3. Learning Objectives
• Basic understanding of international monetary
system
• Basic understanding of currency/foreign
exchange
• Understanding cause and effect of current
events
4. Assessment
• Participation in class discussions 20%
• Case study analysis and presentation 35%
• Almost daily homework 15%
• Final project 30%
5. Class Schedule
• 6/29 Lecture/Discussion
– About the course
– Comparative advantage
– International monetary systems
• 7/3 Lecture/Discussion
– European Monetary Community
– Balance of payments
– 2007-9 credit crisis
6. Class Schedule
• 7/6 Case Study
– California Budget Crisis
• 7/11 Lecture/Discussion
– Foreign exchange market
• 7/13 Case Study
– The Greek Crisis
• 7/18 Lecture/Discussion
– International parity conditions
– Final project teams/topics
7. Class Schedule
• 7/20 Case Study
– China Unbalanced
• 7/25 Lecture/Discussion
– Group meetings/discussions
• 7/27 Final project presentations/discussion
• 8/1 Final project presentations/discussion
9. Case Studies
• Be prepared
– Read before class
– Simple homework questions due at class time
– Class discussion
– Team analysis due next class
10. Almost daily homework
• Will post articles and questions by morning
after class
• Due at beginning of next class
• Will discuss at beginning of class
11. Final Project
• Report and presentation
• In teams
• Assigned/select a country to analyze
– Not where you are from
14. The Global Financial Marketplace
• We may characterize the market place as links among three
items
– Assets – at the heart of the financial asset markets are government
issued debt securities. Several financial assets derive their value from
these underlying financial instruments. The financial markets depend
upon the health of these government securities
15. The Global Financial Marketplace
– Institutions
• Central banks which control each country’s money
supply
• Commercial banks which take deposits and make loans
• Other financial institutions created to develop, market,
and trade securities and derivatives
– Linkages – the interbank networks that provide
the actual medium for exchange e.g. LIBOR
16. The Theory of Comparative
Advantage
• The theory of competitive advantage provides a basis for
explaining and justifying international trade in a model assumed
to enjoy
– Free trade
– Perfect competition
– No uncertainty
– Costless information
– No government interference
17. The Theory of Comparative
Advantage
• The features of the theory are as follows;
– Exporters in Country A sell goods or services to unrelated importers in
Country B
– Firms in Country A specialize in making products that can be produced
relatively efficiently, given Country A’s endowment of factors of
production (land, labor, capital, and technology)
– Country B does the same with different products (based on different
factors of production)
18. The Theory of Comparative
Advantage
– Because the factors of production cannot be
transported, the benefits of specialization are
realized through international trade
– The terms of trade, the ratio at which quantities of
goods are exchanged, shows the benefits of
excess production
– Neither Country A nor Country B is worse off than
before trade, and typically both are better off
(albeit perhaps unequally)
19. The Theory of Comparative
Advantage
• For and example of the benefits of free trade based on
comparative advantage, assume Thailand is more efficient
than Brazil at producing both sports shoes and stereo
equipment
• With one unit of production (a mix of land, labor, capital, and
technology), efficient Thailand can produce either 12 shipping
containers of shoes or 6 shipping containers of stereo
equipment
• Brazil, being less efficient in both, can produce only 10
containers of shoes or 2 containers of stereo equipment with
one unit of input
20. The Theory of Comparative
Advantage
• A production unit in Thailand has an absolute advantage over a
production unit in Brazil in both shoes and stereo equipment
• Thailand has a larger relative advantage over Brazil
in producing stereo equipment (6 to 2) than shoes
(12 to 10)
• As long as these ratios are unequal, comparative advantage exists
• The following exhibit illustrates total world (in this example) production
and consumption if there was no trade and if each country completely
specialized in one product
21. The Theory of Comparative
Advantage
• Clearly the world in total is better off because there are now
10,000 containers of shoes (instead of just 6,000), as well as
6,000 containers of stereo equipment (instead of just 5,600)
• However, the goods are not distributed across international
boundaries!
22. The Theory of Comparative
Advantage
• Trade can resolve that distribution problem
• While total production of goods has increased with the
specialization process, international trade at a certain range
of prices (containers of shoes for a container of stereo
equipment) can be distributed between the countries
• This exchange ratio will determine how the larger output is
distributed
23. The Theory of Comparative
Advantage: Limitations
• Although international trade might have approached the
comparative advantage model during the nineteenth century,
it certainly does not today;
– Countries do not appear to specialize only in those products that
could be most efficiently produced by that country’s particular factors
of production
– At least two of the factors of production (capital and technology) now
flow easily between countries (rather than only indirectly through
traded goods and services)
– Modern factors of production are more numerous than this simple
model
– Comparative advantage shifts over time
24. The Theory of Comparative Advantage
• Comparative advantage is still, however, a relevant theory to
explain why particular countries are most suitable for exports
of goods and services that support the global supply chain of
both MNEs and domestic firms
• The comparative advantage of the 21st century, however, is
one which is based more on services, and their cross border
facilitation by telecommunications and the Internet
25. Convergence in Global Finance
The International Monetary System
Class 1
June 29, 2012
26. Attributes of the “Ideal” Currency
• Exchange rate stability – the value of the currency would be fixed in
relationship to other currencies so traders and investors could be
relatively certain of the foreign exchange value of each currency in the
present and near future
• Full financial integration – complete freedom of monetary flows would be
allowed, so traders and investors could willingly and easily move funds
from one country to another in response to perceived economic
opportunities or risk
• Monetary independence – domestic monetary and interest rate policies
would be set by each individual country to pursue desired national
economic policies, especially as they might relate to limiting inflation,
combating recessions and fostering prosperity and full employment
27. Attributes of the “Ideal” Currency
• This is referred to as The Impossible Trinity because a country
must give up one of the three goals described by the sides of
the triangle, monetary independence, exchange rate stability,
or full financial integration. The forces of economics do not
allow the simultaneous achievement of all three
28. History of the International
Monetary System
• The Gold Standard, 1876-1913
– Countries set par value for their currency in terms of gold
– This came to be known as the gold standard and gained acceptance in
Western Europe in the 1870s
– The US adopted the gold standard in 1879
– The “rules of the game” for the gold standard were simple
• Example: US$ gold rate was $20.67/oz, the British pound was pegged at
£4.2474/oz
• US$/£ rate calculation is $20.67/£4.2472 = $4.8665/£
29. History of the International
Monetary System
• Because governments agreed to buy/sell gold on demand with
anyone at its own fixed parity rate, the value of each currency
in terms of gold, the exchange rates were therefore fixed
• Countries had to maintain adequate gold reserves to back its
currency’s value in order for regime to function
• The gold standard worked until the outbreak of WWI, which
interrupted trade flows and free movement of gold thus forcing
major nations to suspend operation of the gold standard
30. History of the International
Monetary System
• The Inter-War years and WWII, 1914-1944
– During WWI, currencies were allowed to fluctuate over wide ranges in
terms of gold and each other, theoretically, supply and demand for
imports/exports caused moderate changes in an exchange rate about
an equilibrium value
• The gold standard has a similar function
– In 1934, the US devalued its currency to $35/oz from $20.67/oz prior
to WWI
– From 1924 to the end of WWII, exchange rates were theoretically
determined by each currency's value in terms of gold.
– During WWII and aftermath, many main currencies lost their
convertibility. The US dollar remained the only major trading currency
that was convertible
31. History of the International
Monetary System
• Bretton Woods and the IMF, 1944
– Allied powers met in Bretton Woods, NH and created a post-war
international monetary system
– The agreement established a US dollar based monetary system and
created the IMF and World Bank
– Under original provisions, all countries fixed their currencies in terms
of gold but were not required to exchange their currencies
– Only the US dollar remained convertible into gold (at $35/oz with
Central banks, not individuals)
32. History of the International
Monetary System
– Therefore, each country established its exchange
rate vis-à-vis the US dollar and then calculated the
gold par value of their currency
– Participating countries agreed to try to maintain
the currency values within 1% of par by buying or
selling foreign or gold reserves
– Devaluation was not to be used as a competitive
trade policy, but if a currency became too weak to
defend, up to a 10% devaluation was allowed
without formal approval from the IMF
33. History of the International
Monetary System
• Fixed exchange rates, 1945-1973
– Bretton Woods and IMF worked well post WWII,
but diverging fiscal and monetary policies and
external shocks caused the system’s demise
• The US dollar remained the key to the web of exchange
rates
– Heavy capital outflows of dollars became required
to meet investors’ and deficit needs and
eventually this overhang of dollars held by
foreigners created a lack of confidence in the US’
ability to meet its obligations
34. History of the International
Monetary System
– This lack of confidence forced President Nixon to suspend official
purchases or sales of gold on Aug. 15, 1971
– Exchange rates of most leading countries were allowed to float in
relation to the US dollar
– By the end of 1971, most of the major trading currencies had
appreciated vis-à-vis the US dollar; i.e. the dollar depreciated
– A year and a half later, the dollar came under attack again and lost
10% of its value
– By early 1973 a fixed rate system no longer seemed feasible and the
dollar, along with the other major currencies was allowed to float
– By June 1973, the dollar had lost another 10% in value
35. Contemporary Currency Regimes
• The IMF today is composed of national currencies, artificial
currencies (such as the SDR), and one entirely new currency
(Euro)
• All of these currencies are linked to one another via a
“smorgasbord” of currency regimes
