1. 01.22.2001Lecture Notes Finance 3191 Finance 319 Lectures 3 & 4 u Galina A Schwartz u Department of Finance u University of Michigan u Business School

2. 01.22.2001Lecture Notes Finance 3192 Practical Matters Investment History Video My office: D3270A (Davidson Hall) My e-mail: galka@umich.edu My office hours: Mon., 10am -12pm &, Th., 1 pm -3 pm or by appointment Notice a change: was Th., 3 pm - 5 pm

3. 01.22.2001Lecture Notes Finance 3193 Overview of International Monetary System I u Readings: Levich, Chapter 2 –History (seven episodes, see Levich, boxes 2.1 - 2.7) –Current Trends »to float [from fixed] »to less [capital] controls

4. 01.22.2001Lecture Notes Finance 3194 Overview of International Monetary System II u Current rules of the game –volatility  (due to float)  need to hedge –Emerging markets: currency board, »issues: credibility, commitment –Europe: common currency (EURO): will it last?

5. 01.22.2001Lecture Notes Finance 3195 Rules of the Game: a set of explicit and implicit rules –laws & regulations –customs & conventions u IFS as a factor of production (i.e. financial infrastructure) u Government Objective is twofold: –1. Domestic Agenda & Gov-t Promises –2. International Agenda & Gov-t Promises 1 & 2 are contradictory

6. 01.22.2001Lecture Notes Finance 3196 1. The Gold Standard, 1879 - 1913, Box 2.1, p. 24 u I. - a definition u II. - a rule used (no capital controls) u III. - a result of I and II. u VI. - the means to sustain the system. u V. - the means to sustain the system u VI. - a major system feature: common price level.

7. 01.22.2001Lecture Notes Finance 3197 2. Bretton Woods, Box 2.2, p. 27 u I. & II. - a definition u III. - free convertibility - a result of I. u III. (capital controls) & VI. - the means to sustain the system & achieve national macroeconomic autonomy u V. - a major system feature: macro autonomy

8. 01.22.2001Lecture Notes Finance 3198 3. Fixed-Rate Dollar Standard, 1950 - 1970, Box 2.3, p. 29 u growing foreign reserves = U.S. Balance of Payment deficits u countries peg exchange rates to US$ within 1% of par value u which is : US Dollar is used as a gold

9. 01.22.2001Lecture Notes Finance 3199 Why the rules of the game change? u When does the change happen? u How fast does it happen? u Is it easy to change the rules? u Could it possibly be an easy and fast process?

10. 01.22.2001Lecture Notes Finance 31910 More Rules of the Game: u 4. Floating-Rate Dollar Standard, 1973 - 1984, Box 2.4, p. 33 u 5. Plaza-Louvre Accord & Floating- Rate Dollar Standard, 1985-1996, Box 2.5, p. 35

11. 01.22.2001Lecture Notes Finance 31911 6. & 7. The Spirit of EMU & the Current Rules, Box 2.6-7, pp. 38-9 u Benefits of the union: –Exchange rate uncertainty is reduced –Price transparency –Political cooperation & economic convergence. u Costs of the union: –Loss of monetary independence –Difficulty adjusting to external shocks.

12. 01.22.2001Lecture Notes Finance 31912 An Example (US - Mexico) u Does Trade Deficit matter? u Reasons for Trade Deficit –corporate --tax & regulatory –exchange rate dis-equilibrium –dynamic: production & consumption adjustment

13. 01.22.2001Lecture Notes Finance 31913 Next Lecture u To read: Levich, Chapter 3 u Millman, Gregory, 1995, The Vandals' Crown: How Rebel Currency Traders Overthrew the World's Central Banks, Free Press. (further Millman) The golden vanity, pp.65-94. (S)

14. 01.22.2001Lecture Notes Finance 31914 Summary of Today u Basic Concepts, See Lecture 2 notes u Rules of the Game –history of international monetary system –features of the system & its support mechanisms –pluses and minuses of different rules of the game u One central bank speculation