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International Finance

International Finance. Overview Bill Reese. 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. Gold Standard. 1876 – 1913

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International Finance

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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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