Chapter 2 World Trade and the International Monetary System

1. Chapter 2 World Trade and the International Monetary System

2. Integration of the world�s marketsfor goods and services The global trend toward free-market economies Industrialization of the Far East and Pacific Rim The 1995 creation of the World Trade Organization (WTO) The 1991 breakup of the Soviet Union, the reunification of Germany, and the migration of central and eastern Europe toward the EU The emergence of China as a major trading partner, Hong Kong�s 1997 return to China, and China�s 2001 entry into the WTO The 1999 creation of the euro and its adoption by an expanding set of European countries

3. U.S. merchandise trade

4. Integration of financial markets An increase in cross-border financing Increasingly interdependent national financial markets, including cooperative linkages among securities exchanges An increasing number of cross-border mergers, acquisitions, and joint ventures

5. The Bretton Woods Agreement World Bank - which now includes International Bank for Reconstruction and Development International Development Association International Finance Corporation Multilateral Investment Guarantee Agency Int�l Centre for Settlement of Investment Disputes International Monetary Fund (IMF) Responsible for ensuring the stability of the international financial system Compiles balance-of-payments statistics

6. The U.S. balance of payments 1996 2006 Goods: Exports 612 1024 Goods: Imports -803 -1860 Trade Balance -191 -836 Services: Credit 240 413 Services: Debit -151 -342 Balance on Goods & Services -102 -765 Income: Credit 226 622 Income: Debit -202 -629 Balance on Goods, Services, & Income -78 -773 Current transfers: Net -40 -84 Current Account -118 -857 Source: U.S. Bureau of Economic Analysis (www.bea.gov)

7. The U.S. balance of payments 1996 2006 Current Account -118 -857 Capital Account: Net 1 -4 Direct Investment Abroad -92 -249 Direct Invest from Abroad 87 184 Portfolio Investment Assets -236 -322 Portfolio Invest Liabilities 304 827 Other Investment Assets -86 -475 Other Investment Liabilities 161 754 Financial Account 137 719 Net errors and omissions -20 141 Source: U.S. Bureau of Economic Analysis (www.bea.gov)

8. Trade balances in OECD countries GDP in GDP per Trade surplus Trade surplus billions capita per GDP per capita Norway $335 42,300 17.0% $7,197 Ireland $222 41,000 9.5% $3,878 Germany $2,897 30,400 7.1% $2,172 � � � � � Canada $1,259 34,000 2.5% $857 � � � � � Japan $4,367 31,500 1.6% $505 China $2,630 6,800 6.8% $460 � � � � � India $887 3,300 -6.2% $(205) U.K. $2,374 30,300 -5.0% $(1,519) U.S. $13,245 41,800 -6.3% $(2,638) Greece $308 22,200 -12.7% $(2,811) Source: U.S. Bureau of Economic Analysis (www.bea.gov)

9. Exchange rate systems Pegged or fixed exchange rate systems Forges a direct link between inflation differentials and employment levels Can result in large adjustments Floating exchange rate systems Allows exchange rates to adjust for inflation differences Allows employment levels and wages to equalize through the exchange rate mechanism

10. Recent exchange rate arrangements FX regime Africa Asia/Pacific Europe/Mid East Americas No separate WAEMU, Micronesia, Eurozone Ecuador, legal tender CAEMC Palau Panama Currency Egypt, China, HK, Iraq, Kuwait, Bahamas, board or Sudan, Pakistan, Saudi Arabia, Suriname, fixed peg Zimbabwe Vietnam Syria Venezuela Crawling peg Botswana Tonga Denmark, Hungary, Costa Rica, or horiz band Iran, Slovak Rep Nicaragua Managed Algeria, India, Croatia, Czech Rep, Argentina, float Kenya, Malaysia, Russian Fed Colombia, Nigeria Singapore, Jamaica, Thailand Peru Independent S. Africa, Australia, Norway, Poland, Brazil, float Uganda Indonesia, Sweden, Turkey, Canada, Japan, Switzerland, Mexico, S. Korea U.K. U.S. Source: International Financial Statistics, December 2006

11. 1946 Bretton Woods Conference IMF and World Bank created 1971 Exchange rate turmoil begins the modern floating rate period 1976 Jamaica Agreement Floating rates declared acceptable 1979 European Exchange Rate Mechanism (ERM) 1991 Treaty of Maastricht 1999 Introduction of the euro 2002 Euro begins public circulation Major events in forex history

12. 1946 Bretton Woods Conference Dollar is convertible into gold at $35/ounce Other currencies are pegged to the dollar The IMF and the World Bank also were created 1971 - Exchange rate turmoil U.S. dollar falls off the gold standard Most currencies float on world markets Major events in forex history

13. 1976 - Jamaica Agreement Floating rates are declared �acceptable� 1979 - European Monetary System (EMS) European Exchange Rate Mechanism (ERM) established to maintain EEC currencies within a 2.25% band around central rates European currency unit (ECU) created Major events in forex history

14. 1991 - Treaty of Maastricht EC members agree to a broad agenda of economic, financial and monetary reforms A single European currency is proposed as the ultimate goal of monetary union 1999 - Introduction of the euro Emu-zone currencies pegged to the euro European bonds convert to the euro 2002 - Euro begins public circulation The euro is now a major international currency Major events in forex history

15. The EU & the Eurozone

16. Mexican peso crisis of 1995 Asian contagion of 1997 Korea, Indonesia, and Thailand Russian ruble crisis in 1998 Brazilian real crisis in 1998 Argentinian peso crisis of 2002 Recent currency crises

17. Contributing factors in each crisis A fixed or pegged exchange rate system that overvalued the local currency A large amount of foreign currency debt Consequences of currency crises Currency crises have a pronounced negative short-term impact on the local economy A market-based exchange rate can have an invigorating long-term effect on the local economy and on the local stock market Currency crises

18. The 1995 Mexican peso crisis

19. Thailand�s 1997 currency crisis

20. Indonesia�s 1997 currency crisis

21. Korea�s 1997 currency crisis

22. Russia�s 1998 currency crisis

23. Brazil�s 1999 currency crisis

24. Argentina�s 2002 currency crisis

25. The debate over IMF lending Proponents of IMF lending policies believe Short term loans help countries overcome temporary crises Critics of IMF lending believe Capital market liberalizations increase risks IMF loans can leave a legacy of debt that can last for decades IMF loans are often spent trying to support an unsustainable exchange rate IMF remedies benefit developed countries and not the country in crisis

26. IMF lending and moral hazard Moral hazard The existence of a contract can change the behaviors of parties to the contract The IMF�s challenge Develop policies that promote economic stability Ensure that the consequences of poor investment decisions are borne by investors and not taxpayers