Chapter 2 Flashcards
It defines the overall financial environment in which multinational corporations and international investors operate.
The international monetary system
This situation makes it necessary for many firms to carefully measure and manage their exchange risk exposure.
The fact that corporations nowadays are operating in an environment in which exchange rate changes may adversely affect their competitive positions in the marketplace.
How is the euro a measure to face exchange risk exposure?
Because European countries have adopted it as common currency, and so, trade and investment much less susceptible to exchange risk.
It can be defined as the institutional framework within which international payments are made, movements of capital are accommodated, and exchange rates among currencies are determined.
The international monetary system.
What are the stages that international monetary system went through?
- Bimetallism: Before 1875.
- Classical gold standard: 1875-1914.
- Interwar period: 1915-1944.
- Bretton Woods system: 1945-1972.
- Flexible exchange rate regime: Since 1973.
This was a double standard, prior to 1870, in that free coinage was maintained for both gold and silver.
Bimetallism
In Great Britain, bimetallism was maintained until…
Until 1816 (after the conclusion of the Napoleomc Wars) when Parliament passed a law maintaining free coinage of gold only, abolishing the free coinage of silver.
Until what year did bimetallism was maintained in United States?
Remained a legal standard until 1873, when Congress dropped the silver dollar from the list of coins to be minted.
Countries that were on the bimetallic standard often experienced this well-known phenomenon.
Gresham’s law.
Explain the Gresham’s law.
Since the exchange ratio between the two metals was fixed officially, only the abundant metal was used as money, driving more scarce metal out of circulation.
When was the first fully-fledged gold standard established?
In 1821 in Great Britain.
When did the majority of countries got off golf? How much did this system last?
In 1914 when World War I broke out. The classical gold standard as an international monetary system thus lasted for about 40 years.
Is the gold standard used nowadays?
No, not by any country.
When is gold standard said to exist?
When:
(1) gold alone is assured of umestricted coinage
(2) there is two-way convertibility between gold and national currencies at a stable ratio, and
(3) gold may be freely exported or imported.
It is is attributed to David Hume, a Scottish philosopher.
Price-specie-flow mechanism
Explain price-specie-flow mechanism.
Used with gold standard. Fluctuations in prices in a country adjusted completely or partially by an inflow or outflow of gold or specie. This adjusts the price levels across borders and equalized them bringing balance in international transactions and payments.
Five one example of price-specie-flow mechanism.
Consider a situation where Great Britain exported more to France than the former imported from the latter. This land of trade imbalance will not persist under the gold standard. Net export from Great Britain to France will be accompanied by a net flow of gold in the opposite direction. This international flow of gold from France to Great Britain will lead to a lower price level in France and, at the same time, a higher price level in Great Britain. (Recall that under the gold standard, the domestic money stock is supposed to rise or fall as the country experiences an inflow or outflow of gold.) The resultant change in the relative price level, in turn, will slow exports from Great Britain and encourage exports from France. As a result, the initial net export from Great Britain will eventually disappear.
Provide examples of countries that suffered hyperinflation after WWI.
Germany, Austria, Hungary, Poland, and Russia
What’s hyperinflation?
Hyperinflation is extremely rapid or out of control inflation. Hyperinflation occurs when price increases are so out of control that the concept of inflation is meaningless.
Explain the sterilization of gold, the policy implemented after the “international gold standard of the late 1920s” facade.
It was the matching inflows and outflows of gold respectively with reductions and increases in domestic money and credit. Sterilization is a form of monetary action in which a central bank seeks to limit the effect of inflows and outflows of capital on the money supply.
It was characterized by economic nationalism, halfhearted attempts and failure to restore the gold standard, economic and political instabilities, bank failures, and panicky flights of capital across borders.
The interwar period.
It constitutes the core of the Bretton Woods system. Where and when were they signed?
The Articles of Agreement of the International Monetary Fund (IMF). They were signed on In July 1944, when representatives of 44 nations gathered at Bretton Woods, New Hampshire.
Explain the American proposal, headed by Harry Dexter White, that was incorporated into the Articles of Agreement of the IMP.
They proposed a currency pool to which member countries would make contributions and from which they might borrow to tide themselves over dur- ing short-term balance-of-payments deficits.
How can the Bretton Woods system can be described?
As a dollar-based gold-exchange standard. A country on the gold-exchange standard holds most of its reserves in the form of currency of a country that is really on the gold standard.
British Pund —> UD Dollar—Pegged at $35/oz—>Gold
Dilemma that was responsible for the eventual collapse of the dollar-based gold- exchange system in the early 1970s.
Triffin paradox.
Explain the Triffin paradox.
This dilemma pointed out that the country whose currency, being the global reserve currency, foreign nations wish to hold, must be willing to supply the world with an extra supply of its currency to fulfill world demand for these foreign exchange reserves, thus leading to a trade deficit.
What are the special drawing rights (SDRs)?
They refer to an international type of monetary reserve currency (essentially an artificial currency) created by the International Monetary Fund (IMF) in 1969, that operates as a supplement to the existing reserves of member countries, as a response to concerns about the limitations of gold and dollars as the sole means of settling international accounts.
What was initially the value of the SDR?
Initially, the SDR was designed to be the weighted average of 16 currencies.The percent- age share of each currency in the SDR was about the same as the country’s share in world exports.
In 1981, however, the SDR was greatly simplified to comprise only five major currencies. What were those currencies?
U.S. dollar German mark Japanese yen British pound, and French franc.
How are the SDRs currently comprised?
In four major currencies: U.S. dollar (41.9 percent weight) euro (37.4 percent) British pound (11.3 percent) Japanese yen (9.4 percent)
What was the last attempt to save the Bretton Woods system? How long did it last?
10 major countries, known as the Group of Ten, met at the Smithsonian Institution in Washington, D.C., in December 1971. They reached the Smithsonian Agreement. It lasted a little more than a year before it cracked.
It completed the decline and fall of the Bretton Woods system.
When European and Japanese currencies were allowed to float, in March 1973.
