Weekly

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Weekly fun with controversies topics

• Free Trade v. Protectionism

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Day 3 Currency issues

• Is the dollar losing its credibility as the
  worlds reserve currency?
• If yes, what do we replace it with?
• Although it may seem like a minor question, a
  reserve currency of sum form is need to
  rationalize international trade in goods.

3
Bretton-Woods and the Dollar Standard

• Bretton-Woods System
• Henry White (U.S.) negotiated with John Maynard
  Keynes (U.K.) to establish the post-war economic
  arrangements

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Famous Plaque on the Door of the Bretton Woods
Resort
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• Bretton-Woods established both the IMF and the
  World Bank
• Both had very specific (and separate) goals
• Recognizing that Europe could not be the basis
  for a new monetary system, the dollar system
  was adopted

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System worked by indirectly linking currencies to
gold

• All currencies backed by gold, but only through
  dollar
• FF ? ? Gold
• Only the U.S. was in danger of a currency attack
  (gold outflow)

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• System stable until 1971 (Smithsonian Accord)
• Then, U.S. formally departs gold standard in
  1973, leaving 11B in gold at Fort Knox, valued
  at 42/oz.
• 335 billion at todays price of gold
• World now uses Fiat (funny) money
• Recent fiscal carelessness and high money supply
  expansion led to devaluation of dollar
• until euro-zone looked even worse after the
  crisis with the PIIGS
• China is now using a market-basket of currencies
• Has even started using a complete substitute with
  Australia

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The Currency Issue and the Search for Stability

• After the collapse of the dollar-standard,
  nations immediately began searching for another
  way to stabilize currencies
• Gave birth to the ecu (the precursor to the euro)
• Nations of EU formed the European Monetary System
  (EMS)
• Pegged their currencies against the ecu, which
  indirectly pegged them against each others
  currencies

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• Currencies only allowed to move in a narrow band
  around a fixed value to the ecu
• Initially thought that the ecu would be common
  currency, but European Currency Unit didnt
  have a very good ring to it.
• When euro adopted, ecu eliminated.

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• In end, because many countries didnt join the
  EMS (or joined and then left), a common currency
  was considered a better option
• Euro came into being in 1999 (as a unit of
  account)
• Became a full currency in 2001

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• What are some other potential reserve currencies?
• SDR

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Why do we need a reserve currency?

• Currency cross-rates would become meaningless
  without a hard currency
• Hard-pegging and soft-pegging systems impossible
• Several nations (e.g. Ecuador) have dollarized
  not sure what a replacement would look like
• Resulting instability for developing nations that
  prefer a system like this.

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• Maybe SDR (IMF dollars) or commodity money
• How commodity money works (Benjamin Graham)
• 1 cocoadollar (CO) 1 pound of cocoa
• If price of cocoa ?, people trade in CO for
  stockpiled cocoa market price comes back down
  again
• If price ?, people trade in cocoa for COs,
  removing the excess supply and raising prices.

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• What about return to gold standard?
• 11 billion in gold at Fort Knox (_at_42 per ounce)
• Actually 314 Billion at 1200/ounce
• Could be used as a start to backing up a
  currency, but gold-standards are unstable also
• Or the world will adopt a multi-currency model

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This is most likely outcome

• Nations will begin using a basket of currencies
  as a peg (, euro, British Pounds, with a
  smaller component of the C, Japanese Yen and
  Swiss Franc).
• As a side benefit, it substantially reduces
  exchange rate risk.

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End of Day 3

• Questions and Suggestions?
• International trade is on the agenda for next
  time.