Exchange Rates, Currency Regimes and the Intl Monetary System Flashcards
What are some of the risks that come with the growing globalisation of business?
- Exchange rates are constantly changing
- Large fiscal deficits plague most countries, complicating fiscal and monetary policies => interest and exchange rates
- BOP imbalances can move XR
- Ownership, control and governance variations across countries
- decrease in size for global capital markets, which would normally provide the means to lower a firm’s cost of capital + increase amount available
- financial globalisations => ebb and flow of capital in industrialized AND dvp countries, complicating financial management
How do you define globalisation (IB perspective)?
The development of an increasingly integrated global economy marked especially by free trade, free flow of capital, and the tapping of cheaper foreign labor markets. (Merriam Webster)
I define globalisation as producing where it is the most cost-effective, selling where it is the most profitable and sourcing capital where it is cheapest, without worrying about national boundaries (Narayana Murthy)
Which asset play the most critical role in linking major institutions that make up the global financial market place?
The debt securities issued by governments are the most critical. These low-risk or risk-free assets form the foundation for creating, trading, and pricing other financial assets like bank loans, corporate bonds, and equities (stock). In recent years a number of additional securities have been created from the existing securities derivatives, whose value is based on market value changes in the underlying securities. The health and security of the global financial system relies on the quality of these assets
Why have eurocurrencies and LIBOR remained the centrepiece of the global financial marketplace for so long?
- large money market relatively free from government regulation.
- global depositors and borrowers are attracted to the eurocurrency market is because of the narrow interest rate
Under the gold standard, all nat gvt promised to follow ‘the rules of the game’ - what does that mean?
A country’s money supply was limited to the amount of gold held by its central bank or treasury. For example, if a country had 1,000,000 ounces of gold and its fixed rate of exchange was 100 local currency units per ounce of gold, that country could have 100,000,000 local currency units outstanding. Any change in its holdings of gold needed to be matched by a change in the number of local currency units outstanding
What did it mean under the gold standard to ‘defend a fixed exchange rate?’ and what did it imply abt a country’s money supply?
Under the gold standard, a country’s central bank was responsible for preserving the exchange value of the country’s currency by being willing and able to exchange its currency for gold reserves upon the demand of a foreign central bank. This required the country to restrict the rate of growth in its money supply to a rate that would prevent inflationary forces from undermining the country’s own currency value.
What was the foundation of the Bretton Woods international monetary system, and why did it eventually fail?
Bretton Woods, the fixed exchange rate regime of 1945–73, failed because of widely diverging national monetary and fiscal policies, differential rates of inflation, and various unexpected external shocks. The U.S. dollar was the main reserve currency held by central banks and was the key to the web of exchange rate values. The United States ran persistent and growing deficits in its balance of payments requiring a heavy outflow of dollars to finance the deficits. Eventually the heavy overhang of dollars held by foreigners forced the United States to devalue the dollar because the United States was no longer able to guarantee conversion of dollars into its diminishing store of gold.
What does a floating rate of exchange mean, and what is the role of the government in it?
A truly floating currency value means that the government does not set the currency’s value or intervene in the marketplace, allowing the supply and demand of the market for its currency to determine the exchange value.
What are two advantages of fixed exchange rates?
- Fixed rates provide stability in international prices for the conduct of trade. Stable prices aid in the growth of international trade and lessen risks for all businesses
- Fixed exchange rates are inherently anti-inflationary, requiring the country to follow restrictive monetary and fiscal policies.
What are some disadvantages of fixed exchange rates?
Fixed exchange rates are inherently anti-inflationary, requiring the country to follow restrictive monetary and fiscal policies. However, this restrictiveness can often burden a country wishing to pursue policies that alleviate continuing internal economic problems, such as high unemployment or slow economic growth.
Fixed exchange rate regimes necessitate that central banks maintain large quantities of international reserves (hard currencies and gold) for use in the occasional defense of the fixed rate. As international currency markets have grown rapidly in size and volume, increasing reserve holdings has become a significant burden to many nations.
Once in place, fixed rates may be maintained at rates inconsistent with economic fundamentals. As the structure of a nation’s economy changes, and as its trade relationships and balances evolve, the exchange rate itself should change. Flexible exchange rates allow this to happen gradually and efficiently, but fixed rates must be changed administratively—usually too late, too highly publicized, and at too large a one-time cost to the nation’s economic health
What is the difference between a crawling peg system and a pegged exchange rate?
In a crawling peg system, the government will make occasional small adjustments in its fixed rate of exchange in response to changes in a variety of quantitative indicators such as inflation rates or economic growth. In a truly pegged exchange rate regime, no such changes or adjustments are made to the official fixed rate of exchange
What is the Impossible Trinity?
All countries must implicitly decide which of the trinity elements they wish to pursue, and therefore which element they must give up (you can’t have all three)
- exchange rate stability
- monetary independence
- full financial integration = free mvt of capital
What is the difference between a currency board and dollarization?
In a currency board arrangement, the country issues its own currency but that currency is backed 100% by foreign exchange holdings of a hard foreign currency—usually the U.S. dollar.
In dollarization, the country abolishes its own currency and uses a foreign currency, such as the U.S. dollar, for all domestic transactions.
What are special drawing rights?
The Special Drawing Right (SDR) is an international reserve asset created by the IMF to supplement existing foreign exchange reserves. It serves as a unit of account for the IMF and other international and regional organizations and is also the base against which some countries peg the exchange rate for their currencies.
Defined initially in terms of a fixed quantity of gold, it is currently the weighted value of currencies of the five IMF members having the largest exports of goods and services. Individual countries hold SDRs in the form of deposits in the IMF. These holdings are part of each country’s international monetary reserves, along with official holdings of gold, foreign exchange, and its reserve position at the IMF. Members may settle transactions among themselves by transferring SDRs
What is a foreign currency exchange rate?
price of any country’s currency in terms of another country’s currency
