Midterm Study Guide - What is Special about International...

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What is Special about International Finance? o Foreign Exchange Risk o Political Risk o Market Imperfections o Expanded Opportunity Set Reasons to go Global: raw material seekers, market seekers, cost minimizers Free Float (Clean): The largest number of countries allow market forces to determine their currency’s value Managed Float (Dirty): Countries combine govt intervention with market forces to set exchange rates Pegged to another Currency: like US dollar or euro No National currency: some countries do not bother printing their own, they just use their own; ex: Ecuador, Panama, and El Salvador; OR currency board agreements/ common currencies ie Euro Evolution of International Monetary System Bimetallism: Before 1875 o Both gold and silver were used as money o Exchange rates among currencies were determined by either their gold or silver contents o Gresham’s Law: implied that it would be the least valuable metal that tended to circulate (Bad money drives out good) o First Coin: Lydians – Asia minor (610 BC) Classical Gold Standard: 1875-1914 o Gold alone; could be freely exported/imported o The exchange rate between two countries’ currencies would be determined by their relative gold contents o Highly stable exchange rates o Price-Specie-Flow Mechanism: misalignment of exchange rates and international imbalances of payment automatically corrected o Supply of gold was so restricted that growth can be hampered Interwar Period: 1915-1944 o Exchange rates fluctuated as countries widely used “predatory” depreciations of their currencies as a means of gaining advantage in the world export market Bretton Woods System: 1945-1972 o 44 Nations at Bretton Woods NH; purpose to design a post war international monetary system o created IMF and the World Bank o US dollar was pegged to gold at $35 per ounce and other currencies were pegged to the US dollar o Each country was responsible for maintaining exchange within 1% of the adopted par value by buying/selling foreign reserves as necessary o Depended on US running a constant BOP deficit to allow the US$ to be a reserve currency
o High inflation rate in US; US$ depreciated sharply o BW collapsed in 1971 The Flexible Exchange Rate Regime: 1973-Present o Gold was abandoned o Non oil exporting countries and less developed countries given access to IMF funds Mexican Peso Crisis: o 10/20/1994 Mexican govt announce plan to devalue peso against dollar by 14% o rush for exits caused peso to fall by 40% o First serious international financial crisis o Lessons: essential to have a multinational safety net and an influx of foreign capital can lead to an overvaluation in the first place Asian Currency Crisis: o more serious than the Mexican peso crisis o

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