Finance 319 Lecture 3

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Finance 319 Lecture 3

• Galina A Schwartz
• Department of Finance
• University of Michigan
• Business School

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Practical Matters Office Hours Change

• My office D3270A (Davidson Hall)
• My e-mail galka_at_umich.edu
• My office hours
• Mon., 10am -12pm , Th., 1 pm -3 pm
• or by appointment
• Notice a change was Th., 3 pm - 5 pm

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Overview of International Monetary System I

• Readings Levich, Chapter 2
• History (seven episodes, see Levich, boxes 2.1 -
  2.7)
• Current Trends
• to float from fixed
• to less capital controls

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Overview of International Monetary System II

• Current rules of the game
• volatility ? (due to float) ? need to hedge
• Emerging markets currency board,
• issues credibility, commitment
• Europe common currency (EURO) will it last?

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Rules of the Game a set of explicit and implicit
rules

• laws regulations
• customs conventions
• IFS as a factor of production (i.e. financial
  infrastructure)
• Government Objective is twofold
• 1. Domestic Agenda Gov-t Promises
• 2. International Agenda Gov-t Promises
• 1 2 are contradictory

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1. The Gold Standard, 1879 - 1913, Box 2.1, p. 24

• I. - a definition
• II. - a rule used (no capital controls)
• III. - a result of I and II.
• VI. - the means to sustain the system.
• V. - the means to sustain the system
• VI. - a major system feature common price level.

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2. Bretton Woods, Box 2.2, p. 27

• I. II. - a definition
• III. - free convertibility - a result of I.
• III. (capital controls) VI. - the means to
  sustain the system achieve national
  macroeconomic autonomy
• V. - a major system feature macro autonomy

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3. Fixed-Rate Dollar Standard, 1950 - 1970, Box
2.3, p. 29

• growing foreign reserves U.S. Balance of
  Payment deficits
• countries peg exchange rates to US within 1 of
  par value
• which is US Dollar is used as a gold

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Why the rules of the game change?

• When does the change happen?
• How fast does it happen?
• Is it easy to change the rules?
• Could it possibly be an easy and fast process?

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More Rules of the Game

• 4. Floating-Rate Dollar Standard, 1973 - 1984,
• Box 2.4, p. 33
• 5. Plaza-Louvre Accord Floating-Rate Dollar
  Standard, 1985-1996,
• Box 2.5, p. 35

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6. 7. The Spirit of EMU the Current Rules,
Box 2.6-7, pp. 38-9

• Benefits of the union
• Exchange rate uncertainty is reduced
• Price transparency
• Political cooperation economic convergence.
• Costs of the union
• Loss of monetary independence
• Difficulty adjusting to external shocks.

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An Example (US - Mexico)

• Does Trade Deficit matter?
• Reasons for Trade Deficit
• corporate --tax regulatory
• exchange rate dis-equilibrium
• dynamic production consumption adjustment

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Next Lecture

• To read Levich, Chapter 3
• Millman, Gregory, 1995, The Vandals' Crown How
  Rebel Currency Traders Overthrew the World's
  Central Banks, Free Press. (further Millman) The
  golden vanity, pp.65-94. (S)

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Summary of Today

• Basic Concepts, See Lecture 2 notes
• Rules of the Game
• history of international monetary system
• features of the system its support mechanisms
• pluses and minuses of different rules of the game
  
• One central bank speculation