Session 5 Currency Issues

1
Session 5- Currency Issues
2
Session 5 Objectives

• Explain the developments shaping the world
  monetary system
• Understand balance of payments
• Compare relative strengths and weaknesses of
  currencies
• Identify the major foreign exchange markets of
  the world
• Understand changes being caused in the FX markets
• Understand the central reserve asset/national
  conflict of the U.S. dollar
• Discuss the euro and its present state of
  acceptance by EU countries

3
A Brief Gold Standard History

• From about A.D. 1200 to the present
• Direction of the price of gold has been generally
  up.
• During this time, the price of gold rose from
  about 21 per ounce to just under 200 in
  December 1976.

4
A Brief Gold Standard History

• Most trading or industrial countries adopted the
  gold standard.
• The gold standard is countries agree to buy or
  sell gold for an established number of currency
  units (i.e. dollars or yen).
• A government cannot create money that is not
  backed by gold.

5
A Brief Gold Standard History

• Return to the Gold Standard?
• Argument that the U.S. dollar is currently a
  reserve asset of nations is unsustainable.
• Because of its high value, gold is very portable.

6
Bretton Woods and the Gold Exchange Standard

• In 1944, representative of the major Allied
  powers met at Bretton Woods, New Hampshire to
  plan for the future.
• General consensus
• Stable exchange rates were desirable.
• Floating or fluctuating exchange rates had proved
  unsatisfactory.
• Government controls of trade, exchange, and
  production, that had developed through WWII were
  wasteful and discriminatory.

7
Bretton Woods and the Gold Exchange Standard

• To achieve its goals, the Bretton Woods
  Conference established
• The International Monetary Fund (IMF)
• The IMF Articles of Agreement entered into force
  in December 1945.
• From 1945-1971, IMF agreement was the basis of
  the international monetary system.
• The US was agreed to be the only central reserve
  asset.
• An ounce of gold was agreed to be worth US35.

8
Balance of Payments
9
General Information

• A countrys BOP is a very important indicator of
  what may happen to the countrys economy.
• If countrys BOP is in deficit
• Inflation is often the cause.
• A company doing business there must adjust its
  pricing, inventory, accounting, and other
  practices to inflationary conditions.
• The government may take measures to deal with
  inflation and the deficit.

10
What can be done

• Actions the government may take to deal with
  inflation and the BOP deficit include
• Market measures
• Deflating the economy
• Devaluing the currency
• Nonmarket measures
• Currency controls
• Tariffs
• Quotas

11
Debits and Credits

• Debits and Credits in International Transactions
• International Debit Transactions
• Involve payments by domestic residents to foreign
  residents.
• International Credit Transactions
• Involve payments by foreign residents to domestic
  residents.

12
Related Activities

• Examples of Debit Transactions
• (from the U.S. Perspective)
• Dividend, interest, and debt repayment services
  on foreign-owned capital in America.
• Merchandise imports.
• Purchases by Americans traveling abroad.

13
More Related Activities

• Examples of Debit Transactions (contd)
• Transportation services bought by Americans on
  foreign carriers.
• Foreign investment by Americans.
• Gifts by Americans to foreign residents.
• Imports of gold.

14
Accounting Adjustments

• Double-Entry Accounting
• The BOP is presented as double-entry accounting
  statement
• Total credits and debits are always equal.
• Statement of a countrys BOP is divided into
  several accounts.
• Current Account
• Capital Account
• Official Reserves Account

15
Balance of Payments (BOP)

• Current Account
• Subaccounts include
• Goods or merchandise
• Services
• Unilateral transfers

16
BOP related Accounting

• Current Account
• Goods or merchandise
• Deals with visibles, such as autos, grain,
  machinery, and equipment.
• The net balance on merchandise transactions is
  referred to as the countrys trade balance.

17
Balance of Payments Current Accounts

• Current Account
• Services
• Deals with invisibles that are exchanged or
  bought internationally.
• Examples include dividends or interest on foreign
  investments, royalties on patents or trademarks
  held abroad, travel, insurance, banking, and
  transportation.

18
Current Accounts Continued

• Current Account
• Unilateral transfers
• Transfers with no quid pro quo.
• Some of these transfers are made by private
  persons or institutions, and some by governments.
• Some private unilateral transfers are for
  charitable, educational, or missionary purposes.
• The largest government unilateral transfers are
  aid.

19
When BOP is too high

• Temporary BOP deficit
• Can be corrected by the countrys monetary
  policies or fiscal policies.
• May be corrected by short-term IMF loans and
  advice.

20
Gold Exchange Standard
21
Gold Exchange Standard

• Gold and Dollars Go Abroad
• From 1958 through 1971, United States cumulative
  deficit was 56 billion.
• Deficit was financed partly by use of the U.S.
  gold reserves.
• Deficit partly financed by incurring liabilities
  to foreign central banks.

22
August 15, 1971

• By 1971, many more dollars were in the hands of
  foreign central banks than the gold held by the
  U.S. Treasury could cover.

23
1971-1973

• August 15, 1971
• President Nixon closed the gold window.
• Currencies began to float.
• Stated US value of 35 dollars per ounce of gold
  was now meaningless.
• The gold exchange was ended.

24
Steps taken during 1971-1973

• December 1971
• Smithsonian Accord was signed.
• Agreement on trade obstacles reached along with
  new currency exchange rates.
• This led to the devaluation of the US.
• However, new rates could not be maintained.
• By 1973 currencies were floating.

25
The Present Currency Situation

• Since 1973
• Two kinds of currency floats
• Free (clean) float
• Managed (dirty) float

26
Free Float

• Currency Floats
• Free (clean) Float
• Closest approach to perfect competition.
• No government intervention.
• Billions of the product (units of money) are
  traded by thousands of buyers and sellers.

27
Dirty Floats

• Currency Floats
• Managed (dirty) Float
• Governments intervene in the currency markets as
  they perceive their national interests to be
  served.
• Nations may explain their interventions in terms
  of smoothing market irregularities or assuring
  orderly markets

28
Currency Status

• Currency Areas
• Currencies that float against each other and
  against the euro include the
• U.S. dollar
• Canadian dollar
• Japanese yen
• Swiss franc

29
Foreign Exchange
30
Money Markets, Foreign Exchange

• London is the worlds largest foreign exchange
  market.
• It has 30 percent share of foreign exchange
  turnover.
• New York is the second largest foreign exchange
  market.
• Asia, Tokyo, Hong Kong, and Singapore are
  fighting for foreign exchange supremacy.

31
Asian Currencies

• Asian Currencies to the rescue
• Asian currencies are no longer thought of as
  exotic since their markets have emerged.
• The more liquid currencies include the
• Singapore dollar
• Thai baht
• Indonesian rupiah
• Malaysian ringgit

32
Currency Trading

• The US is the most traded currency.
• The US-Euro market is the busiest, closely
  followed by the US-yen.
• Virtually all trading in the Asian foreign
  exchange market is conducted through the dollar.

33
Special Drawing Accounts

• SDRs in the Future
• Special drawing rights (SDRs)
• May be a step toward a truly international
  currency.
• The US has been the closest thing to such a
  currency since gold in the pre-WWI gold standard
  system.
• The objective was to make the SDR the principal
  reserve asset in the international monetary
  system.

34
How are SDRs established

• Value of the SDR
• The SDRs value is based on a basket of the
  following five currencies
• U.S. dollar (41.3)
• euro Germany (19)
• euro France (10.3)
• Japanese yen (17)
• British pound (12.4)
• The percentages are changed periodically.

35
Why SDRs?

• Uses of the SDR
• The SDRs value remains more stable than that of
  any single currency.
• Holders of SDRs include
• The International Monetary Fund (IMF)
• Most of the 181 members of the IMF
• 16 official institutions
• These institutions typically regional development
  or banking institutions prescribed by the IMF.
• Equity Issue

36
Euro

• From the European Currency Unit (ECU) to the Euro
• The ECU was established as the EMS bookkeeping
  currency.
• The ECU was more popular than the SDR because
• Neither the US nor the yen was included in the
  currency basket that determined its value.
• Of active sponsorship of the ECU by European
  governments, banks, and businesses.

37
ECU and the EU

• The European Currency Unit (ECU)
• The ECU was a weighted basket of currencies, and
  its uses include
• Denominating bonds.
• Calculating the EU budget.
• Raising levies.
• Distributing funds that were translated into
  domestic, national currencies.

38
Money Markets, Foreign Exchange

• The European Currency Unit (ECU)
• The euro has replaced the ECU and has replaced
  some national currencies.
• The euro is a retail currency, whereas the ECU
  was only a wholesale and debt market currency