W K11 International Monetary System

Inter Bus, BBA 2010 1

WK11.1 Agenda• News, Daily good deeds• Project: Homework: Topic by Friday January

14, 2011. How and where to find the impact information?

• Presentation: Friday January 21, 2011.• Exam Part II: Wednesday January 26, 2011.• Session III will start January 12, 2011• Last week article• Monday Discovery


Article• Read the article and answer the questions.• What do you call Chinese exporters that

promote their products to US or EU through Thailand?

• Do you think it’s ok? Will this benefit Thailand?

• What is rule of origin? What is custom union?• What’s 10 billion Yuan equal to Thai baht?


Picture Discovery


Picture Discovery


Picture Discovery


Picture Discovery• What are the major currencies?

Why should we study about it?• What’s the trend in

2010?


Picture Discovery• What’s this? • What’s the meaning of

this chart?


IMF Games

• Play Monetary Mania from the IMF website.

• http://www.imf.org/external/np/exr/center/econed/index.htm

• Jot down the important information(Money, Economics, Monetary, etc.).

• Report your group knowledge on the board.

• Play World Trader from IMF.

• What score did you get?

• Did you achieve your goal?

• What did you learn?

http://www.imf.org/external/np/exr/center/econed/index.htm




WK11.2 Agenda

• News, Daily good deeds• Next Wednesday January 19, 2010:

Meditation• Project Next Friday January 21, 2010• Exam Part II Next Wednesday 26, 2010.• More Discovery


Big Mac Exercise• Law of one price: In an efficient market, the price of the same product

should be the same everywhere, else the process of arbitrage will occur.• If we want the same price as in the US., what should be the exchange

rate?

Countries Big Mac PriceUS= 3.73 $

Theoretical Exchange Rate

Current Exchange Rate

Thailand 70

China 13.2

Japan 320

Australia 4.35

Euro Area 3.38



should be the same everywhere, else the process of arbitrage will occur.• In the long run what would happen to the exchange rate of each

country?• What are the limitations of using Big Mc index?• Differences in tax, cost of production(rent & labor), consumer

preferencesdifference market position and price


Theoretical Exchange Rate (Implied PPP)


Thailand 70 18.77 30.4

China 13.2 3.54 6.6

Japan 320 85.7 83.1

Australia 4.35 1.17 1.01

Euro Area 3.38 (1.1)(0.9) (1.3)


Interest, Inflation and Exchange Rate• Fisher Effect• Real interest rate=Nominal

interest rate-Inflation

• International Fisher Effect

• Concept that the interest rate differentials for any two currencies will reflect the expected change in their exchange rate.

• Where will you invest?• Thailand: Nominal interest 2%,

inflation 5%• China: Nominal interest 3%,

inflation 1%• How can you make money?• Japan: interest rate 1%• Australia: bond yield 6%• According to the Fisher effect,

real interest rate of countries should be the same, what would happen to the exchange rate?

• What are the relationship of interest rate, inflation, and exchange rate?

¥ ¥


Video Clip Discovery

• US-China currency dispute• What does the US want? Why?• Where does China put the money from trade?• What is hot money? Why they are afraid of it?• What happens when the currency appreciate?


Reading Discovery

• Read the following article and answer the questions.

• US BOP: Is the sky falling?


Article: U.S. BOP Deficit


WK11.3 Agenda• News, Daily good deed• Project update, information, grading criteria• Working on campus• Meditation class on Wednesday January 19,

2011• Lecture• Class wrap up


International Monetary System• The international monetary system:• Establishes the rules by which countries value and exchange

their currencies and provides a mechanism for correcting imbalances between a country’s international payments and receipts.

IMS IMS

Institutions

Agreements

Process

Rules


History of IMS

Gold Standard

1880

Bretton Woods Agreement (Fixed

Rate System)1945

Floating Currency Exchange Rate

System1972


Gold Standard• Each country set its par value(unit of

its currency) to an ounce of gold. Currencies were pegged to gold. The ratio of the two currencies equal to the gold equivalence establishes the exchange rate between the two countries.

• Gold Specie: gold coin as money • Gold Bullion: the government can

print out the money equal to the gold reserve

• Discipline, Security, Flexibility

• WW period, great depression, beggar-thy-neighbor policies

• Bank couldn’t redeem the money for gold at the par value.

• UK: 1 once of gold=4 £

• US: 1 once of gold=20 $

• France: 1 once of gold = 10 franc

• Exchange rate UK/US=? US/France?

• 4/20=1 £ per 5 $, 2 $ per franc


Bretton Woods AgreementAfter WWII governmental representatives met at Bretton Woods NH, USA. to arrange the plan for post war economic environment to promote peace and prosperity.

The fixed exchange rate restored the gold standard and tied to US dollar. Only the US dollar would be redeemable for gold. US dollar became a mean for international payment and reserve currency for other governments. Each country pledged to maintain the value of its currency + 1% of its par valueAdjustable peg.

Creation of International Bank for Reconstruction and Development (the World Bank): to help finance reconstruction of European economies, build economies of the world’s developing countriesCreation of IMF: To promote international monetary cooperation, facilitate the expansion and balanced growth of international trade, promote exchange stability, maintain orderly exchange arrangements among members, avoid competitive exchange depreciation, assist in the establishment of a multilateral system of payments, give confidence to members, shorten the duration and lessen the degree of disequilibrium in their BOPSpecial Drawing Rights (SDR): An international reserve asset , the unit of account for the IMF and other international organizations


Bretton Woods System• Triffin Paradox:• A national currency that is also a

reserve currency will eventually run a deficit, which eventually inspires a lack of confidence in the reserve currency and leads to a financial crisis.

• The deficit was financed partly by the shrinking gold reserve and liabilities to other foreign central banks.

• End of Bretton Woods: President Richard Nixon announcement: U.S. dollar inconvertible to gold

• G10 Smithsonian Conference

USA

UK

France

Japan

China

Confidence


Floating Currency Exchange Rate System

• Floating currency exchange rates:

• Rates that are allowed to float against other currencies and are determined by market forces.

• Which direction is for depreciation?


Summary of Currency Arrangements

System Gold Bretton Woods Floating

Pros Simplicity, Widely trusted, Monetary discipline

Fixed rates,Supported trade growth

Flexibility, Reflect market forces, Handle huge volume

Cons Impractical with large trade flow, Holding costs

BOP deficit for U.S.,Shrinking U.S. gold reserve, U.S. government liabilities to foreign central banks

Wide swings in currency values

ControllingMechanism

Gold flows Government adjusted rates against dollar, Dollar constant against gold

Market forces with some government intervention


Current Currency Arrangements• Categorized by IMF 1) Exchange arrangement with no separate legal tender: one country adopt the

currency of another(Timor, Panama) or a group of countries adopting a common currency(Euro).

2) Currency board arrangements: the board legislate the fixed exchange rate and control the domestic money supply through foreign reserves(Brunai).

3) Other conventional fixed peg arrangements: fixed rate with + 1% (Saudi)4) Pegged exchange rates within horizontal band: the exchange rate could

fluctuate greater than 1% (Denmark)5) Crawling pegs: the currency is readjusted periodically at a fixed, preannounced

rate6) Crawling banks: the currency readjustments to maintain fluctuation margins

around a central rate.7) Managed floating with no preannounced path for the exchange rate: the

government actively intervene the exchange rate depending on the economic indicators(BOP, reserve, interest rate, etc.) China, Malaysia, Singapore

8) Independently float exchange rates: There maybe government intervention to moderate the rate of change not the rate establishment (USA, Japan, UK)


Exchange Rate QuotationsBid price: buying price

Ask price, offer rate: sales price

Spot rate: the exchange rates between two currencies for delivery within 2 business days

Forward rate: the exchange rate between 2 currencies for delivery in the future, usually 30, 60, 90, or 180 days.

Spot rate: 1$/30 Baht

Forward premium: 1$/35 Baht

Forward discount: 1$/28 Baht


Exchange Rate Quotations• Direct rate: one unit of the local

currency to foreign currency (1 Baht/0.033$)

• Examples of the indirect rate: (1$/30 Baht), (1€/40 Baht), (1Yuan/4.8 Baht)

• Cross rate: calculate the exchange rate of the two countries using the third major currency ($/Yuan=?)

• Arbitrage:?• purchase of a product in one market

for immediate resale in a second market in order to profit from a price discrepancy.

• In the market 1$/6.6 Yuan, how can we profit from Yuan, Baht, and Dollar?


Exchange Rate Movement

Exchange Rate

Currency Supply& Demand

Interest Rate

Inflation Rate

E(future)Tax Rate

Trade Policies

World Events


Theories of Exchange Rate

Law of one price:In an efficient market, like products will have like prices.

Fisher effect:The real interest rate will be the nominal interest rate minus the expected rate of inflation.

International Fisher effect:

The interest rate differentials for any two currencies will reflect the expected change in their exchange rates.



should be the same everywhere, else the process of arbitrage will occur.• In the long run what would happen to the exchange rate of each

country?• What are the limitations of using Big Mc index?• Differences in tax, cost of production(rent & labor), consumer

preferencesdifference market position and price


Theoretical Exchange Rate (Implied PPP)


Thailand 70 18.77 30.4

China 13.2 3.54 6.6

Japan 320 85.7 83.1

Australia 4.35 1.17 1.01

Euro Area 3.38 (1.1)(0.9) (1.3)


Interest, Inflation and Exchange Rate• Fisher Effect• Real interest rate=Nominal

interest rate-Inflation• International Fisher Effect• Concept that the interest rate

differentials for any two currencies will reflect the expected change in their exchange rate.

• Where will you invest?• Thailand: Nominal

interest 2%, inflation 5%• China: Nominal interest

3%, inflation 1%• How can you make

money?• Japan: interest rate 1%• Australia: bond yield 6%• What would happen to

the exchange rate?

¥ ¥


Balance of Payment• The BOP accounting system is

a double-entry bookkeeping system designed to measure and record all economic transactions between residents of one country and residents of all other countries during a particular time period.

• Assists policy makers in designing appropriate public policies.

• In theory: Current Account + Capital Account + Official Reserves Account = 0


Summary• History• Theories to explain the direction of:• Interest Rate Inflation

Exchange rate• Balance of payment• Exchange rates affect business operations in three

primary areas: marketing, production, and finance. Examples?

α


Class Wrap Up• Change?• News, knowledge• Daily good deeds• Language skills• Responsive


Video Clip Review• US Trade deficit controversial plan.• What’s the government plan to fix the

problem?• What are the pros and cons of the plan?

Documents

W K11 International Monetary System