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Understanding International Finance Dynamics

Explore the history and types of exchange regimes, the role of the Federal Reserve, Euro currency, and the operations of the foreign exchange market. Learn about the Gold Standard, Bretton Woods Agreement, and Floating Exchange Rates.

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Understanding International Finance Dynamics

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  1. International Finance Overview Bill Reese

  2. Learning Objectives • In this unit we will learn: • The history of XRs in the U.S. • The different types of XR regimes • What the Federal Reserve is • What the Euro is • How the FX market operates

  3. Gold Standard • 1876 – 1913 • Values of currency set against precious metals • Each country set own conversion rate • Must maintain adequate reserves (Fort Knox) for redemption

  4. Gold Standard • Gold standard implied fixed XR • Limited growth of money supply for any country • Need enough gold • WWI limited free movement of gold

  5. 1920s and 1930s • Some countries reverted to gold standard • Some abandoned • Some pegged to dollar or pound • Period of instability • International trade declined

  6. Bretton Woods Agreement • International agreement in 1944 • Fixed exchange rates • All currencies pegged to dollar • Dollar set at $35/ounce of gold • Intervention to prevent fluctuation of > 1% • Lasted until 1973

  7. Floating Exchange Rates • By 1971, dollar had depreciated • Concerns about U.S. ability to convert dollars to gold • March 1973 • U.S. allows dollar to float • Other major currencies float as well

  8. Countries with Floating XRs

  9. Countries with Pegged XRs

  10. Floating Exchange Rates • Determined by supply and demand • Factors affecting demand • Demand for nation’s product • Demand for nation’s stocks and bonds • Inflation expectations • Government stability

  11. Floating Exchange Rates • Supply is determined by monetary policy of central bank • U.S. central bank is the Federal Reserve • Too much supply – inflation • Not enough supply - recession

  12. Federal Reserve • U.S. Central Bank • Established in 1913 • 12 federal reserve banks

  13. Federal Reserve • Board of Governors • Seven members • Appointed by President and confirmed by congress • 14-year term • Chairman’s term is four years

  14. Federal Reserve • FOMC • Chief policymaking committee • All 7 governors • President of NY fed bank • Four other fed presidents • All fed presidents attend meetings • All votes are equal • Chairman has much influence

  15. Federal Reserve • FOMC determines monetary policy • Supply of money • Purchase or sell fixed income assets • Influences short-term rates • Impacts XR

  16. Federal Reserve • Mission • Maximum employment • Stable prices • Moderate long-term interest rates • Goals may conflict • XR is not explicit goal

  17. Euro • Launched Jan. 4, 1999 • 11 original members • Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, Netherlands, Austria, Portugal, Finland • Greece, Cyprus, Estonia, Malta, Slovenia and Slovakia have joined since then

  18. Euro • Requirements for entry • Nominal inflation < 1.5% above average for three members with lowest inflation rates during previous year • Long-term rates < 2% above average for three members with lowest interest rates

  19. Euro • Requirements for entry • Fiscal deficit < 3% of GDP • Government debt < 60% of GDP

  20. Euro • Advantages • Lower transaction costs • Less XR risk • Greater price transparency and price-based competition

  21. Foreign Exchange Market • Spans the globe • Operates 24 hours/day • Major exchanges • Singapore, Hong Kong, Tokyo, Bahrain, London, New York, San Francisco, Sydney

  22. Tokyo opens Asia closing 10 AM In Tokyo Europe opening Americas open London closing Afternoon in America 6 pm In NY Lunch In Tokyo Foreign Exchange Market

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