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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

International Finance

Overview

Bill Reese


Learning objectives
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
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


Gold standard1
Gold Standard

  • Gold standard implied fixed XR

  • Limited growth of money supply for any country

    • Need enough gold

  • WWI limited free movement of gold


1920s and 1930s
1920s and 1930s

  • Some countries reverted to gold standard

  • Some abandoned

  • Some pegged to dollar or pound

  • Period of instability

    • International trade declined


Bretton woods agreement
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


Floating exchange rates
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




Floating exchange rates1
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


Floating exchange rates2
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


Federal reserve
Federal Reserve

  • U.S. Central Bank

    • Established in 1913

    • 12 federal reserve banks


Federal reserve1
Federal Reserve

  • Board of Governors

    • Seven members

      • Appointed by President and confirmed by congress

      • 14-year term

      • Chairman’s term is four years


Federal reserve2
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


Federal reserve3
Federal Reserve

  • FOMC determines monetary policy

    • Supply of money

      • Purchase or sell fixed income assets

      • Influences short-term rates

      • Impacts XR


Federal reserve4
Federal Reserve

  • Mission

    • Maximum employment

    • Stable prices

    • Moderate long-term interest rates

  • Goals may conflict

    • XR is not explicit goal


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


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


Euro

  • Requirements for entry

    • Fiscal deficit < 3% of GDP

    • Government debt < 60% of GDP


Euro

  • Advantages

    • Lower transaction costs

    • Less XR risk

    • Greater price transparency and price-based competition


Foreign exchange market
Foreign Exchange Market

  • Spans the globe

  • Operates 24 hours/day

  • Major exchanges

    • Singapore, Hong Kong, Tokyo, Bahrain, London, New York, San Francisco, Sydney


Foreign exchange market1

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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