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When was Bimetallism Era?
Prior to 1875
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What what Bimetallism?
A double standard in the sense that both gold and silver were used as money
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During Bimetallism, what were the exchange rates among currencies determined by?
Gold or Silver contents
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What era brought Gresham's Law?
Bimetallism era (prior to 1875)
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What is Gresham's Law?
States that the least valuable metal tends to circulate driving the good money out of the market
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What is the problem with Bimetallism?
Good money trades equal to or below its intrinsic value (being the amount of gold/silver it has in it) while bad money trades above its intrinsic value
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With Bimetallism, why does "bad" money trade above its intrinsic value?
People will keep the good one for themselves and settle trades with less valuable money that has a face value enforced by law, which drives good money out of circulation and ultimately out of the market
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What is a given example of a Bimetallism problem?
- In 1965 in the U.S., half-dollar coins were issued with half the silver content but same face value. Coins with higher silver content disappeared from the marketplace.
- In 2007, the Euro and Dollar pennies and five cent coins were more valuable for copper and zinc content than face value
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Which "Era" was from 1875 to 1914?
Classical Gold Standard
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What was the Classical Gold Standard era?
When gold alone was assured of unrestricted coinage, it could be freely exported or imported, and there were two-way convertibility between gold and national currencies at a stable ratio
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How was the exchange rate determined during the Classical Gold Standard time?
By their relative gold contents
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How were misalignments of exchange rates and international balances of payment corrected with the Classical Gold Standard?
Price-Specie-Flow Mechanism
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Were the exchange rates stable with the Classical Gold Standard?
Yes, which provided an environment conducive to international trade
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Would it be possible for Great Britain to export more to France than France to export to Great Britain with the Classical Gold Standard?
No, the net exports of goods from GB to France will be accompanied by a net flow of gold from France to GB. The flow would lead to a lower price level in France and a higher in GB
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During which stage did the stabilization effect occur?
Classical Gold Standard (1875-1914)
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What were the shortcomings associated with the Classical Gold Standard?
The supply of newly minted gold is so restricted that the growth of world trade and investment would be hindered due to the lack of sufficient monetary reserves
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Which period began in 1915 and ended in 1944?
Interwar Period
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What consisted of the Interwar Period?
Exchange rates fluctuated as countries widely used "predatory" depreciations of their currencies as a means of gaining advantage in the world export market.
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During which period was "Hyperinflation" prevalent?
Interwar Period
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During the Interwar Period there was and a "sterilization of gold". What was this?
Major countries gave priority to the stabilization of domestic economies and followed a system of the sterilization of gold by matching inflows and outflows of gold respectively with reductions and increases in domestic money and credit.
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What was an example of "sterilization of gold" seen in the U.S.?
The Federal Resere kept some gold oustdie the credit base by circulating it as gold certificates
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During which period did the U.S. dollar emerge as the dominant world currency?
Interwar Period (1915 - 1944)
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Which system was used from 1945 to 1972?
Bretton Woods System
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What consisted of the Bretton Woods System?
Purpose was to design a postwar international monetary system with a goal of exchange rate stability without the gold standard
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IMF and the World Bank were created during which system?
Bretton Woods System
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The U.S. dollar was pegged to $35 per ounce of gold, what were other currencies pegged to?
The U.S. dollar
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What was the responsibility of each country during the Bretton Woods System?
To maintain its exchange rate within 1% of the adopted par value by buying or selling foreign reserves as necessary
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What was the standard during the Bretton Woods System?
Dollar-Based Gold Exchange Standard
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What was the Bretton Woods System's demise?
Widley diverging monetary and fiscal policies as well as differential rates of inflation and various currency shocks
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Which currency became the main reserve currency held by banks during Bretton Woods System?
U.S. Dollar
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How did the U.S. dollar becoming the main reserve currency effect the economy?
There was a consistent and growing balance of payment deficits which required heavy capital outflow of dollars to finance these deficits and meet the growing demand for dollars from investors and businesses
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The heavey overhang of dollars by foreigners resulted in what?
A lack of confidence in the ability of the U.S. to meet its commitment to convert dollars to gold
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What did Richard Nixon do during the Bretton Woods System?
He suspended official purchases or sales of gold by the U.S. Treasury which resulted in subsequent devaluations of the dollar
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Which period are we currently in?
Flexible Exchange Rate Regime
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What consists of the Flexible Exchange Rate Regime?
Flexible exchange rates were declared acceptable to the IMF members
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During which period did the Jamaica Agreement come?
Flexible Exchange Rate Regime
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What rights were given to Central Banks during the start of the Flexible Exchange Rate Regime?
Central Banks were allowed to intervene in the exchange rate markets and iron out unwarranted volatilities
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What happened to Gold during the Flexible Exchange Rate Regime?
Gold was abandoned as an international reserve asset
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Were non-oil exporting countries and less developed countries given greater access to IMF funds during the Flexible Exchange Rate Regime?
Yes
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Under the current exchange rate arrangements, what is free float?
The largest number of countries (around 48) allow market forces to determine their currency's value
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What does it mean to be a country with managed float with exchange rates?
Combines government intervention with market forces to set exchange rates (around 25 countries)
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What are the possible current exchange rate arrangements?
Fixed Regime, Free Float, Managed Float, Pegged to another currency, and No National Currency
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What is a positive to flexible exchange rates?
They have easier external adjustments and national policy autonomy
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What is a negative to Flexible Exchange Rates?
There is exchange rate uncertainty which my hinder international trade & there are no safeguards to prevent crisis
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When was the Mexican Peso Crisis?
December 20th, 1994
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What was the Mexican Peso Crisis?
The Mexican Governemnt announced a plan to devalue the peso against the dollar by 14%, but the peso fell by as much as 40%
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Which crisis represents the first serious international financial crisis?
Mexican Peso Crisis
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Which crisis occurred when many firms with foreign currency bonds were forced into bankruptcy?
Asian Currency Crisis
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What brought about the Argentinean Peso Crisis?
In 1991, the Argentine government passed a convertibility law that linked the Peso to the U.S. dollar at parity
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How were the initial economic effects positive in the Argentinean Peso Crisis?
Chronic Inflation was curtailed and foreign investment poured in
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What happened as the U.S. dollar appreciated?
The Argentine Peso became stronger as well, but the strong peso hurt exports from Argentina and caused a protracted economic downturn that led to the abandonment of peso-dollar parity in January 2002
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What happened to the unemployment rate and inflation rate in Argentina?
Unemployment rate rose by 20% and the inflation rate reached a monthly rate of 20%
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What were the three factors related to the collapse of the currency board arrangement and the ensuring economic crisis?
Lack of fiscal discipline, Labor market inflexibility, and contagion from the financial crisis in Brazil and Russia
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What does a currency's value do in the LONG RUN in theory?
mirrors the fundamental strength of its underlying eeconomy
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What does a currency's value do in the SHORT RUN?
A currency trader's expectations play a more important role, so traders and lenders use of modern communications and their act of fight or flight instincts take over
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In the short run, what would be the result for a trader/lender if they expect others are going to sell Brazilian reals for U.S. dollars?
They want to get to the exits first because of the fears of depreciation that become self-fulfilling prophecies
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What is Gresham's Law?
Refers to the phenomenon that abundant (bad) money drives scarce (good) money out of circulation. **Bimetallism Period**
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What is the mechanism used to restore the balance of payments equilibrium when it is disturbed under the gold standard?
Price-Specie-Flow Mechanism (David Hume), which states that a balance of payment disequilibrium will be corrected by a counter-flow of gold
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If the U.S. imports more from the U.K. than it exports latter under the Classical Gold Standard, gold will flow from the U.S. to the U.K. and as a result the U.S. will experience a decrease in money supply with the U.K. experiencing the opposite. The price level will fall in the U.S. and the products of the U.S. become more competitive in the export market, which hurts the U.K. This is an example of?
Price-Specie-Flow Mechanism, which will restore the problem
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What are the advantages to the Gold Standard?
The supply of gold is restricted so countries can't experience high inflation and the balance of payment disequilibrium can be corrected automatically through cross border flows of gold.
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What are the disadvantages of the Gold Standard?
The world economy can be subject to deflationary pressure due to restricted supply of gold, and teh gold standard itself has no mechanism to enforce the rules of the game so countries are capable of pursing economic policies that are incompatible with the standard such as the de-monetization of gold.
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What were the main objectives of the Bretton Woods System?
To achieve exchange rate stability and promote internation trade and development
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What was the proposition that the Bretton Woods system was programmed to an eventual demise?
Triffin Paradox; the reserve-currency country should run BOP deficits to supply reserves to the world economy but if the deficits are large they can lead to a crisis of confidence in the reserve currency itself (Example seen in the U.S.)
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How were the special drawing rights constructed?
Created by the IMF in 1970 as a new reserve asset to alleviate the pressure on the U.S. dollar, and was comprised of 5 major currencies; Dollar, Mark, Yen, Franc, Pound.
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What are the advantages of the flexible exchange rate system?
Automatic achievement of balance of payments equilibrium and maintenance of national policy autonomy
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If Flexible Exchange Rate System: what may discourage international trade and encourage market segmentation?
Exchange Rates fluctuating randomly
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How can the random fluctuation of exchange rates be countered?
Hedge exchange risk by means of forward contracts and other techniques
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What do governments often do in a fixed exchange rate regime?
Restrict international trade in order to maintain the exchange rate
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What measures can be taken to prevent another financial crisis?
There should be a multinational safety net to safeguard the world financial system, international institutions (IMF & World Bank) whould monitor problematic countries more closely and to provide advice, lastly third countries should depend more on domestic savings and long-term foreign investments rather than short-term portfolio capital
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What criteria constitutes "good" international monetary system?
Sufficient liquidity to the world economy, smooth adjustments to BOP disequilibrium, and safeguard against the crisis of confidence in the system
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Why is it difficult for capital markets, once integrated, to maintain a fixed exchange rate?
Once Capital Markets are integrated, vast amounts of money may flow in and out in a short period of time
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