencies were now linked to the US Dollar. As gold couldn’t be mined fast enough (takes approx 10 years), the US called for all nations to de-link currency and gold, and mutually decide a standard. That’s how exchange rates were determined.īut as economies grew, they needed to print more money, which could not be done if they did not have sufficient gold in their reserves. Similarly, the UK has ￡1,000 printed, backed by 50 tonnes of gold. The more, the merrier.Įg: Assume the US has a total of $100 printed, backed by 50 tonnes of gold. The amount of gold you had determined the value of your currency. How would the individual countries have a common exchange value? What would determine this value? What would the value depend on?Īnd thus, began the era of the Gold Standard. Now, the major function of a currency is to serve as a medium of exchange. Each territory (now, countries) has its own currency. How do you know what is worth what and whether items are constantly being overvalued and undervalued?Īnd so, transactions moved to various forms of currency. Flashback to the good old days: our predecessors were busy trading food for clothes, clothes for jewellery, jewellery for utensils.
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