Chapter 14 The Evolution of the International Financial System - PowerPoint PPT Presentation

1 / 30
About This Presentation
Title:

Chapter 14 The Evolution of the International Financial System

Description:

A gold standard has a serious weakness, which is that revenue-hungry governments ... The Gold Standard was an order built on the faith that paper money and bank ... – PowerPoint PPT presentation

Number of Views:2702
Avg rating:5.0/5.0
Slides: 31
Provided by: unkn522
Category:

less

Transcript and Presenter's Notes

Title: Chapter 14 The Evolution of the International Financial System


1
Chapter 14The Evolution of the International
Financial System
2
The Goals of This Chapter
  • Present the history of the international
    financial system that existed before todays
    mixture of floating, fixed, and manipulated
    exchange rates.
  • Use the historical examples to illustrate how the
    trilemma was dealt with and how well each system
    promoted human welfare.
  • Show why financial orders tend to change when
    changing economic, social, and political
    conditions cause policy makers to address the
    trilemma differently.
  • Enable students to better judge the pros and
    cons of the different financial orders.

3
Time Line of International Financial Orders
4
The Rules of the Game
  • The set of rules and other formal and informal
    incentives under which a financial system
    operates is called an order.
  • An international monetary order is sometimes
    referred to in the international finance
    literature as the rules of the game, a term
    reportedly coined by John Maynard Keynes.
  • A monetary order is to a monetary system somewhat
    like a constitution is to a political system.

5
Judging Past International Financial Systems
  • 1. How fast did economies grow and raise
    standards of living?
  • 2. How fast did international trade and
    investment expand?
  • 3. How compatible was the order with sound
    monetary policies and price stability?
  • 4. How well were outside economic shocks
    dissipated and negative consequences to
    employment and inflation avoided?
  • 5. How much flexibility did individual countries
    have in setting policies aimed at specific
    national economic objectives?
  • 6. How were the benefits and costs of operating
    under the order spread across the different
    countries that adhered to the system?
  • 7. Was the system was largely self-regulating or
    did it require costly institutional guidance and
    frequent policy adjustments by individual
    countries?

6
Report Card
  • The textbook evaluates each international
    financial order according to seven criteria.
  • A report card covering each of the criteria will
    be used to summarize the conclusions, with a P
    awarded for success and a Ðfor failures.
  • Sometimes it will be necessary to leave a grade
    undetermined with a ? when conflicting evidence
    makes it difficult to pass judgment.
  • Students are encouraged to reach their own
    conclusions and apply their own evaluations.
  • Economic growth
  • Globalization
  • Price stability
  • Output stability
  • Policy flexibility
  • Mutually beneficial
  • Self-regulating

7
The Order of the Gold Standard
  • Under the Gold Standard, the order effectively
    followed by national government required that
    they
  • Fix an official gold price or parity for the
    national currency in terms of a fraction of an
    ounce of pure gold
  • Permit the free conversion of gold into domestic
    money and domestic money into gold at the parity
    price in unlimited amounts and without question
  • Eliminate all restrictions on foreign exchange
    transactions and allow the import and export of
    gold.

8
The Order of the Gold Standard
  • A gold standard has a serious weakness, which is
    that revenue-hungry governments are tempted to
    issue more paper currency than they can back with
    the gold stored in their vaults.
  • Suspicious holders of paper money could then
    panic and start a run on gold, in which case
    the government would have to suspend
    convertibility of paper money into gold and
    effectively leave the gold standard.
  • The Gold Standard was an order built on the faith
    that paper money and bank accounts could always
    be converted to pure gold at any time without
    restrictions.

9
The Order of the Gold Standard
  • To enhance faith in the system, several other
    rules of the game had to be respected by
    governments
  • Back domestic coin and currency fully with gold
    reserves, and link the growth of domestic money
    to the availability of reserves.
  • Effectively allow the domestic price level to be
    determined by the worldwide supply and demand for
    gold.
  • If the central bank must serve as a lender of
    last resort in the case of short-term credit
    crises in the domestic banking sector, always
    charge interest rates well above market.

10
The Gold Standard and Exchange Rates
  • Fixed gold parities, free convertibility, and
    credible economic policies meant that exchange
    rates remained fixed.
  • For example, the British government set the
    pounds for gold parity rate at 4.24 pounds per
    one ounce of gold, and the U.S. government set
    its parity at the rate of 20.67 per ounce of
    gold.
  • These two parities defined the exchange rate to
    be 4.24 pounds per 20.67 dollars, or 1.00
    4.87.

11
(No Transcript)
12
The Gold Standard and Exchange Rates
  • The free export and import of gold was an
    important rule of the game.
  • The potential movement of gold along with free
    convertibility kept exchange rates within a
    narrow band of the fixed exchange rate defined by
    the cost of shipping gold (gold points).

13
The Gold Standard and Exchange Rates
  • For example, if the supply of foreign exchange
    increases from S to S, without the gold standard
    rules, e would fall to 4.00.
  • Demanders of dollars will not buy dollars at e
    4.00 they will instead buy gold at the official
    price of 4.24 per ounce, ship it to the U.S.,
    and exchange it at 20.67 per ounce.
  • This effectively gives them 4.87 for every
    pound, minus the expense of shipping the gold.

14
Humes Specie-Flow Mechanism
  • The specie flow mechanism and was first described
    as far back as 1752 by David Hume, before the
    establishment of the gold standard.
  • Humes reasoning was used to argue that the gold
    standard was self-correcting.
  • If a trade deficit caused gold to flow out of a
    country, its money supply would fall and prices
    would decline, thus restoring international
    competitiveness without changing the exchange
    rate.
  • Similarly, a trade surplus would cause gold to
    flow into the country, increasing the money
    supply, and eventually reducing exports and
    increasing imports.

15
Report CardThe Gold Standard
  • 1. Economic growth P
  • 2. Globalization P
  • 3. Price stability P
  • 4. Output stability Ð
  • 5. Policy flexibility Ð
  • 6. Mutually beneficial ?
  • 7. Self-regulating ?

16
Figure 14.2The Trilemma and the Gold Standard
17
Returning to the Gold Standard under Changed
Circumstances After World War I
  • Inflation during the war years meant that
    countries would have to deflate if they were to
    return to the gold standard under the old gold
    parities.
  • John Maynard Keynes argued that the tight
    monetary policies required to restore the real
    value of gold relative to the worlds money
    supplies cost too much in terms of unemployment,
    falling investment, and lost output.
  • He suggested that countries forget trying to
    return to the gold standard under the old gold
    parities and that they should set new parities
    and simply seek to maintain price stability at
    the higher price levels instead of trying to
    deflate prices.

18
Returning to the Gold Standard under Changed
Circumstances After World War I
  • A strong case can be made that the deflationary
    policies of the 1920s, driven by the desire to
    return to the gold standard under the traditional
    gold parities, caused the Great Depression.
  • According to Nobel-laureate Robert Mundell
  • Had the price of gold been raised in the late
    1920's, or, alternatively, had the major central
    banks pursued policies of price stability
    instead of adhering to the gold standard, there
    would have been no Great Depression, no Nazi
    revolution, and no World War II.
  • Policy makers would design a very different
    financial order after World War II.

19
Report CardThe Inter-War Period
  • 1. Economic growth Ð
  • 2. Globalization Ð
  • 3. Price stability Ð
  • 4. Output stability Ð
  • 5. Policy flexibility Ð
  • 6. Mutually beneficial Ð
  • 7. Self-regulating Ð

20
The Extraordinary Bretton Woods Conference
  • In July of 1944, while the Second World War was
    still raging, the economic policy makers from the
    allied countries met in the U.S. to establish the
    order that would guide the post-World War II
    international system.
  • The motivation for the Bretton Woods Conference
    was to reverse the trend toward economic
    isolation and growth-retarding economic policies
    during the inter-war years.
  • The purpose of the Bretton Woods conference was
    to design a world economic order that would
    minimize economic conflict, encourage sound
    macroeconomic policies to generate growth and
    employment in all economies, and restore the flow
    of goods and investments between countries.

21
The Bretton Woods Order
  • 1. Countries other than the U.S. intervene in the
    foreign exchange market to keep their exchange
    rate within 1 of the dollar peg.
  • 2. The U.S. does not intervene in the foreign
    exchange markets, but will convert dollars to
    gold at 35/oz. for foreign central banks.
  • 3. The International Monetary Fund (IMF) serves
    as the central bankers central bank, providing
    liquidity to intervene in the foreign exchange
    markets.
  • 4. Pegs should be adjusted in the exceptional
    circumstances of a fundamental disequilibrium
    otherwise adjust domestic monetary policies to
    keep the exchange rate fixed.
  • 5. The U.S. and its large economy effectively
    anchors the world price level with its monetary
    policy.
  • 6. Currency should be freely convertible for
    current account transactions.

22
Devaluation? Depreciation?Whats the Difference?
  • The term depreciation (appreciation) refers to a
    decline (rise) in value of a currency relative to
    other currencies under a regime of floating
    exchange rates.
  • The term devaluation (revaluation) refers to an
    intentional one-time lowering (raising) of the
    fixed value of a currency under a fixed exchange
    rate arrangement.

23
Figure 14.7The Trilemma and the Bretton Woods
System
Early Bretton Woods 1944-1958
24
Report Card Bretton Woods
  • 1. Economic growth P
  • 2. Globalization P
  • 3. Price stability ?
  • 4. Output stability ?
  • 5. Policy flexibility Ð
  • 6. Mutually beneficial ?
  • 7. Self-regulating Ð

25
Figure 14.8The Trilemma The Post-Bretton Woods
Float
26
Report Card Post-1973 Floating Rates
  • 1. Economic growth ?
  • 2. Globalization P
  • 3. Price stability Ð
  • 4. Output stability Ð
  • 5. Policy flexibility P
  • 6. Mutually beneficial ?
  • 7. Self-regulating P

27
Figure 14.10The Real Effective Exchange Rate of
the U.S. Dollar 1973-2000
28
Establishing a European Monetary Union
  • At a meeting in Madrid in December of 1995, the
    European Union, jus having expanded to 15
    members, reconfirmed its intent to create a
    single currency.
  • The new currency was to be called the euro and
    denoted by the symbol i.
  • European governments agreed to a three-step
    procedure for moving toward a single currency.
  • Most importantly, a set of specific economic
    goals were set, and these goals would have to be
    met by a country before it could become part of
    the single currency area.
  • At the start of 2002, the euro became the
    currency of Austria, Belgium, Finland, France,
    Germany, Greece, Ireland, Italy, Luxemburg, the
    Netherlands, Portugal, and Spain.

29
The 5 Criteria for Joining the Euro
  • 1. The currencys exchange rate must have
    remained within a tight band for two years.
  • 2. Inflation must be less than 1.5 percent above
    the average inflation rate of the three European
    countries with the lowest inflation.
  • 3. Interest rates on openly-traded government
    bonds must be less than 2 percentage points above
    the average rates for the three European
    countries with the lowest rates.
  • 4. The government budget deficit must be less
    than 3 percent of GDP.
  • 5. Total government debt must be less than 60
    percent of GDP.

30
Figure 14.11Summary of 1870-2003 Financial Orders
Write a Comment
User Comments (0)
About PowerShow.com