Forex: Prices Fixed in Buyer's Currencies
It is quite possible that both import and export markets are structured to keep devaluation from affecting the prices import buyers on both sides perceive in terms of their own currencies. This can be the result either of seller's short-run pricing rules or of perfectly elastic long-run import demand curves.
A frequent real-world occurrence not easily represented with conventional supply curves is that settlers in the short run try to shield buyers from fluctuations in cost conditions, by letting the cost changes alter only their profit margin and not the prices seen by their customers. Some exporters followed this short-run pricing rule during two recent exchange-rate adjustments.
During the depreciation of the U.S. dollar after August 15, 1971, countless U.S. exporters reportedly kept their foreign currency prices fixed, pocketing the full rise in the dollar value of these fixed foreign currency prices as the dollar sank. On the U.S. import side, foreign auto firms such as Volkswagen kept their prices fixed in U.S. dollars, apparently not wanting to disrupt the U.S. market and lose sales volume by having their prices jump when U.S. subcompacts were not mounting in price very rapidly.
Volkswagen had to absorb the exchange-rate change by accepting fewer marks for the same dollar price on each car sold to the United States. This prevailed for several weeks, before raising its dollar prices to regain better prices in deutsche marks. Similar occurrences were noted when the British pound took dive across the fall of 1976. British auto and electronic products exporters took advantage of the increase in pound prices implied by their maintenance of sturdy dollar prices on the supplies they exported, at a time when each dollar earned bought tremendous of the depreciating pounds.
Whatever one may think of the profit and productivity consequences of this short-run pricing behavior, it does happen and it clearly does make devaluation improve the devaluing country's trade balance. Although the foreign buyers of exports notice a fixed foreign currency price and fixed sales volumes, such devaluating country saved the foreign exchange on the import side. In 1971, for example, the United States slashed the foreign currency value of its given import volumes as long as companies like Volkswagen accepted lower foreign currency prices.
In whichever currency one chooses to view this, it adds up to a trade-balance improvement for the devaluating country in the short run. Over the long run, the same result could be obtained if prices were fixed in buyer's currencies by infinite demand flexibility. With rising export volumes, fixed pound prices of exports, and declining import volumes and prices.
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