UNIT 6: INTERNATIONAL FINANCE

1
UNIT 6 INTERNATIONAL FINANCE
1. Fiscal and Monetary Policy 2. Exchange
Rates 3. The History of Exchange Rates 4.
Exchange Rate Assignment 5. Fixed Versus Floating
Exchange 6. Interdependence 7. The International
Currency 8. Managing Coordinating Currencies 9.
Trade the Environment 10. Globalization 11.
Future of Trade
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FISCAL POLICY

• The Economy From a Big Picture Perspective
• Y C I G (X-M)
• Output Consumption Investment
• Government (Exports-Imports).
• Fiscal Policy
• -- Increase Government Spending
• (e.g., Spending on Schools and Highways)
• -- Deficits Run During Depressions (Keynes)
• -- Problem Big Lag Times

3
MONETARY POLICY

• Influence the Economy by Manipulating the Money
  Supply
• And Interest Rates
• Mechanisms for Implementing Monetary Policy
• A) Open Market Operations
• B) Changing the Discount Rate

• Independence of Central Banks Varies
• (German Bank Very Independent Italian Bank Is
  Not)
• Monetary and Fiscal Policy Can Influence
  Exchange
• Rates and Trade Patterns

4
EXCHANGE RATES

• Any International Trade Requires Currency
  Exchange
• Current Exchange Rates (As of 10am 03/25/04)
• Japanese Yen/dollar 106.23
• Canadian dollar/dollar 1.34
• British Pound/dollar 0.54
• Euro-11/dollar 0.82
• You can also think of this in reverse
• -- one British Pound buys 1.84 dollars.

5
HISTORY OF THE INTERNATIONAL MONETARY SYSTEM

• Barter Exchange Product for Product
• -- Difficulty Linking Buyer Seller
• -- Haggle Over Price
• -- Carry Products Around
• Solution Money
• -- People Believe its Valuable Relatively Short
  Supply
• -- Examples Gold and Wampum

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HISTORY OF THE INTERNATIONAL MONETARY SYSTEM

• Europe in 1500 Over 500 Political Units
• Fixed Versus Floating Exchange
• 1500 - 1870 Metal Coins and Letters of Credit
• British Sterling Pound the Gold Standard
  (1870-1914)
• Interwar Period (1919-1939)
• Bretton Woods System (1945-1971)
• Floating System After 1973

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FLOATING EXCHANGE RATESSUPPLY AND DEMAND
50/1
Supply
Baht/ Dollar
45/1
40/1
Demand
Quantity of Dollars
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FACTORS WHICH DETERMINE EXCHANGE RATES
Economic Factors
Government Policy
Interest Rates and the Money Supply
Expectations
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FLOATING EXCHANGE RATES
10
CURRENCY APPRECIATION

• U.S. Currency Becomes More valuable
• (e.g., 25 baht/dollar shifts to 50 baht/dollar)
• U.S. Exports Fall
• -- Price of Exports Increases Demand for
  Exports Falls
• U.S. Imports Rise
• -- Price of Imports Decreases Demand for
  Imports Rises
• U.S. Trade Deficit Rises
• Trick Appreciation Depreciation are Flip Sides
  of Same Coin

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CURRENCY DEPRECIATION

• U.S. Currency Becomes Less valuable
• (e.g., 25 baht/dollar shifts to 20 baht/dollar)
• U.S. Exports Rise
• -- Price of Exports Decreases Demand for
  Exports Rises
• U.S. Imports Fall
• -- Price of Imports Increases Demand for
  Imports Falls
• U.S. Trade Deficit Falls

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STUDENT ASSIGNMENT
Exchange Rate January 1997 25.8
baht/dollar Exchange Rate January 1998 52.4
baht/dollar Pretend you are a Thai business
person involved in the production and sale of
personal computers in both the domestic market
and abroad. Suppose you can produce a 200 MHz
computer with 32MB Ram and a Pentium processor
for 38,700 Baht. How much would this computer
sell for in dollars in the United States on 21
January 1997? How much would it sell for in the
United States on 21 January 1998? Has the price
of the computer in the Thailand computer store
changed? Finally, how do you suppose domestic
producers of computers in the United States will
react to this changing situation?
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IMPACT OF FALLING FALLING CURRENCY
Thai Made Computer U.S. Made Car
Computer Price in Car Price Date Baht Dolla
r in Baht The U.S. in Dollars in
Thailand Jun-97 25 1 25,000 1,000 15,000 375,00
0 Dec-97 40 1 25,000 625 15,000 600,000
THAI TRADE BALANCE
EXPORT PRICES
IMPORT PRICES
CURRENCY
EXPORTS
IMPORTS
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FIXED VERSUS FLOATING WHICH IS BETTER?

• Fixed Exchange Rates
• () Stability in Short Run Encourages Trade
• (-) Cannot Adjust to Structural Shifts
• (-) Big Shifts When Rates Do Change
• (-) Perform Poorly with Sudden Shocks (e.g. Oil
  Crisis)
• (-) Depends on Supply of Gold Miners and Luck
• Floating Exchange Rates
• () Automatically Adjusts to Structural Shifts
• () Fewer Sudden and Large Scale Shifts
• (-) Danger of Constant Movement Undermines
  Trade
• Empirical Evidence 1930s versus the 1980s

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COMPETITIVE DEVALUATIONS

• Governments Attempt to Manipulate Rates
• Y C I G (X-M)
• A Standard Prisoners Dilemma
• Retaliation is Very Likely
• Net Result All Are Worse Off After Devaluations

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INTERDEPENDENCE
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THE INTERNATIONAL CURRENCY

• Why do you Need an International Currency?
• What are the International Currencies?
• Is it Good or Bad to be the International
  Currency?
• -- Gives You the Freedom to Run Deficits
• -- Allows You to Export Inflation
• -- Encourages Lack of Discipline

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MANAGING AND COORDINATING CURRENCIES

• Should Governments Manage Currencies?
• Can Governments Manage Currencies in a Floating
  System?
• Coordination is a Good Thing, but there are some
  problems
• Collective Action Problem
• Costs May Outweigh the Benefits
• Potentially Conflicting Preferences due to
  Multiple Goals

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TRADE AND THE ENVIRONMENT

• Is trade good for the environment?
• Example The Tuna Controversy
• What would an environmentalist say?
• How would an economist respond?
• Which argument is more persuasive?

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GLOBALIZATION

• Core of the Debate
• Is it a New Phenomenon?
• Positive Consequences of Globalization

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GLOBALIZATION II

• Negative Consequences of Globalization
• Winners, but also some Losers
• Rapidly Changing Environment
• Whats the Verdict? What do you Think?
• Could the US Opt Out of the Globalization
  Process?

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THE FUTURE OF TRADE

• Business as Usual School
• -- WTO Continues the Work of GATT
• Regional Trading Block School
• -- Is NAFTA an Alternative to GATT/WTO?
• Return to Protectionism School
• -- House of Cards

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4th SCENARIO DRUCKER AND THE DEMISE OF THE
PRODUCT CYCLE

• Product Cycle Based on Comparative Advantage
• -- Incentive to Follow Low Wages
• Decline in Labor Costs as a Percentage of Total
  Costs
• Knowledge Intensive Products (e.g., Computer
  Chips)
• Automation Removing the Worker
• Decline in Raw Materials as a Percentage of
  Total Costs