International Business Final
Two Features of the Foreign Exchange Market
the market never sleeps integration of the various trading centers implies there can be no significant difference in exchange rates quoted in the trading centers arbitrage- buying a currency low and selling it high
Tariff Rate Quota
a lower tariff rate is applied to imports within the quota than those over the quota ex) US beef quotas system
Technical Analysis
focuses on trends and believes that past trends and waves are reasonable predictors of future trends and waves
Political Case for Integration
free trade makes neighboring economies dependent on each other creating incentives for political cooperation between the neighboring states and reduces potential for violent conflict countries can enhance their political weight in the world by grouping economies
Freely Convertible
when the country's government allows both residents and nonresidents to purchase unlimited amounts of a foreign currency with it
Brokers
professionals who assist in the transfer of funds between banks and find most favorable currency prices
Location Specific Advantage
the advantages that arise from utilizing resource endowments or assets that are tied to a particular foreign location and that firms finds valuable to combine with its own assets
Exchange Rates are Determined by
the demand and supply of one currency relative to the demand and supply of another if we understand how exchange rates are determined we may be able to forecast exchange rate movements
Currency Conversion
the exchange rate allows us to compare the relative prices of goods and services in different countries
Quota Rent
the extra profit that producers make when supply is artificially limited by an import quota
inflows of FDI
the flow of FDI into a country
1947-1979: GATT, Trade Liberalization and Economic Growth
1947 Geneve GATT was a multinational agreement whose objective was to liberalize trade by eliminating tariffs, subsidies, import quotas, etc tariff reduction stimulated economic growth
Asian Crises 1997
1980s unprecedented growth in SE Asia, based on exports 1990s developments investment boom in property banks engaged in excessive lending excessive government involvement in economy expanding imports local currencies pegged to the dollar 1997 overvalued assets/ currencies lead to bankruptcies foreign investors get worried and capital leaves the countries global crises, with global production contraction and drop in oil prices most countries recovered by 2001
Mercosur
1988, free trade pact Brazil and Argentina expanded to include Paraguay and Uruguay in 1990 has been successful at reducing trade barriers between member states Critics: worry that Mercosur may be diverting trade rather than creating trade, and local firms are investing in industries that are not competitive on a worldwide basis Venezuela joined in 2006 but is not yet a full member and was suspend in 2016
Treaty of Lisbon
2007 member states signed new treaty under which the power of the European Parliament was increased; Parliament was co-equal legislator for almost all European laws and created new position of president of the European council
Host Country Costs of FDI
Adverse Effects on Competition: foreign MNEs may have greater economic power than indigenous competitors foreign MNE may be able to draw funds generated elsewhere to subsidize its cost in the host market and drive out indigenous companies Adverse Effect on Balance: subsequent outflows of earnings from the foreign subsidiary to its parent company foreign subsidiary imports a substantial number of its inputs from abroad resulting in a debit on the current account of host country balance of payments National Sovereignty and autonomy: FDI is accompany by some loss of economic dependence
Association of Southeast Asian Nations ASEAN
Brunei, Cambodia, Indonesia, Laos, Malaysia, Philippines, Singapore, Thailand, and Vietnam
Pragmatic Nationalism and FDI
FDI has both benefits and costs FDI can benefit a host country by bringing capital, skills, technology, and jobs Cost is that profits of that investment of abroad
Role of IMF
Discipline- fixed exchange rate regime imposes discipline in two ways the need to maintain a fixed exchange rate puts a brake on competitive devaluations and brings stability to the world trade environment a fixed exchange rate regime imposes monetary discipline on countries thereby curtailing price inflation Flexibility- two major features of the IMF Articles of Agreement fostered this flexibility to avoid his unemployment IMF lending facilities- lend foreign currencies to members to tide them over during short periods of balance of payments deficits when a rapid tightening of monetary or fiscal policy would hurt domestic employment adjustable parities- allowed for the devolution of a country's currency by more than 10% if the IMF agreed that a country's balance of payments was in fundamental disequilibrium- countries suffering permanent adverse shifts in the demand for their products
Host Country Policies on FDI
Encouraging Inward FDI: offer incentives to foreign firms to invest in their countrys through tax concessions, low interest loans, and grants or subsidies Restricting Inward FDI: ownership restraint foreign firms excluded form certain sectors performance requirements
Home Country Policies on FDI
Encouraging Outward FDI: government backed insurance programs to cover foreign investment risk Restricting Outward FDI: limit capital outflows manipulated tax rules to encourage firms to invest at home
How did the EURO Come About
European Monetary Union EMU created in 1995 through Maastricht Treaty Euro launched at governmental level in 1999 11 countries Euro launched into participating economies in 2002 12 countries Not all EU members can or want to join the EMU Today 19 members have adopted euro not G Britain, Denmark, or Sweden To adopt the Euro a country must: keep government deficit low (<3%) have low government debt/GDP ratio (60%) Low inflation rates (<1.5% above EU minimum) Long-term interest rates (<2% of EU minimum) Participate in EMS in good standing
Evolution of the European Union
European Union EU- is the product of two political factors the devastation of western Europe during two world wars, and the desire for a lasting peace the Europeans nations' desire to hold their own on the world's political and economic stage formed in 1951 Treaty of Rome- 1957 treaty that created the European Community which became EU in 1993; provided for the creation of a common market elimination of international trade barriers and the creation of a common external tariff and requiring members states to abolish obstacle to the free movement of factors of production among the members necessary harmonization of the members states' laws common policies in agriculture and transportation
1980-1993 Protectionist Trends on World Trade System
Greater protectionism trends around world due to economic success of Japan during that time strained the world trading systems by the persistent trade deficit in the world's largest economy the US many countries found ways to get around GATT regulations
FDI Direction
Historically most FDI has been directed at the developed nations of the world the US is a favorite target as is the EU More recently developing nations have been the recipients of FDI South, East and southeast Asia particularly China have received significant inflows Latin America is also emerging as an important region for FDI
Criticism of IMF Policies
IMF's traditional policy represent a one size fits all approach to macroeconomic policy that is inappropriate for many countries moral hazard- arises when people behave recklessly because they know they will be saved if things go wrong Lack of Accountability- IMF has become too powerful for an institution that lacks any real mechanism for accountability
FDI in China
In the late 1970s, China opened its doors to foreign investors. By 2011, China attracted a record $124 billion of FDI, and now claims the position of being second only to the United States in terms of attracting FDI. China's large population is a magnet for many companies and because high tariffs make it difficult to export to the Chinese market, firms frequently turn to foreign direct investment. However, many companies have found it difficult to conduct business in China, and in recent years investment rates have slowed. In response, the Chinese government, hoping to continue to attract foreign companies has established a number of incentives for would-be investors. China has tremendous market potential it is still a poor country. Anticipated demand does not always translate into actual demand. In addition, opportunistic and inexperienced local joint venture partners can make it challenging for companies to successfully establish their presence in China. Furthermore, the country's highly regulated environment and lack of protection for proprietary assets can make it difficult for companies to conduct business Recognizing the problems associated with its infrastructure, the country has committed $800 billion to improvements over the next decade. In addition, China is offering preferential tax breaks to countries that invest in more remote areas.
Levels of Economic Integration
Less Amount of Integration: free trade customs union common market Economic Union Political Union Most amount of integration
Most Important Trade Centers are
London, NY, Zurich, Tokyo, and Singapore then Frankfurt, Paris, Hong Kong, and Sydney
Establishment of the Euro
Maastricht Treaty- 1992 committed EC members to adopting a common currency the euro lost of control over monetary policy optimal currency area- similarities in the underlying structure of economic activity make it feasible to adopt a single chancy and use a single exchange rate as an instrument of macroeconomic policy
Radical View and FDI
Marxist political and economic theory that argues that MNE is an instrument of imperialist domination and a tool for exploiting host countries to the exclusive benefit of their capitalist home countries no country should ever permit foreign corporations to undertake FDI because they can never be instruments of economic development only economic dominations where MNEs already exist they should be nationalized
NAFTA Benefits
Mexico: increased jobs as low cost production moves south and more rapid economic growth US and Canada: access to a large and increasingly prosperous market lower prices for consumers from goods produced in Mexico increased competitiveness in world markets US and Canadian firms with production sites in Mexico increased the neighbor's stability political and economic
Case for Fixed Exchange Rates
Monetary Discipline: the need to maintain fixed exchange rate parity ensures that governments do to expand their money supplies at inflationary rates Speculation: in a floating exchange rate regime argue that speculation can cause fluctuations in exchange rates fixed exchange rate system will limit the destabilizing effects of speculation Uncertainty: speculation adds to uncertainty surrounding future currency movements that characterizes floating exchange rate regimes adds risk to exporting, importing, and foreign investment activates Trade Balance Adjustments and Economic Recovery
The Case for Floating Exchange Rates
Monetary Policy Autonomy: under a fixed system a country's ability to expand or contract its money supply as it sees fit is limited by the need to maintain exchange rate parity monetary expansion can lead to inflation putting downward pressure on a fixed exchange rate monetary contraction requiers high interest rates leading to an inflow of money from abroad which puts upward pressure on a fixed exchange rate advocates of a floating exchange rate regime argue that removal of the obligation to maintain exchange rate parity would restore monetary control to a government Trade Balance Adjustments Crisis Recovery
Single European Act
Objectives of the Act- have one market in place Remove all frontier controls among EC countries thereby abolishing delays and reducing the resources required for complying with trade bureaucracy apply principle of mutual recognition to product standards institue open public procurent to nonnational suppliers, reducing costs directly by allowing lower cost suppliers into national economies and indirectly by foreign national suppliers to compete lift barriers to competition in the retail banking and insurance businesses remove all restrictions on foreign exchange transactions between members countries abolish restrictions on cabotage (right of foreign truckers to pick up and deliver goods within another member states borders)
Limitations of Exportations
transportation costs and trade barriers
Political Case for Government Intervention
Protecting Jobs and Industries- driven by political pressure (unions and industries), favors those with more political clout National Security- includes Boeing Retaliation- threat to intervene in trade policy as a bargaining tool to help open foreign markets and force trading partners to play by the rules, chicken tax Protecting Consumers- from unsafe products, US vs EU hormone free beef Furthering Foreign Policy Objectives- build stronger relations; pressure or punish rogue states that do not abide by international law or norms Protecting Human Rights and Environment
Host Country Benefits of FDI
Resource Transfer Effect- FDI supplies host courtly with capital, technology, and management resources that would otherwise not be viable and thus boost country's economic growth rate increase technology in production process and product FDI brings host country jobs that would otherwise not be there Balance of Payments Effects- usually see a surplus rather than deficit Effects on Competition and Economic Growth- establish of new enterprise increasing competition which drives down prices and increase economic welfare of consumers increased competition stimulates capital investments
Smith to the Great Depression World Trading System
Smoot- Hawley Act which erected an enormous wall of tariff barriers aimed at avoiding rising unemployment by protecting domestic industries and diverting consumer demand away from foreign products damaging effect on employment abroad other countries reacted by raising their own tariff barriers and the US exports tumbled in response and world slid into a greater depression
Economic Integration of Europe Timeline
The forerunner of the Eu was the European Coal and Steel Community Free Trade agreement on Coal and Steel industries 1951 Germany, France, Belgium, Italy, Luxemburg, the Netherlands The Treaty of Rome established the European Economic Community Common Market 1957 Specifically included to establish common policies in agriculture and transportation The Treaty of Maastricht 1992 committed to EC members to an economic union the name was changed to the EU in 1994
Main Countries of Sources of FDi
US, UK, Netherlands, Germany, Japan, France
Volkswagen Hedging Strategy
Volkswagen's decision to not properly hedge its foreign exchange exposure in 2003. Volkswagen saw a 95 percent drop in its fourth quarter profits after an unexpected surge in the value of the euro left the company with losses of $1.5 billion. Traditionally, Volkswagen, which produced its vehicles in Germany and exported them to the United States, hedged some 70 percent of its foreign exchange exposure. However, in 2003, the company made the unfortunate decision to hedge just 30 percent of its exposure but in 2003, the company was caught off guard by a sudden rise in the value of the euro against the dollar. Experts had failed to predict the rise in the euro, and Volkswagen, like other companies that failed to hedge their foreign exchange exposure, was hard hit. Volkswagen lost some €1.2 billion as a result of its decision to hedge just 30 percent of its foreign exchange exposure. Volkswagen was especially vulnerable to the rise of the euro against the U.S. dollar in 2003 because the company manufactured its cars in Germany and then exported them to the United States. When Volkswagen failed to adequately hedge its exposure to foreign exchange rate changes, and the euro-dollar relationship shifted, the company lost out. Had Volkswagen produced some of its cars in the United States, the effects of the currency shift would have been much smaller.
Political Union
a central political apparatus coordinates the economic, social, and foreign policy of the member states; EU is on the road to this
Import Quota
a direct restriction on the quantity of some goods that may be imported into a country; usually enforced by issuing import licenses to a group of individuals or firms ex) EU quotas to agricultural products
Subsidy
a government payment to a domestic producer; cash grant, low interest loans, tax breaks, and government equity participation in domestic firms helps domestic producers compete against foreign imports and gain export markets difficult to control and to implement without retaliation
North American Free Trade Agreement NAFTA
agreement between US, Canada, and Mexico abolition on 99% of the tariffs removal of most barriers on cross border flow of services allowing financial institutions unrestricted access to Mexico market protection of intellectual property rights removal of most restriction on FDI among members countries although special treatment (protection) will be given to Mexico energy and railway industries, American airline and radio, and Canadian culture application of national environmental standards establishment of two commission with the power to impose fines and remove trade privileges when environmental standards or legislation involving health and safety, minimum wages, or child labor are ignored
Free Trade Area
all barriers to the trade of goods and services among member countries are removed each country however is allowed to determine its own trade policies with regard to nonmembers
Cross Rate
an exchange rate computed from two other exchange rates
Countervailing Duties
antidumping duty on the offending foreign imports; special tariff
What Causes a Currency Crisis
anything that causes a collapse of investor's confidence in that currency sudden increase on inflation current account deficit excessive domestic borrowing leads to a capital flight Argentinism: capital golondrina (swallow capital) this results in a government inability to uphold the currency via its international reserves
Black Markets
are an indication of true supply and demand for a currency the less flexible an XR the more likely there will be a black market
Administrative Trade policies
are bureaucratic rules designed to make it difficult for imports to enter a country include antidumping policies they tend to hurt consumers by denying access to foreign products (or increasing their cost) environmental requirements, labor requirements, etc.
Anti-Dumping Policies
are designed to punish foreign firms that engage in dumping; to protect domestic producers from unfair foreign competition US firms that believe a foreign firm is dumping can file a complain with the government if the complain has merit, antidumping policies aka countervailing duties may be imposed
Special Tariffs
are levied as a fixed charge for each unit of a good imported
Ad Valorem Tariffs
are levied as a proportion of the value of the imported goods
Free Market View and FDI
argues that international production should be distributed among countries according to the theory of comparative advantage MNE is an instrument for dispersing the production of gods and services to the most efficient locations around the global FDI by MNE increases overall efficiency of the world economy
Bretton Woods
at the height of WWII representatives from 44 countries met at Bretton Woods, NH to design new international monetary system; established two multinational institutions; also called for a system of fixed exchange rates that would be policed by IMF International Monetary Fund IMF- task would be to maintain order in the international monetary system World Bank- task would be to promote general economic development all countries were to fix the value of their currency in terms of gold but not required to exchange their currencies for gold commitment not to use devolution as a weapon of competitive trade policy
Eclectic Paradigm
attempts to combine the two other perspectives into a single holistic explanation of foreign direct investment
Home Country Cost of FDI
balance of payments suffer from the initial capital outflow reacquired to finance the FDI current account of the balance of payment suffers if the purpose of the foreign investment is to serve the home market from a low cost production location current account of balance of payments suffers if the FDI is a substitute of direct exports
Interbank Market
banks dealing with other banks in large volumes, usually involving transactions exceeding $1 M
Russian Ruble Crisis 1998
between 1992 and 1995 value of ruble fell from R 125/$ to R 5130/$ money supply too large, resulting in very high inflation used up all their international reserves trying to keep the ruble stable IMF bailtout, 1996, 1998 in exchange for concessions 1998 bailout comes in the wake of the Asian financial crisis and the sudden drop in oil prices 1999 Russian economy more stable since then
Trends in FDI
both the flow and stock of FDI in the world economy have increased over the last 35 years FDI has grown more rapidly than world trade and world output because: firms still fear protectionist policies the shift toward democratic political institutions and free market economies encourages FDI Globalization is prompting firms to ensure they have a significant presence in many regions of the world
Court of Justice
comprised of one judge from each country, is the supreme appeals court for EU law; required to act as independent officials rather than as representatives of national interest
Balance of Payments Accounts
countries account that tracks both its payment to and its receipts from other countries be concerned if running a deficit current account- tracks export and import of goods and services trade deficit happens when country imports more than exports
Three Factors that Impact Future Exchange Rate
country's price inflation interest rate of country market psychology
WTO is currently focusing on
cutting tariffs on industrial goods and services phasing out subsidies to agricultural producers reducing barriers to cross-border investment limiting the use of anti-dumping laws TRIPS impose WTO members enforcement of patents lasting 20 years and copyrights lasting 50 years
Shifting Ideology on FDI
decline of number of countries that adhere to radical ideology increase number of countries gravitating toward free market end of spectrum and have liberalized their foreign investment regime
Growth of FDI due to
despite's decline in trade barriers firms still fear protectionist pressures and they see FDI as a way of circumventing future trade barriers driven by the political and economic changes occurring in many of the world's developing nations general shift toward democratic political institutions and free market economies economic growth, economic deregulation, privatization programs
European Parliament
directly elected by the populations of the member states; primarily consultative rather than legislative body debates legislation proposed by commission and forwarded to it by the council can propose amendments to that legislation
Fundamental Analysis
draws upon economic factors like interest rates, monetary policy, inflation rates, or balance of payments information to predict exchange rates
customs union
eliminates trade barriers between member countries and adopts a common external trade policy Common External Trade Policy
Economic Union
even closer economic integration and cooperation; involves the free flow of products and factors of production among member countries and the adoption of a common external trade policy, but also reacquires a common currency, harmonization of member's tax rates, and a common monetary and fiscal policy high degree of integration demand a coordination bureaucracy and the sacrifice of significant amounts of national sovereignty to that bureaucracy common currency, tax policy harmonization, common monetary and fiscal policy
Spot Market
exchange rates quoted for transactions that require immediate delivery or within two days Two quotes given by the FX trader the bid (buy) and the offer (sell) rates the spread in the spot market is the difference between the bid and the offer rates
Gains and Losses from Import Tariffs
government gains because increase revenue domestic producers gain consumers lose because they pay more for certain imports pro producer and anti consumer reduce overall efficiency of the world economy
Exchange Rates Regimes in Practice
governments around the world pursue a number of different exchange rate policies range from a pure free float where the exchange rate is determined by market forces to a pegged system that has some aspects of pre 1973 Bretton Woods system of fixed exchange rates smaller states now have no separate legal tender of their own and have adopted a foreign currency as legal tender within their borders other countries adopted a system under which their exchange rate is allowed to fluctuate against other currencies within a target zone
common market
has no barriers to trade among member countries, includes a common external trade policy, and allows factors of production to move freely among members labor and capital free to move because no restrictions on immigration, emigration, or cross border flows of capital among member countries demand a degree of harmony and cooperation on fiscal, monetary, and employment policies free movement of production factors, common external trade policy
Home Country Benefits of FDI
home country's balance of payment benefit from inward flow of foreign earnings creating demand for home courtly exports positive employment effects arise when foreign subsidiary creates demand for home country exports MNE learns valuable skills from foreign exposure and can bring that skill back home
Purchasing Power Parity PPP
if the law of one price were true for all goods and services the PPP exchange rate could be found from any individual set of prices by comparing the prices of identical products in different currencies it would be possible to determine the real or PPP exchange rate that would exist if markets were efficient efficient market- no impediments to the free flow of goods and services such as trade barriers given relatively efficient markets the price of a basket of goods should be roughly equivalent in each country Exchange rate will change if relative prices change
Collapse of Bretton Woods
in 1973 Bretton Woods collapsed due to pressure on the dollar to devalue caused US dollar to no longer be convertible into gold Bretton Woods system had an Achilles' heel: the system could not work if its key currency the US dollar was under speculative attack Bretton Woods system could work only as long as the US inflation rate remained low and the US did not run a balance of payments deficit once these things occurred the system soon became strained to the breaking point
Economic Argument for Government Intervention
infant industry argument- many developing countries have potential comparative advantage in manufacturing but new manufacturing industries cannot initially compete with established industries in developed countries but to allow manufacturing to get a toehold government should support new industries until they have grown strong enough industry should be protected until it can develop and be viable and competitive internationally ex) latin american import substitution policies in 60s and 70s strategic trade policy- argument form new trade theory
Impediments to Integration
integration is not easy to achieve or sustain for two reasons economic integration aids the majority it has its costs because while a nation as a whole may benefit significantly from free trade certain groups may lose; free trade regime involves painful adjustments concern of national sovereignty because close economic integration demands that counties give up some degree of control over sushi keys issues like monetary policy, fiscal policy, and trade policy
Interest Rates and Exchange Rates
interest rates reflect expectations about likely future inflation rates in countries where inflation is expected to be high, interest rates also will be high because investors want compensation for the decline in value of their money
Offshore Production
international trade theory and FDI refers to FDI undertaken to save the home market
Limitations of Licensing/ Internationalization Theory
internationalization theory- seeks to explain why firms often prefer FDI over licensing as a strategy for entering foreign markets; also called market imperfections; 3 major drawbacks licensing may result in a firm's giving away valuable technological know how to potential foreign competitor licensing does not give a firm the right control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitability firm's competitive advantage is based not as much on its products as on the management, marketing, and manufacturing capabilities that produces those products
Lead Strategy
involves attempting to collect foreign currency receivables early when a foreign currency is expected to depreciate and paying foreign currency payables before they are due when a currency is expected to appreciate
Carry Trade
involves borrowing in one currency where interest rates are low and then using the proceeds to invest in another currency where interest rates are high
Lag Strategy
involves delaying collection of foreign currency receivables if that currency is expected to appreciate and delaying payables if the currency is expected to depreciate
Licensing
involves granting a foreign entity the right to produce and sell the firm's product in return for a royalty fee on every unit sold
Exporting
involves producing goods at home and then shipping them to the receiving country for sale
Currency Speculation
involves the short-term movement of funds form one currency to another in the hopes of profiting from shifts in exchange rates
Foreign Exchange Market
is a market for converting the currency of one country into that of another country; is the lubricant that enables companies based in countries that use different currencies to trade with each other One function of the foreign exchange market is to prove some insurance against the risks that arise from foreign exchange risk Serves two main functions: to cover the currency of one country into the currency of another provide some insurance against foreign exchange risk is a global network of banks, brokers, and foreign exchange dealers connected by communication systems
Voluntary Export Restrain VER
is a quota on trade imposed by the exporting country typically at the request of the importing country's government 80s Japan vs US car dispute benefit domestic producers by limiting competitive from abroad also increasing prices for consumers
local content requirement
is a requirement that some specific fraction of a good be produced domestically can be in physical terms can be in value terms originally implemented to promote development of local industries tend to favor local industry and creates job with the increased globalization of production and expansion of international trade agreements, Local Content Requirements have been imposed by members of international trade agreements to avoid loopholes Mexicans cars export to US- NAFTA
Foreign Debit Crisis
is a situation in which a country cannot service its foreign debt obligations, whether private sector or government debt
European Commission
is responsible for proposing EU legislation, implementing it, and monitoring compliance with EU laws by member-states run by a group of commissioners appointed by each member country for five year renewal terms has to be approved be European Parliament monopoly
Exchange Rate
is simply the rate at which one currency is converted into another
Economic Exposure
is the extent to which a firm's future international earning power is affected by changes in exchange rates
Transaction Exposure
is the extent to which the income from individual transactions is affected by fluctuations in foreign exchange values
Transiation Exposure
is the impact of currency exchange rate changes on the reported financial statements of a company
Currency Swap
is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates are transacted between international businesses and their banks, between banks, and between governments when it is desirable to move out of one currency into another for a limited period without incurring foreign exchange risk
NAFTA Drawbacks
jobs could be lost and wage levels could decline in the US and Canada Mexican workers could emigrate North pollution could increase due to Mexico's more lax standards Mexico would lose its sovereignty
Why do we see FDI?
limitations of exporting limitations of licensing advantages of FDI: FDI will be favored over exporting when: transportation costs are high trade barriers are high FDI will be favored over licensing when: the firms wants control over its technological know how the firm wants control over its operations and business strategy the firm's capabilities are not amenable to licensing
Pegged Exchange Rate
manes the value of the currency is fixed relative to a reference currency and then the exchange rate between that currency and other currencies is determined by the reference currency exchange rate
Dollarization
many countries are moving towards atoning the dollar are their primary currency response to continual currency crises: Ecuador, El Salvador, Panama, Argentina quasi-dollarization- many more countries including Israel, other Latin American countries
outflows of FDI
meaning the flow of FDI out of a country
The Jamaica Agreement
meeting revised the IMF's Articles of Agreement to reflect the new reality of floating exchange rates; main elements include: floating rates declared acceptable; IMF members permitted to enter the foreign exchange market to even out unwarranted speculative fluctuations gold was abandoned as a reserve asset; IMF returned its gold reserves to members at the current market prices, placing the proceeds in a trust fund to help poor nations; IMF members permitted to sell their own gold reserves at the market price total anual IMF quotas- the amount member countries contribute to the IMF were increased to $41 billion
Acquisitions vs Greenfield Investments
mergers and acquisitions easier to execute than greenfield investments foreign firms are acquired because those firms have valuable strategic assets and it easier and less risky to acquire those assets than to build them ground up through greenfield investment firms make acquisitions because they believe they can increase the efficiency of the acquired unit by transferring capital, technology, or management skills
General Agreement on Tariffs and Trade GATT
modern international trading system is based on this this and the WTO are the creations of a series of multinational treaties
Central Banks
national banks that implement government policies regarding currency values
Financial Crises in the Post Bretton Woods Era
number of board types of financial crises have occurred over the past 30 years many of which have required IMF involvement
Direct Quotes
number of units of the domestic currency needed to acquire one unit of the foreign currency
Indirect Quotes
number of units of the foreign currency needed to acquire one unit of the domestic currency
foreign direct investment FDI
occurs when a firm invests directly in facilities to produce or market a product in a foreign country once a firm undertakes FDI it becomes a multinational enterprise two forms: greenfield investment- which involves the establishment of a new operation in a foreign country acquiring or merging with an existing firm in the foreign country MNC engage in FDI: Walmart opens a supermarket in China Ford opens a assembly line in Mexico Santander Bank buys Soveregin Bank in the US
currency crisis
occurs when a speculative attack on the exchange value of a currency results in a sharp depreciation in the value of the currency or forces authorities to expend large volumes of international currency reserves and sharply increase interest rates to defend the prevailing exchange rate
Trade Creation
occurs when high cost domestic producers are replaced by low cost producers within the free trade area; it may also occur when higher cost external producers are replaced by lower cost external producers within free trade area
Trade Diversion
occurs when lower cost external suppliers are replaced by higher cost suppliers within the free trade area a regional free trade agreement will benefit the world only if the amount of trade it creates exceeds the amount it diverts
Capital Flight
occurs when residents and non residents rush to convert their holdings of domestic currency into a foreign currency most likely to occur when the value of the domestic currency is depreciating rapidly because of hyperinflation or when a country's economic prospects are shaky in other respects
Forward Exchange
occurs when two parties agree to exchange currency and execute the deal at some specific date in the future forward exchange rates- exchange rates governing future transactions
Role of the World Bank
officials called International Bank for Reconstruction and Development IBRD initial mission was to help finance the building of Europe's economy by providing low interest loans then trend to development and began lending money to third world nations money raised through bond sales in the international capital market then borrowers pay the bank a market rate of interests offers low interest loans to risky customers whose credit rating is often poor
Exchange Rates Since 1973
oil crisis in 1971 when the Organization of Petroleum Exporting Countries OPEC quadrupled the price of oil; harmful effect of this on the US inflation rate and trade position resulted in a further decline in the value of the dollar
Mexico Currency Crisis 1995
pegged to the dollar since early 1980s according to IMF prescription 1994 NAFTA and Government engage in selling bonds in dollars to finance its expansionary policies in a presidential election year December 1994 confidence in the currency evaporated, investors started converting pesos into dollars, causing a run on the banks and investments to leave New IMF prescriptions caused deep recession for two years, recovery in 1997
Gold Standard
pegging currencies to gold and guaranteeing convertibility was medium of exchange when international trade was limited in volume ex) 1$ = 23.33 grains fo fine (pure) gold gold par value- the amount of currency needed to purchase one ounce of gold British pound valued at 113 grains of fine gold
Export Tariffs
raise revenue for the government reduce exports from a sector often for political reasons
Banking Crisis
refers to a loss of confidence in the banking system that leads to a run on banks, as individuals and companies withdraw their deposits
Countertrade
refers to a range of barter-like agreements by which goods and services can be traded for other goods and services makes sense when a country's currency is nonconvertible
Free Trade
refers to a situation in which a government does not attempt to restrict what its citizens can buy from or sell to another country in a world without trade barriers trade patterns are determined by the relative productivity of different factors of production in different countries (countries will specialize in products that they can make most efficiently while importing products that they can produce less efficiently) nations tend to intervene in international trade to protect the interests of politically important groups Even countries and economies unions at the front of free trade promotion have their own protectionist measures, for example: US chicken tax, sugar tax EU quotas to agricultural products
flow FDI
refers to the amount of FDI undertaken over a given time period (normally a year)
International Monetary System
refers to the institutional arrangements that govern exchange rates
stock of FDI
refers to the total accumulated value of foreign owned assets at a given time
Argentina Crisis 2001
repetitive mess since 60s of hyperinflation 76-80 microdevaluations 80-89 inflation to hyperinflation 91 convertibility plan that pegged to $, single digit inflation, constant monetary base Argentina offer stabilization funds for Mexico 2001 couldnt maintain constant monetary base, move to floating 2003 dirty floating, initiate recovery
European Council
represents the interest of member-states; ultimate controlling authority within the EU because draft legislation from the commission can become EU law only if the council agrees
Foreign Exchange Risk
risks that arise from volatile changes in exchange rates currency fluctuations can makes seemingly profitable trade and investment deals unprofitable and vice versa the adverse consequences of unpredictable changes in exchange rates
Dumping
selling goods in foreign market at below their costs of production or as a selling goods in a foreign market below their fair market value predatory behavior (using local profits to wipe out foreign industries, to later raise prices) sell excess production abroad below cost to sustain production level locally ex) Russia and China had been dumping magnesium in the US and magnesium imports rose and prices fell but ITC ruled in favor of America and fines were put emplace against China and Russian Companies decision was good for employees but bad for consumers because magnesium prices became significantly higher than those in world markets
Fisher Effect
states that a country's nominal interest i is the sum of the reacquired of the reacquired real rate of interest r and the expected rate of inflation over the period for which the funds are to be lent I i = r + I
International Fisher Effect
states that for any two countries the sport exchange rate should change in an equal amount but in the opposite direction to the difference in nominal interest rates between the two countries
Law of One Price
states that in competitive markets free of transportation costs and barriers to tariffs, identical products sold in different counties must sell for the same prices when their price is expressed in terms of the same currency
Sugar Subsidies Drive Candy Makers Abroad
sugar prices in the US are much higher, its double the worldwide average due to the combination of trade barriers and price supports government says that 85% of the market in the US will be made of US producers, limiting imports and also has a price floor costs Americans around $3 billion a year and causing manufacturers to produce outside US causing job loss
Free Trade of Americas FTAA
talks began in 1998 to establish a Free Trade of The Americas FTAA by 2005 was not established current support for the agreement by the US and Brazil is limited if the FTAA is established it would create a free trade area of 850 million people
The Uruguay Round 1986
tariffs on industrial goods were to be reduced by 1/3 and tariffs scrapped on more than 40% of manufactured goods average tariffs rates imposed by developing nations on manufactured goods were to be reduced to less than 4% of value agricultural subsidies were to be substantially reduced GATT fair trade and market access rules were to be extended to cover a wide range of services GATT rules extended to provide enhanced protection for patents, copyrights, and trademarks (intellectual property) Barriers on trade in textiles were to be significantly reduced over 10 years WTO to be created to implement GATT agreement
Detractions
tax levied on exports that effectively drops the price of the product sold in the country as tariffs they increase government revenues, protect domestic consumers, but may make producers not competitive in the world pro-consumer anti-producer
Tariff
tax levied on imports or exports; fall into two categories; placed on imports to protect domestic producers from foreign competitors by raising the price of imported goods; produce revenue for a government special tariffs ad valorem tarrifs
European Free Trade Association EFTA
the most enduring free trade area in the world; established in 1960 and joins four countries Norway, Iceland, Liechtenstein, and Switzerland; emphasis on free trade on industrial goods members free to determine the level of protection applied to goods coming from outside EFTA agriculture left out so each member being allowed to determine its own level of support
Trade in Hormone Treated Beef
trade battle between the United States and the European Union over beef from cattle that have been given growth hormones Some may argue that the European Union's ban on growth hormones in cattle was little more than a thinly veiled form of protectionism. Australia, New Zealand, and Canada, which also use the hormones in their cattle industry, were also affected by the ban. The European Union claimed that it was merely protecting the health of its citizens, however studies showed that the hormones posed no health issues for people The World Trade Organization ruled against the European Union stating that the European Union's ban on imported hormone treated beef had no scientific justification. Even so, the European Union refused to lift the ban, which had strong public support, and in the end, the European Union was assessed punitive tariffs. The European Union held on to its principles though, and as of 2008, continued to maintain its restrictions on hormone treated beef despite the resulting punitive tariffs
NAFTA Success
trade between three countries increased by 250% the members have become more integrated productivity has increased in member nations employment effects have been small Mexico initially became more politically stable, but drug related violence remains a problem
Doha Round 2001 World Trade Organization WTO
umbrella organization that encompasses the GATT along with two new sister bodies, one on services and the other on intellectual property TRIPS created to narrow gaps in the way intellectual property rights are protected around world and bring them under common international rules responsible for arbitrating trade disputes and monitoring trade policies of member countries global police; positive effect includes cutting tariffs on industrial goods and services, having out subsidies to agricultural producers, reducing barriers to cross border investment, and limiting use of antidumping laws
Market Forces and Government iNtervention have determined the value of the dollar
under a floating exchange rate regime, market forces have produced a volatile dollar exchange rate in addition to direct intervention statements from government officials have frequently influenced the value of the dollar the dollar may not have declined by as much as it did in 2004 had not US government officials publicly ruled out any action to stop the decline a signal not to intervene can affect the market managed float system- the frequency of government intervention in the foreign exchange market explains why the current system is a dirty float system
The Economic Case for Integration
unrestricted free trade will allow countries to specialize in the production of goods and services that they can produce most efficiently result is greater world production than would be possible with trade restrictions opening a courtly to free trade stimulated economic growth, creating dynamic gains from trade FDI can trader technological, marketing, and managerial knowledge to host nations and stimulates economic growth free trade and investment is a positive sum game
International Institutions and the Liberalization of FDI
until 1990s no consistent involvement by multinational institutions in the governing of FDI but changed with the WTO in 1995 WTO embraces the promotion of international trade in services
Special Drawing Rights SDRs
used to help countries maintain BOPs and increase international reserves (based on basket of currencies)
Andean Community
was largely based on the EU model but far less successful at achieving its stated goals; included international tariff reductio program, common external tariff, common transportation policy, common industrial policy, and special concessions for the smallest members (Bolivia and Ecuador) Bolivia, Chile, Ecuador, Colombia, and Peru
Regional Economic Integration
we mean agreement among countries in a geographic region to reduce, and ultimately remove, tariff and non tariff barriers to the free flow of goods, services, and factors of production between each other some worry that a world in which regional trade blocks compete against each other resulting in trade between blocs offsetting the gains from free trade within blocks
Hedging
when a firm insures itself against foreign exchange risk
Devaluation
when a government reduces the value of its currency relative to that of a foreign currency
Dirty Float
when counties try to hold the value of their currency within some range against an important reference currency or a basket of currencies float because value of currency is determined by market forces but is dirty because the central bank of a country will intervene in the foreign exchange market to try to maintain the value of its currency if it depreciates too rapidly against an important reference currency Chinese yuan, linked to euro, dollar, and yen
Revaluation
when government increases the values of its currency relative to that of a foreign currency
Nonconvertible
when neither residents nor nonresidents are allowed to convert it into a foreign currency
Externally Convertible
when only nonresidents may convert it into a foreign currency without any limitations
Floating Exchange Rate
when the foreign exchange market determines the relative value of a currency; determined by market forces and fluctuate against each other day to day four of the world's major trading currencies US $, EU euro, Japanese yen, British pound all free float against each other
International Business 4 Main uses of Foreign Exchange Markets
when the income it receives from exports, foreign investment or licensing is received it may be in a foreign currency use the market when they must pay a foreign company for its products or services in its country's currency use when they have spare cash that they wish to invest for short terms in money markets currency speculation (carry trade)
Balance of Trade Equilibrium
when the income its residents earn from exports is equal to the money its residents pay to other countries for imports gold standard contained a powerful mechanism for achieving this
Spot Exchange
when two parties agree to exchange currency and execute the deal immediately spot exchange rates- is the rate at which a foreign exchange dealer converts one currency into another currency on a particular day
Fixed Exchange Rate
which the values of a set of currencies are fixed against each other at some mutually agreed on exchange rate European Monetary System EMS- before introduction of euro in 1999 EU operated with fixed exchange rates
Smithsonian Agreement 1971
widened XR flexibility from 1 to 2.25% from par
Why do we have currency
without a currency we were force into barter it makes trade easy Currency is an instrument: easy to carry we all agree its valuable fungible (you can transform it on what you need) it is an efficient way to trade What currency is universal? we don't have one
