FIRE 473 Note 2

The Gold Exchange Standard

Only U.S. and Britain allowed to hold gold resevres Other countries could hold gold, dollars, or pound reserves -Great Depression (1929-1932) -Austrian Banking System Collapse -International Financial Crisis (1931) - currencies devaluation led to trade wars

Post Bretton Woods System

-Current System(Hybrid System) --Major currencies use freely-floating method --Others move in and out of various fixed-rate systems A) Smithonsian Agrement: --US $ devalued to 1/38oz of gold --By 1973: World on a freely floating exchange rate system B) Jamaica Agreement (1976) --Terminated par value system based on gold (end of bretton woods agreement) --Permitted each member to peg or float its own currency

International Monetary Fund (IMF)

-In 1944, the Bretton Woods Agreement established a US dollar based internantional monetary system and added 2 new insititutions, IMF and World Bank World Bank: Helped countries with BOP and exchange rate problems IMF: aided in post war reconstruction, but since has supported general economic development

The Snake Within The Tunnel

-In may 1972, the european community agreed to allow their currencies to flucuate a maximum of 2.25 percent against one another, while permitting a 4.5 percent flucuation against other currencies. -The SNAKE was the narrowert band of 2.25 percent permitted among the European Community countries and the TUNNEL was the wider band of 4.5 percent allowed by the smithsonian agreement -The TUNNEL was elimitated in March 1973 when the Smithsonian Agreement collapsed -The SNAKE was eliminated on March 13th, 1979 when the European Monetary System went into effect

Classification of Currency Arrangements (before 1999)

-Pegged to another currency (Currency Peg) -- peg to single value -Pegged to a basket (Currency Basket) -- A basket consists of currencies of major trading partners -Flexible against a single currency -- Peg to a range -Joint float - Peg each members currency to all others and joint float of all members currencies together against non EMS currencies -Adjusted according to indicators -- adjust currency automatically against changes in particular indicators -Managed float -- central bank sets the exchange rate against a predetermined goal -Independent floating -- Central bank allows the exchange rate to be determined by the market force alone. Currencies of advanced countries are freely floating

Objectives of the IMF

-Promote International monetary cooperation -Facilitate the balanced growth of international trade -Promote exchange stability -Eliminate Exchange Restrictions -Create standby reserves

Special Drawing Rights (SDR)

-SDR is an internation reserve asset created by IMF to supplement exisitng foreign exchange reserves. -It is the weighted currency value of 5 IMF members that have the largest exports of goods and services (the weighs are recalculated every 5 years) -Individual countries hold SDRs in the form of deposits at the IMF. These holdings are part of each countrys international monetary reserves, along with the official holdings of gold, Foreign exchange, and its reserve position at the IMF

The Bretton Woods System (1944-1973)

-The US $ was key currency, valued at $1 - 1/35oz of gold -All currencies linked to that price in a fixed rate system -Exchange rates were allowed to flucuate by 1% above or below initially set rates -Collapse in 1971 because of the US high inflation rate, US $ depreciated sharply, and Large US BOP defecit (1940-1971)

Soft Currency

A currency that is expected to drop in value (devalue or depreciate) relative to trading currencies

Hard Currency

A currency that is expected to gain in value (revalue or appreciate) relative to major trading currencies

For a transaction of supply and demand curves.. There will always be an

An increase in demand of a currency AND increase of supply in another currency

Classification of Currency Agreements (1999 and AFTER)

Exchange Agreements with No Separate Legal Tender: The currency of another country circulates as the sole legal tender or the member belongs to a monetary or currency union in whicht he same legal tender is shared by the members of the union Currency Board Agreements: A monetary regime based on an implicit legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate, combined with restrictions on the issuing to ensure fulfillment of its legal obligation Other conventional fixed-peg agreements: The country pegs its currency (formally called de facto) at a fixed rate to a major currency or a basket of currencies, where the exchange rate flcuates within a narrow margin at or most + 1% around a central rate Pegged Rate within horizontal Bands: The value of the currency is maintained within margins of fluctuation around a formal or de facto fixed peg that are wider than the 1% around a central rate Crawling Pegs: The currency is adjusted periodically in small amounts at a fixed, preannounced rate or in response to change in selective quantitative indicators Exchange rates within crawling bands: The currency is maintained within certain fluctuation margins around a central rate that is adjusted periodally at a fixed preannounced rate or in response to change in selective quantitative indicators. Managed Floating with no preannounced path for exchange rate: The monetary authority influences the movements of the exchange rate through active intervention in the foreign exchange market without specifying or precomitting to a preannounced path for the exchange rate. Independent floating: The exchange rate is market-determined, with any foreign exchange intervention aimed at moderating the rate of change and preventing undue fluctuations in the exchange rate, rather than at establishing a level for it.

Demand and Supply Curve of Foreign Currecy

If you want to exchange your $ for Yen: Buy Yen = Increase in demand for Yen Sell $ = Increase in supply for $

In any transaction, the demand for a currency and supply for another currency

Increase and increase Demand for FX comes from: Imports and Capital outflows Supply of foreign exchange comes from: Exports and capital inflows

The following factors can shift the deamnd and supply curve

Inflation Rates Interest Rates GNP Government Intervention

Classic Gold Standard 1821-1914

Involved commitment by nations to fix the price of domestic currency in terms of a specific amount of gold Maintenance involved the buying and selling of gold at that price Disturbances in price levels would be offset by the price-specifc-flow (gold coin) mechanism.

Foreign Currency Exchange Rate

Price of one countrys currency in units of another currency or commodity (gold or silver)

Devaluation

Refers only to a drop in foreign exchange value of a currency that is pegged to gold or to another currency

Weaking, Deterioration, or Depreciation

Refers to a drop in foreign exchange value of a floating currency

Revaluation

Refers to gain in foregin exchange value of a currency that is pegged to gold or to another currency (opposite of devaluation)

Strengthening or Appreciating

Refers to gain in the exchange value of a floating currency

Par Value

The rate at which the currency is fixed or pegged

Floating or Flexible Exchange Rate System

The system that the government does not interefere the currency valuation in any way

Fixed or Managed Exchange Rate Systm

The system that the government interferes (intervenes) the currency valuation