1. International Economics
国际经济学
Lectured by Yuanfen Tu
School of International Trade and Economics

2. International Economics By Robert J. Carbaugh 13th Edition
Chapter 8:
International Banking: Reserves, Debt and Risk

3. Introduction Banking System
Role that banks play in world financial markets
Risks associated with international banking
Strategies employed to deal with these risks

4. Nature of International Reserves
Enable nations to finance disequilibrium in their balance-of-payments positions
Deficit: monetary receipts fall short of monetary payments
Settled with international reserves
Enable nations to sustain temporary balance-of-payments deficits
Until acceptable adjustment measures can operate to correct the disequilibrium 4

5. Demand for International Reserves
Depends on
Monetary value of international transactions
Disequilibrium that can arise in balance-of-payments positions
Contingent on
Speed and strength of the balance-of-payments adjustment mechanism
Overall institutional framework of the world economy 5

6. Demand for International Reserves
Exchange-rate flexibility
Automatic adjustment mechanisms that respond to payments disequilibrium
Economic policies used to bring about payments equilibrium
International coordination of economic policies 6

7. Demand for International Reserves
Changes in the degree of exchange-rate flexibility
Inversely related to changes in the quantity of international reserves demanded
More rapid and flexible exchange-rate adjustments requires smaller reserves 7

8. The demand for international reserves and exchange-rate flexibility
FIGURE 8.1
The demand for international reserves and exchange-rate flexibility
When exchange rates are fixed (pegged) by monetary authorities, international reserves are necessary for the financing of payment imbalances and the stabilization of exchange rates. With floating exchange rates, payment imbalances tend to be corrected by market-induced fluctuations in the exchange rate; the need for exchange-rate stabilization and international reserves then disappears. 8

9. Demand for International Reserves
Automatic adjustment mechanisms
Prices, interest rates, incomes, and monetary flows
The more efficient each of these adjustment mechanisms is
The smaller and more short-lived market imbalances will be and
The fewer reserves will be needed 9

10. Demand for International Reserves
Choice & effectiveness of government policies
Adopted to correct payments imbalances
The greater a nation’s propensity to apply commercial policies to key sectors
Tariffs, quotas, and subsidies
The less will be its need for international reserves
Assuming that the policies are effective in reducing payments disequilibrium 10

11. Demand for International Reserves
International coordination of economic policies
Goal of economic cooperation:
Reduce the frequency and extent of payment imbalances
Reduce the demand for international reserves
Quantity demanded of international reserves
Positively related to the level of world prices and income 11

12. Supply of International Reserves
Total supply of international reserves
Owned reserves
Gold, acceptable foreign currencies
Special drawing rights (SDRs)
Borrowed reserves
Lenders:
Foreign nations with excess reserves
Foreign financial institutions
International agencies 12

13. International reserves, 2006, all countries (in billions of SDRs*)
TABLE 8.1
International reserves, 2006, all countries (in billions of SDRs*) 13

14. Foreign Currencies 1800s–1900s, reserve currencies The U.S. dollar
The UK pound
Trading nations have traditionally been willing to hold them as international reserve assets
Since World War II, the U.S. dollar has been the dominant reserve currency 14

15. Foreign Currencies The U.S. dollar as reserve currency
Early 1950s - a dollar-shortage era
Massive development programs in Europe
Excess demand for the dollars
Late 1950s, dollar glut
U.S. continued to provide reserves to the world through its payments deficits
1960s, liquidity problem
1970, creation of SDRs as reserve assets 15

16. Gold Gold standard, historically Monetary role of gold today
International means of payments
Unit of account
Viable store of value
Overall acceptability
Monetary role of gold today
Glittering ghost haunting efforts to reform the international monetary system 16

17. Gold International gold standard, 1880 to 1914
Values of most national currencies were anchored in gold
Gold coins circulated
Generally accepted means of payment
Money supply
Fixed relation to the monetary stock of gold
Growth in monetary gold
Growth in the money supply
At a rate that corresponded to the growth in real national output 17

18. Gold U.S. and the gold standard 1934, the Gold Reserve Act
U.S. government - title to all monetary gold
Required citizens to turn in their private holdings to the U.S. Treasury
The U.S. dollar - devalued in 1934
Official price of gold was raised from $20.67 to $35 per ounce 18

19. Gold Gold exchange standard, dollar-gold system
International monetary system as formulated by the IMF nations
To economize on monetary gold stocks as international reserves
The U.S – dominant economy
Productive capacity and national wealth 19

20. Gold Gold exchange standard, dollar-gold system The United States
Assume the role of world banker
The dollar - chief reserve currency of the international monetary system
Responsibility for buying and selling gold at a fixed price to foreign official holders of dollars
The dollar – convertible to gold
All other currencies – pegged to the dollar 20

21. Gold Gold exchange standard, dollar-gold system
1968, two-tier gold system
Official tier - central banks could buy and sell gold for monetary purposes at the official price of $35 per ounce
Private market - gold as a commodity could be traded at the free-market price 21

22. Gold Demonetization of gold August 1971, President Richard Nixon
The United States was suspending its commitment to buy and sell gold at $35 per ounce
U.S. stock of monetary had declined to $11 billion
Deteriorating U.S. balance-of-payments position
January 1, 1975
The official price of gold was abolished as the unit of account for the international monetary system 22

23. Special Drawing Rights
SDR
Created in 1970 by the IMF
A new reserve asset
Objective: to introduce into the payments mechanism a new type of international money
In addition to the dollar and gold 23

24. Special Drawing Rights
SDR today
Limited use as a reserve asset
Main function: unit of account of the IMF and some other international organizations
Some of the IMF’s member nations peg their currency values to the SDR
Potential claim on the freely usable currencies of IMF members 24

25. Special Drawing Rights
Value of SDR
Basket of currencies
The U.S. dollar, Japanese yen, UK pound, and the euro
The weights of the currencies reflect the amount of exports and imports of these countries during the previous five years 25

26. Should SDRs replace the dollar as the world’s reserve currency?
The United States dollar
Main reserve currency in the world today
Medium of exchange, unit of account, and store of value
Wealth in dollar-denominated assets
64% of world’s official foreign exchange reserves
86% of daily foreign exchange trades
Other reserve currencies
The euro, the British pound, Japanese yen 26

27. Should SDRs replace the dollar as the world’s reserve currency?
Benefits for the U.S.
Americans
Can purchase products at a marginally cheaper rate
Can borrow at lower interest rates for homes and automobiles
The U.S. government
Can finance larger deficits longer and at lower interest rates
Can issue debt (securities) in its own currency
Pushing exchange rate risk onto foreign lenders 27

28. Should SDRs replace the dollar as the world’s reserve currency?
Concerns
Substantial dollar depreciation
Losing purchasing power
The U.S. - huge deficits and massive borrowing
Volatility of the dollar
Destabilizing effect that it can have on international trade and finance 28

29. Should SDRs replace the dollar as the world’s reserve currency?
2009, China - Special Drawing Right (SDR) to replace the dollar
New world reserve currency
Based on a basket of currencies instead of just the dollar
SDR: euro, yen, pound, and dollar
Expand to include all major currencies
SDR would be managed by the IMF 29

30. Should SDRs replace the dollar as the world’s reserve currency?
Benefits of SDRs
China - cushion any depreciation in the dollar’s exchange value
Help stabilize the value of China’s holdings of U.S. Treasury securities
Support aggregate demand in the world
Economic welfare of the world should not depend on the behavior of a single currency 30

31. Should SDRs replace the dollar as the world’s reserve currency?
Benefits of SDRs
Currency risk - diversified through a basket reserve unit
Enhancing stability and confidence throughout the world
Equity
U.S. can attract the savings of other countries even when the interest rates it pays are very low 31

32. Should SDRs replace the dollar as the world’s reserve currency?
Potential pitfalls of SDRs
SDR is backed by nothing other than the good faith and credit of the IMF
Who would determine the “right price” of the SDR?
Add another step to each international transaction
Convert local currency into SDRs 32

33. Should SDRs replace the dollar as the world’s reserve currency?
The U.S. and SDRs
Americans would have to pay more for imported goods
Interest rates on both private and governmental debt would increase
Increased private cost of borrowing
Weaker consumption, decreased investment, and slower growth 33

34. Facilities for Borrowing Reserves
IMF drawings
The transactions by which the fund makes foreign-currency loans available
Deficit nations
Do not borrow from the fund
Purchase with their own currency the foreign currency required to help finance deficits
Reverse the transaction when the balance-of-payments position improves
Limit: First 50 percent of fund quotas
Special permission for excess drawings
Standby arrangements that guarantee credit 34

35. Facilities for Borrowing Reserves
General Arrangements to Borrow, 1962
G-10 agreed to lend the fund up to a maximum of $6 billion
Do not provide a permanent increase in the supply of world reserves
Once the loans are repaid, world reserves revert back to their original levels
World reserves - more flexible and adaptable to the needs of deficit nations 35

36. Facilities for Borrowing Reserves
Swap arrangements
Bilateral agreements between central banks
Each government provides for an exchange of currencies to help finance temporary payments disequilibrium
The nation requesting the swap
Expected to use the funds to help ease its payments deficits and discourage speculative capital outflows
Repay within a stipulated period of time, normally within 3 to 12 months 36

37. International Lending Risk
Credit risk
Financial
The probability that part or all of the interest or principal of a loan will not be repaid
The larger the potential for default on a loan
The higher the interest rate that the bank must charge the borrower 37

38. International Lending Risk
Country risk - Political
Closely related to political developments in a country
Government’s views concerning international investments and loans
Currency risk - Economic
Associated with currency depreciations and appreciations as well as exchange controls 38

39. The Problem of International Debt
Concern: insufficient international lending
After the oil shocks in 1974–1975 and 1979–1980
Oil-importing developing nations might not be able to obtain loans to finance trade deficits
Resulting from the huge increases in the price of oil
Able to borrow dollars from commercial banks
1980s, commercial banks
Part of an international debt problem
Lent so much to developing nations 39

40. The Problem of International Debt
Debt service/export ratio
Indicator of debt burden
Scheduled interest and principal payments as a percentage of export earnings
Interest rate that the nation pays on its external debt
Growth in its exports of goods and services 40

41. The Problem of International Debt
A nation has debt-servicing problems because
May have pursued improper macroeconomic policies that contribute to large balance-of-payments deficits
May have borrowed excessively or on unfavorable terms
May have been affected by adverse economic events that it could not control 41

42. The Problem of International Debt
Options for a nation facing debt-servicing difficulties
Cease repayments on its debt
Service its debt at all costs
Debt rescheduling
Obtain emergency loans from the IMF
Conditionality 42

43. Reducing Bank Exposure to Developing-Nation Debt
Stability of the international financial system
Threatened when developing nations cannot meet their debt obligations to foreign banks
Banks - improve their financial position
Increasing their capital base
Setting aside reserves to cover losses
Reducing new loans to debtor nations 43

44. Reducing Bank Exposure to Developing-Nation Debt
Banks - improve their financial position
Liquidate developing-nation debt
Loan sales to other banks in the secondary market
Debt buyback
Government of the debtor nation buys the loans from the commercial bank at a discount
Debt-for-debt swaps
Bank exchanges its loans for securities issued by the debtor nation’s government
Lower interest rate or discount 44

45. Reducing Bank Exposure to Developing-Nation Debt
Banks - improve their financial position
Debt/equity swaps
Commercial bank sells its loans at a discount to the developing-nation government
For local currency, which it then uses to finance an equity investment in the debtor nation
Debt reduction
Debt forgiveness 45

46. Debt Reduction and Debt Forgiveness
Voluntary scheme that lessens the burden on the debtor nation to service its external debt
Use of negotiated modifications in the terms and conditions of the contracted debt
Debt reschedulings
Retiming of interest payments
Improved borrowing terms
Debt/equity swaps
Debt buybacks 46

47. Debt Reduction and Debt Forgiveness
Arrangement that reduces the value of contractual obligations of the debtor nation
Markdowns of developing-nation debt
Write-offs of developing-nation debt
Abrogation of existing obligations to pay interest 47

48. The Eurodollar Market Eurodollar market Eurocurrency market
Financial intermediary
Brings together lenders and borrowers
Bank deposit liabilities
Time deposits
Denominated in U.S. dollars and other foreign currencies in banks outside the United States
Transactions in dollars
Three-fourths of the volume of transactions 48

49. The Eurodollar Market Eurodollar market Eurodollar deposits
Redeposited in other foreign banks, lent to business enterprises, invested, or retained to improve reserves or overall liquidity
Free of regulation by the host country
Eurodollars increase the efficiency of international trade and finance
Internationally accepted medium of exchange, store of value, standard of value 49