1. Finance 319 Lecture 3 Galina A Schwartz Department of Finance
Lecture Notes
Finance 319 Lecture 3
Galina A Schwartz
Department of Finance
University of Michigan
Business School
Lecture Notes Finance 319
International Finance

2. Practical Matters Office Hours Change
Lecture Notes
Practical Matters Office Hours Change
My office: D3270A (Davidson Hall) My
My office hours:
Mon., 10am -12pm &, Th., 1 pm -3 pm
or by appointment
Notice a change: was Th., 3 pm - 5 pm
Lecture Notes Finance 319
International Finance

3. Overview of International Monetary System I
Lecture Notes
Overview of International Monetary System I
Readings: Levich, Chapter 2
History (seven episodes, see Levich, boxes )
Current Trends
to float [from fixed]
to less [capital] controls
Lecture Notes Finance 319
International Finance

4. Overview of International Monetary System II
Lecture Notes
Overview of International Monetary System II
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?
Lecture Notes Finance 319
International Finance

5. Rules of the Game: a set of explicit and implicit rules
Lecture Notes
Rules of the Game: a set of explicit and implicit rules
laws & regulations
customs & conventions
IFS as a factor of production (i.e. financial infrastructure)
Government Objective is twofold:
1. Domestic Agenda & Gov-t Promises
2. International Agenda & Gov-t Promises
1 & 2 are contradictory
Lecture Notes Finance 319
International Finance

6. 1. The Gold Standard, 1879 - 1913, Box 2.1, p. 24
Lecture Notes
1. The Gold Standard, , Box 2.1, p. 24
I. - a definition
II. - a rule used (no capital controls)
III. - a result of I and II.
VI. - the means to sustain the system.
V. - the means to sustain the system
VI. - a major system feature: common price level.
- a drawback - no variability allowed
Lecture Notes Finance 319
International Finance

7. 2. Bretton Woods, Box 2.2, p. 27 I. & II. - a definition
Lecture Notes
2. Bretton Woods, Box 2.2, p. 27
I. & II. - a definition
III. - free convertibility - a result of I.
III. (capital controls) & VI. - the means to sustain the system & achieve national macroeconomic autonomy
V. - a major system feature: macro autonomy
a drawback - need of capital controls,
an advantage - variability across the countries
Lecture Notes Finance 319
International Finance

8. 3. Fixed-Rate Dollar Standard, 1950 - 1970, Box 2.3, p. 29
Lecture Notes
3. Fixed-Rate Dollar Standard, , Box 2.3, p. 29
growing foreign reserves = U.S. Balance of Payment deficits
countries peg exchange rates to US$ within 1% of par value
which is : US Dollar is used as a gold
Lecture Notes Finance 319
International Finance

9. Why the rules of the game change?
Lecture Notes
Why the rules of the game change?
When does the change happen?
How fast does it happen?
Is it easy to change the rules?
Could it possibly be an easy and fast process?
Lecture Notes Finance 319
International Finance

10. More Rules of the Game: 4. Floating-Rate Dollar Standard, 1973 - 1984,
Lecture Notes
More Rules of the Game:
4. Floating-Rate Dollar Standard, ,
Box 2.4, p. 33
5. Plaza-Louvre Accord & Floating-Rate Dollar Standard, ,
Box 2.5, p. 35
Lecture Notes Finance 319
International Finance

11. 6. & 7. The Spirit of EMU & the Current Rules, Box 2.6-7, pp. 38-9
Lecture Notes
6. & 7. The Spirit of EMU & the Current Rules, Box 2.6-7, pp. 38-9
Benefits of the union:
Exchange rate uncertainty is reduced
Price transparency
Political cooperation & economic convergence.
Costs of the union:
Loss of monetary independence
Difficulty adjusting to external shocks.
Lecture Notes Finance 319
International Finance

12. An Example (US - Mexico)
Lecture Notes
An Example (US - Mexico)
Does Trade Deficit matter?
Reasons for Trade Deficit
corporate --tax & regulatory
exchange rate dis-equilibrium
dynamic: production & consumption adjustment
Lecture Notes Finance 319
International Finance

13. Next Lecture To read: Levich, Chapter 3
Lecture Notes
Next Lecture
To read: Levich, Chapter 3
Millman, Gregory, 1995, The Vandals' Crown: How Rebel Currency Traders Overthrew the World's Central Banks, Free Press. (further Millman) The golden vanity, pp (S)
Lecture Notes Finance 319
International Finance

14. Summary of Today Basic Concepts, See Lecture 2 notes Rules of the Game
Summary of Today
Basic Concepts, See Lecture 2 notes
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
One central bank speculation
Lecture Notes Finance 319
International Finance