International Monetary Exchange in Theory. Lecture 11 – Thursday, 15 October 2009 J A Morrison. Satirical Cartoon of John Law’s Mississippi Scheme (Paris, 1720). Admin. Papers back Soon—Friday? Online Discussion: Another post by 29 Oct. We’re at another turning point in the course….
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Lecture 11 – Thursday, 15 October 2009J A Morrison
Satirical Cartoon of John Law’s Mississippi Scheme (Paris, 1720)
Before we launch into the specifics of international monetary exchange, let’s step back to consider international monetary exchange in the context of international trade.How does money compare to trade?
Here’s our plan…We’ll proceed as we did for trade: first theory, then empirics. Be prepared that money will be challenging. I’ll do my best to unpack the key terms and concepts. But you might have to turn things up a notch. (Good thing you’ve caught up on rest!)
It’s easy to understand why we trade goods & services: the benefits of specialization are readily apparent.Understanding the invention and use of money, however, is less immediately accessible.
Money evolves as a means to resolve this problem. Individuals accept a common good with certain characteristics (high value to bulk ratio, divisible, durable, uniform in quality) that becomes the common medium of exchange.
Across history, nations have chosen a wide variety of materials to serve as money. The ancient Greeks used cattle, some Native Americans used wampum, and the early Chinese used cowry shells.Today, most countries use “paper” currency, which is usually made from cotton and/or linen.
(Here, we’ll treat “backed” or “representative” currencies as commodity money since they can, by definition, be traded with the government for a commodity of high value.)
Woman burning money instead of firewood (Germany, 1923)
The historical trend is clearly away from commodity money and toward fiat money. Policymakers generally prefer fiat money because (1) they gain increased revenue from seigniorage; and (2) the market imposes fewer constraints on monetary policy when using fiat money.But the power to “print” money is frequently abused. Some economists, like FA Hayek, appreciated the discipline imposed by commodity money systems.
The same logic that impels the development of a common medium of exchange within economies impels the adoption of international media of exchange between economies.Such a currency is sometimes called the Nth Currency.
Gold & silver previously performed this role. After WWII, the US dollar was the preeminent Nth Currency. Today, the dollar faces competition from the Euro, the Yen, and the Renminbi.
“The United States would be mistaken to take for granted the dollar’s place as the world’s predominant reserve currency…Looking forward, there will increasingly be other options to the dollar.”-- World Bank President Robert B. Zoellick (26 Sept 2009)(Source: NYT 28 Sept 2009)
(Source: Barton, et al, p 13)
A state’s exchange rate regime is the set of rules that determine the relationship (including valuation) between domestic currency and foreign or international currencies.
For now, we assume governments enjoy monetary sovereignty, the ability to control the market value of domestic currency, the currency used for transactions in the home market.
Is it possible to fix a currency with respect to several things simultaneously?
Answer: Not usually.Different parts of the economy grow at different rates. Maintaining stability with respect to one precludes stability with respect to the others.
Stability can only be maintained along one dimension at a time
-- We’ll talk here in terms of regimes that are “fixed” and those that are and “flexible/adjustable.”
Government intervention sometimes fails to achieve its goal.“Fixed” ER regimes do not always generate stable market ERs. And sometimes states claim to have “flexible” ERs but, in reality, regulate them such that their market values remain stable.
Grieco & Ikenberry, 62.
Well, Dewb, I thought you could use a refresher...
Remember that the balance of payments (BoP) reconciles all of a country’s financial transactions with the world.This includes trade, remittances, investment, loans, &c.