prices in foreign currencies with the latest exchange rates. But given the fact that this to some people creates a psychological barrier greater than it should be for rational reasons, it still creates a small barrier.
A more important reason for why different currencies are a barrier to trade is exchange rate fluctuations or more importantly the fear of exchange rate fluctuations. This is of course not applicable to credible fixed-exchange rate regimes, but only to countries with floating exchange rates as well as fixed-exchange rate systems which lacks credibility.
Exchange rate fluctuations create a great deal of uncertainty which makes people less inclined to make investments which involves trade with other currency zones. This is because a changing exchange rate might undermine the profitability of a investment project deemed profitable at the current exchange rate. Take for example a businessman in England who considers an investment which will enable exports of cookies to Germany. His costs may be say £0.75 per box of cookies and he will be able to sell them in Germany for €1.26 per box. At the time, the exchange rate may have been €1.50/£ and he would therefore be able to sell them for £0.84 per box, making a profit of £0.09 per box. But if the exchange rates moves to €1.75/£ then his income will only be £0.72 and he will make a loss of £0.03 per box.
The dampening effects on trade from exchange rate risks is enhanced from the fact that export firms often also imports some of the materials needed to make the goods . Say that this businessman imported raw materials like sugar and wheat from the United States worth of $0.63 per box, which at the hypothetical exchange rate of $1.75/£ meant £0.36 per box. If the exchange rate goes to $1.50/£ then the costs will rise to £0.42 and overall costs will rise to £0.81. The effects of the pounds movement on the dollar and the euro will then turn the projected net profit of £0.09 per box into a net loss of £0.09 per box.
One counter-argument to the »exchange rate risk« argument is that the risk can be traded away with different forms of financial market instruments. If a British company expects a income of