The Time Value of the Money of 74 Countries Around 1995

The following is based on the article, "Defining Exchange Rate Parity in Terms of GPD per Hour of Work," Applied Behavioral Science Review, 1996, Vol. 4, Number 1, pages 55-79.

An exchange rate is the amount of the currency of one country that exchanges for the currency of another country. If you travel to another country, you will need to exchange the money of the country you are leaving for the money of the country you are entering. The money you receive will be determined by the currency exchange rate. Exchange rates also determine how much the goods of one country cost the people of another country when those goods are imported.

Exchange rates are fair if they are neutral, similar to how within the same country we can exchange one amount of currency for an exactly equivalent amount, say, when we trade a $10 bill for 10 $1's. Exchange rates are unfair when they are biased in favor of one country and therefore biased against another country, like giving up a $10 bill and receiving only 5 $1's in return.

Today, many currency exchange rates are unfair. It takes a few minutes of work in some countries to equal their exchange rates while in others it takes many hours of work. Fair exchange rates would have currencies trading for equal amounts of work time.

The amount of work time required to equal countries' exchange rates around 1995 are shown in the second table below. The data used to calculate them are from the December, 1996 issue of International Financial Statistics published by the International Monetary Fund. Exchange rates are end of period rates per Standard Drawing Rights (1.49 SDR = $1 US).

Hour rates were calculated by dividing Gross Domestic Product by number of people employed times 2000. The 2000 represents the number of hours a person would work in a year at 40 hours per week for 50 weeks. So the divisor is an estimate of the total hours of work that produced the GDP. Estimates for the 74 countries in the table below are based on number of people employed times 2000.

To get an estimate of total hours worked for countries where the number of people employed is not available, a fair approximation is half the total population times 2000.

Hour rates and exchange rates correlate strongly. For 1994-1995, hour rates correlate .78 with exchange rates. Their logarithms correlate .88. These strong correlations mean that work time accounts for 78 to 88 percent of 1994-95 currency exchange rates. Strong correlations have existed throughout the 50 year history of the International Monetary Fund.

Correlations of Exchange Rates and Hour Rates

In IMF	Number of
Since	Countries		1950	1960	1970	1980	1985	Avg.
1950-	42	Rates	.89	.94	.98	.96	.95	.94
		Logs	.90	.88	.84	.86	.83	.86
1960-	20	Rates		.82	.60	.92	.89	.81
		Logs		.95	.91	.73	.89	.87
1970-	27	Rates			.75	.58	.62	.65
		Logs			.85	.79	.82	.82
1980-	24	Rates				.57	.68	.63
		Logs				.75	.71	.73
Misc.	29	Rates	.41					.41
Years		Logs	.78					.78

The strength of the correlations vary with length of membership in the International Monetary Fund. The correlations are strongest for the 42 countries that have been in the IMF for the longest time. The weakest correlation, r = .41, occurs for the 29 countries that entered and left the IMF at various times thoughout IMF history. These correlations tell us that the work hour is the center of gravity for exchange rates. It is probably the equilibrium point dictated by economic fundamentals that economists seek.

In spite of these strong correlations, deviations from hour-for-hour exchange rates favor some countries at the expense of others. This is clear when each country's exchange rate is expressed in minutes of work (Exchange Rate/Hour Rate times 60). If exchange rates were fair, all exchange rates would equal the same number of minutes. Instead, Japan at the head of list has an exchange rate equal to a fraction more than 2 minutes. Down the list, work time increases to a crippling 415 minutes for Bangladesh at the end of the list.

Are these differences due to differences in productivity? If that were so, we should expect the products of the most productive countries to be cheaper, not more expensive, than the products of less productive countries. Instead, exchange rates make the products of the supposedly most productive countries more expensive than those of the least productive countries. It is directly opposite to what fair price would dictate.

Countries close to each other on the list can trade with each other on fair terms. The further apart on the list, the more unfair the terms of trade between countries. For example, Switzerland and Norway can trade fairly. Their exchange rates are both equal to about 2.5 minutes. But trade between Austria and Hungary is biased in favor of Austria where about 3 minutes of work equals the exchange rate of its schilling compared to Hungary where 13 minutes of work are needed to equal the exchange rate of its forint.

What needs to be done is to move exchange rates to work time parity - to where they trade on an equitable basis - equal work time for equal work time. The strong correlations between work time currency exchange rates and actual rates throughout the history of the IMF, especially for countries that have been members longer, tell us that work time parity is where exchange rates tend naturally. Deviations are probably maintained unnaturally by the desire of the countries that control the IMF to keep exchange rates biased in their favor. But this is the main reason that so many countries today are poor when we have at hand the means for all countries to be wealthy.

To read an abstract of the original article, browse: Applied Behavior Science Review