1. Exchange Rates and Instruments of International Business

2. BOP Trade Deficit Exports – Imports Foreign Receipts
Foreign Remittances
Foreign Payments

3. The Balance of Payments Account
Meaning of the balance of payments
The current account
trade in goods
trade in services
balance of trade in goods and services
income flows
current transfers of money
balance on current account

4. UK balance of payments: 2006 (£ millions)

5. UK balance of payments: 2006 (£ millions)

6. The Balance of Payments Account
The capital account
The financial account
investment
direct
portfolio
other financial flows (mainly short term)
flows to and from reserves
financial account balance
Overall balance of payments
Assessing balance of payments figures

7. FOREIGN EXCHANGE

8. Evolution Bimetallism Gold & Silver: Before 1875
Classical Gold Standard:
Interwar Period:
BW System:
Flexible Exchange Rate system: to Date ( Jamaica Agreement)

9. Exchange rate systems in practice
The Bretton Woods system
the Triffin dilemma
a non-adjustable system
stable exchange rates and the postwar boom
The non-system
The non-system as an inflation ‘shock absorber’
The European exchange rate mechanism (ERM)
A zone of monetary stability in Europe
a fixed but adjustable system 1979–87
a non-adjustable system after 1987

10. Fixed Exchange rate system Floating Exchange rate System
Current systems
Fixed Exchange rate system
Floating Exchange rate System
Managed System
There is no absolute system of these. Mostly combination of these.

11. The balance of payments, exchange rates and business
Fixed exchange rates
expenditure reduction policy and expenditure-switching policy
Flexible exchange rates
no depression of demand in the domestic market
Fixed versus flexible exchange rates in a business context
firms prefer stable economic conditions to less stable ones
some advantage in a degree of currency management

12. Exchange Rates The rate of exchange Determination of exchange rates
individual rates of exchange
exchange rate index
Determination of exchange rates
the equilibrium exchange rate
appreciation and depreciation
shifts in currency demand and supply

13. The weights of the currencies of various countries in the sterling exchange rate index

14. Determination of the rate of exchange
S by UK b a QD QS
$ price of £
D by USA
Q of £

15. Determination of the rate of exchange
S by UK
$ price of £ d c QS QD
D by USA
Q of £

16. Floating exchange rates: movement to a new equilibrium
€ / £ D1 D2
Q of £

17. Factors Affecting Exchange rate Determination
Market Forces ( Demand and Supply)
GDP
Interest Rate
BOP
Inflation

18. Exchange Rates The rate of exchange Determination of exchange rates
individual rates of exchange
exchange rate index
Determination of exchange rates
the equilibrium exchange rate
appreciation and depreciation
shifts in currency demand and supply
differences in interest rates
differences in inflation rates
relative investment prospects
change in aggregate demand
speculation

19. Exchange Rates and Balance of Payments
Exchange rates and the balance of payments: no government intervention
a floating exchange rate
how rates are determined by dealers
automatic balancing of overall balance of payments
current, capital and financial accounts may not separately balance

20. Exchange Rates and Balance of Payments
Exchange rates and the balance of payments: government intervention
reducing short-term fluctuations
using reserves
borrowing from abroad
changes in interest rates
maintaining a fixed rate of exchange over the longer term
deflation / reflation
supply-side policies
import controls

21. Fixed versus Floating Exchange Rates
Advantages of fixed exchange rates
certainty
no speculation (if rate is absolutely fixed)
prevents 'irresponsible' government policies
Disadvantages of fixed exchange rates
conflicts with other macro objectives
danger of competitive deflations
problems of international liquidity
difficulties in adjusting to shocks
speculation

22. Fixed versus Floating Exchange Rates
Advantages of free-floating rates
automatic correction
no problem of international liquidity
insulation from external events
less constraint on domestic macro policy
Disadvantages of free-floating rates
possibly unstable exchange rates
speculation
uncertainty for business
but use of forward markets
lack of discipline on economy

23. FOREX Facts Daily turn over : 1 Trillion $ daily Three regions
Australasia
Sydney, Hong Kong, Singapore, Tokyo, Bahrain
Europe
London, Amsterdam, Paris, Frankfurt, Geneva
America
New york, Ottawa, San Francisco etc

24. Representing Forex Currency Markets
US method or Direct Method
European Method or Indirect Method
Currency Markets
Spot Market
Forward Market

25. Forex Exposure
Transaction Exposure
Translation Exposure
Economic Exposure

26. Arbitrage Opportunity
Triangle Arbitrage
Hedging
Derivatives
Currency Swaps

27. Questions
Why is China following a sort of Fixed exchange rate system? And why is that a concern for US?
Why is it so that some developed countries like Japan has lower exchange rate?

28. EURO

29. History
Treaty of Rome was ratified in 1958 European Economic Community (EEC)
Single European Act (1986)
Treaty on European Union (1992)
European Central Bank (ECB) 1 June 1998.

30. The Origins of the Euro Post-war regulation of exchange rates The ERM
the Bretton Woods system
its collapse in the early 1970s
dirty floating
The ERM
features of the ERM
the 1980s
crisis in the ERM
events of 1992
events of 1993
a return of calm

31. The Origins of the Euro The Maastricht Treaty Birth of the euro
the timetable for EMU
the convergence criteria
inflation
interest rates
budget deficits
general government debt
exchange rates
Birth of the euro
meeting the convergence criteria
role of the European Central Bank (ECB) 21

32. What are the criteria for joining the EU
The Copenhagen criteria 1993
Must have a good human rights record and protect minorities – Turkey still some way to go on the Kurds, Hungary improve record with Roma people
Must agree to adopt the ‘aquis communautaire’ – all previous EU treaties and legislation – in its entirety with no opt outs. Therefore will have to join the Euro when they meet the entry criteria of the Euro, can’t opt out unlike UK, Denmark and Sweden. Thus must adopt freedom of trade, health and safety regulations, minimum environmental standards etc

33. Criteria
Must be fundamentally democratic with free and fair universal elections, have the rule of law and have a functioning market economy i.e. reform after collapse of Communism
Must have economic stability with low or non excessive levels of unemployment, inflation and public debt
Must commit to a broad common foreign policy
Must remove subsidies and preferable status for native industries i.e. introduce market reforms.

34. Participating Countries
Belgium
Germany
Greece
Spain
France
Ireland
Italy
Luxembourg
The Netherlands
Austria
Portugal
Finland
Cyprus and Malta
Exceptions Denmark, Sweden and UK

36. How the European Single Currency Evolved
A Brief Glossary of Euronyms

37. Euro Currency 1st January 2002
5, 10, 20, , 200 and 500 denominations

38. Currency speculation and exchange rate systems
Speculators as economic social workers
Currency turbulence is inimical to trade, and as speculation fosters turbulence, speculation is an economic ‘bad’

39. European Monetary Union
Werner Plan
Single European Act (SEA) 1986
Delors Report (1989)
Maastricht Treaty (1991)

40. Maastricht criteria:
that the inflation rate in each national economy should not exceed that of the average of the best three EU national performances by more than 1.5 per cent
that long-term interest rates in each national economy should not exceed the average of the lowest three rates in the EU by more than 2 per cent

41. Maastrich
that the indebtedness of national governments should be limited, expressed as either a 3 per cent ceiling on annual budget deficits, or a ceiling on accumulated debt equivalent to 60 per cent of GDP
that national currencies must be maintained in the narrow band of the ERM for two years, without undue tensions arising

42. Euro advantages Euro weaknesses EURO ADVANTAGE & DISADVANTAGES
deeper integration
micro advantages
macro advantages
Euro weaknesses
optimum currency areas
a chronically weak currency?

43. European Economic and Monetary Union
How desirable is EMU?
Advantages of a single currency
eliminating conversion costs
increased competition and efficiency
elimination of exchange-rate uncertainty
increased inward investment
lower inflation and interest rates
Disadvantages of EMU
political arguments
adjustment to shocks
problem of asymmetric shocks
EU12 may not be an optimal currency area
regional problems 21

44. What Is an Optimum Currency Area?
It is a region where it is best (optimal) to have a single currency.
Optimality depends on degree of economic integration:
Trade in goods and services
Factor mobility
A fixed exchange rate area will best serve the economic interests of each of its members if the degree of output and factor trade among them is high.

45. The Theory of Optimum Currency Areas
It predicts that fixed exchange rates are most appropriate for areas closely integrated through international trade and factor movements.

46. The Theory of Optimum Currency Areas
Economic Integration and the Benefits of a Fixed Exchange Rate Area: Schedule
Monetary efficiency gain
The joiner’s saving from avoiding the uncertainty, confusion, and calculation and transaction costs that arise when exchange rates float.
It is higher, the higher the degree of economic integration between the joining country and the fixed exchange rate area.
GG schedule
It shows how the potential gain of a country from joining the euro zone depends on its trading link with that region.
It slopes upward.

47. The Future of EMU
If EMU succeeds it will promote European political as well as economic integration.
If EMU fails the goal of European political unification will be set back.
Problems that the EMU will face in the coming years:
Europe is not an optimum currency area.
Economic union is so far in front of political union.
EU labor markets are very rigid.

48. Summary
Fixed exchange rates in Europe were a by-product of the Bretton Woods system.
The EMS of fixed intra-EU exchange rates was inaugurated in March 1979.
In practice all EMS currencies were pegged to the DM.
On January 1, 1999, 11 EU countries initiated an EMU by adopting a common currency, the euro.
Greece became the 12th member two years later.

49. Summary
The Maastricht Treaty specified a set of macroeconomic convergence criteria that EU countries would need to satisfy to qualify for admission to EMU.
The theory of optimum currency areas implies that countries will wish to join fixed exchange rate areas closely linked to their own economies through trade and factor mobility.
The EU does not appear to satisfy all of the criteria for an optimum currency area.

50. Globalisation and the Problem of Instability
Interdependence through trade
international effects of changes in aggregate demand
vulnerability of open economies
Financial interdependence
size of international financial flows
international effects of changes in interest rates

51. Globalisation and the Problem of Instability
The need for policy co-ordination
the search for policy co-ordination
G7/G8 meetings: attempts at harmonisation
but lack of convergence
Difficulties in achieving harmonisation
differences in budget deficits and debt
interest rate divergence
different internal structures of economies
politicians more concerned with domestic issues