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International Finance
Overview
Bill Reese
1
Learning Objectives
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In this unit we will learn:
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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
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1876 – 1913
Values of currency set against precious
metals
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Each country set own conversion rate
Must maintain adequate reserves (Fort Knox) for
redemption
Gold Standard
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Gold standard implied fixed XR
Limited growth of money supply for any
country
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Need enough gold
WWI limited free movement of gold
1920s and 1930s
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Some countries reverted to gold standard
Some abandoned
Some pegged to dollar or pound
Period of instability
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International trade declined
Bretton Woods Agreement
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International agreement in 1944
Fixed exchange rates
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All currencies pegged to dollar
Dollar set at $35/ounce of gold
Intervention to prevent fluctuation of > 1%
Lasted until 1973
Floating Exchange Rates
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By 1971, dollar had depreciated
Concerns about U.S. ability to convert dollars
to gold
March 1973
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U.S. allows dollar to float
Other major currencies float as well
Countries with Floating XRs
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Countries with Pegged XRs
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Floating Exchange Rates
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Determined by supply and demand
Factors affecting demand
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Demand for nation’s product
Demand for nation’s stocks and bonds
Inflation expectations
Government stability
Floating Exchange Rates
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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
Federal Reserve
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U.S. Central Bank
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Established in 1913
12 federal reserve banks
Federal Reserve
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Board of Governors
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Seven members
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Appointed by President and confirmed by congress
14-year term
Chairman’s term is four years
Federal Reserve
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FOMC
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Chief policymaking committee
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All 7 governors
President of NY fed bank
Four other fed presidents
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All votes are equal
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All fed presidents attend meetings
Chairman has much influence
Federal Reserve
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FOMC determines monetary policy
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Supply of money
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Purchase or sell Treasuries
Influences short-term rates
Impacts XR
Federal Reserve
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Mission
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Goals may conflict
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Maximum employment
Stable prices
Moderate long-term interest rates
XR is not explicit goal
Euro
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Launched Jan. 4, 1999
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11 members
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Belgium, Germany, Spain, France, Ireland, Italy,
Luxembourg, Netherlands, Austria, Portugal, Finland
Greece added one year later
Euro
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Requirements for entry
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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
Euro
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Requirements for entry
Fiscal
deficit < 3% of GDP
Government debt < 60% of
GDP
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Euro
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Advantages
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Lower transaction costs
Less XR risk
Greater price transparency and price-based
competition
Foreign Exchange Market
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Spans the globe
Operates 24 hours/day
Major exchanges
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Singapore, Hong Kong, Tokyo, Bahrain, London,
New York, San Francisco, Sydney
Foreign Exchange Market
25,000
20,000
15,000
10,000
5,000
0
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10 AM
Lunch Europe
In Tokyo In Tokyo opening
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7
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9
Asia
closing
10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
Americas London
open
closing
Afternoon
in America
6 pm Tokyo
In NY opens