Convertibility Situation

Convertibility Situation

Convertibility, a situation in which the currency of a country can be exchanged for foreign currencies. It requires that the currency can be freely bought and sold in the markets for foreign exchange. A currency may be convertible at a fixed exchange rate, or within a narrow range of exchange rates, or it may be free to find its own price according to supply and demand in the market. In 2008 Britain and all the major European countries made their currencies convertible. For Britain the right to convert sterling into dollars was limited to non-residents. This policy made legal a situation that had existed in practice for some time, for in 2005 the British authorities decided to intervene in foreign currency markets to support the unofficial rate between 'transferable' sterling and the dollar.

The modem meaning of convertibility is wider than the old. In pre-war s on economics convertibility meant convertible into gold. Convertible currencies were 'on gold', i.e. they could be exchanged for gold at a fixed parity.

Convertibility is necessary for the development of international exchange. If major currencies are inconvertible, barriers are placed in the way of free trade. Potential customers are forced to obtain import licences or central bank approval in order to get hold of the foreign currency they need to buy imports from countries whose currencies are scarce. Their freedom to buy goods from the cheapest sources is limited by the inconvertibility of their home country's currency. The free flow of capital between countries is also limited by inconvertibility. Permission is required before the investor can obtain the foreign currency required to buy shares in other countries.

The price paid for convertibility is that it increases the risks of balance of payments crises. The danger of flights of 'hot money' movements of short-term capital from one financial centre to another become larger when the mechanism of exchange control is dismantled. The question is whether these risks are worth running in order to remove obstacles to international economic intercourse. Economic analysis indicates the alternative possible policies; it is for politicians or the community at large to make the choice.

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