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Class #4 Last class in Spain
Brian David Butler Professor of international finance and global entrepreneurship with Forum-Nexus Study Abroad.  Guest le...
Brian Butler is a specialist in international economic analysis, and is founder of the prestigious “GloboTrends“ ( www.glo...
Lecture Schedule* * Does not include professional visits,  *Subject to change, modification without warning <ul><li>Tues 2...
Observations while in Spain…  <ul><li>This class –  </li></ul><ul><li>Each student - tell one thing about Spanish economy ...
Review…
Who can tell me… what is the difference between a liquidity crisis, and a solvency crisis for banks?
Liquidity     Solvency Money flows?   Enough $? (to cover short term debts?)  (more than expenses?) Who can tell me… what ...
Competitive Devaluations Dr. Kishore Dash, January 20, 2007 “ Beggar thy neighbor” Last class we talked about “competitive...
http://mohammedfikri.files.wordpress.com/2010/02/bretton_woods_sign.jpg Who can tell me what happened at Bretton Woods ?  ...
“ As Good as Gold” Dr. Kishore Dash, Thunderbird, January 20, 2007 <ul><li>U.S. Dollar Pegged to  Gold ($35 per ounce) </l...
Fixed vs. Flexible exchange rates <ul><li>What system is Better? Why? </li></ul><ul><ul><li>Groups of 2-3 students, answer...
Brief History – Key points <ul><li>Key point: there is  NO “best” system </li></ul><ul><li>It all depends on what you want...
Brief History – Key points <ul><li>QUESTION: </li></ul><ul><ul><li>Why change from flexible to fixed? (give 1 reason) </li...
Brief History – Key points <ul><li>ANSWER: </li></ul><ul><ul><li>Why change from flexible to fixed? </li></ul></ul><ul><ul...
FIXED system…  <ul><li>KEY QUESTION: </li></ul><ul><ul><li>Under a fixed system, how do you increase exports?  </li></ul><...
FIXED system… <ul><li>Answer </li></ul><ul><ul><li>need to decrease prices, wages  </li></ul></ul><ul><ul><li>So exports m...
What will the future hold?  ….Fixed vs. Flexible ?
What will the future hold?  ….Fixed vs. Flexible ? <ul><li>Future… if crisis brought terrible volatility… </li></ul><ul><l...
Take away: Key points <ul><li>History:  systems change </li></ul><ul><li>Business leaders NEED to watch carefully for SHIF...
Mundell Trilemma Decisions countries must make…
Difficult Choices…  the “Mundell Trilemma” <ul><li>Countries face a trade-off when deciding whether to fix or be flexible ...
Mundell Trilemma <ul><li>example of USA - Country wants: </li></ul><ul><li>Monetary Policy control (US wants to have contr...
Mundell Trilemma <ul><li>example of Spain joining Euro-Zone -  Country wants: </li></ul><ul><li>Group assignment:  discuss...
Mundell Trilemma <ul><li>Country wants ( example of Spain joining Euro-Zone ) </li></ul><ul><li>Open access to internation...
Review: <ul><li>We talked about fixed and flexible exchange rates, monetary policy, controls of global capital flows, the ...
GROUP ASSIGNMENT <ul><li>Write down: </li></ul><ul><ul><li>According to the Mundell Trilemma, what are the 3 things that c...
GROUP ASSIGNMENT <ul><li>Write down: </li></ul><ul><ul><li>After WWII, at the Breton Woods conference, which 1 of 3 was gi...
China + Mundell Trilemma <ul><li>China: </li></ul><ul><ul><li>Which 2 of 3 that they have selected.  Who can guess?  Why d...
International money markets Arbitrage + international money markets
Borrowing in Foreign Currencies…. Where would you prefer to borrow? <ul><li>You have a factory in Brazil, and want to borr...
New problem…
Question: If you were a US based investor, with dollars to invest for 12 months…..where would you choose to deposit your m...
Where would you invest?? International Money Market Rates (Bid Side) United States dollar England sterling Europe euro Swi...
Right??  … maybe not!! International Money Market Rates (Bid Side) United States dollar England sterling Europe euro Switz...
Need to consider…. <ul><li>You might be temped to choose the England (sterling) option of 6% because it’s the highest… </l...
Need to consider…. <ul><li>Answer:  it  DEPENDS  not just on the interest rate, but also on the expected change in foreign...
Which would you choose now?? International Money Market Rates (Bid Side) United States dollar England sterling Europe euro...
Answer… <ul><li>You wouldn’t care (all investment options would appear neutral) </li></ul><ul><li>Foreign exchange markets...
Controlling the economy 2 tools – monetary + fiscal policy
Monetary vs. Fiscal Policy <ul><li>Group assignment; </li></ul><ul><li>Who can describe the difference? </li></ul>
Monetary vs. Fiscal Policy <ul><li>Monetary Policy: </li></ul><ul><ul><li>Think “interest rates”, </li></ul></ul><ul><ul><...
Fiscal Policy <ul><li>Fiscal Policy </li></ul><ul><ul><li>Think “tax & spend” </li></ul></ul><ul><ul><li>Trouble is = gov’...
Monetary policy <ul><li>“ interest” = cost of money </li></ul><ul><li>Increase interest = increased cost of money </li></u...
Monetary policy – to speed up economy (lower interest rates, print money) http://www.daily-bourse.fr/images/analyses/2009/...
 
Monetary policy <ul><li>Group Question: </li></ul><ul><ul><li>“ why would a government EVER want to increase interest (inc...
Inflation <ul><li>2 ways to think about it: </li></ul><ul><ul><li>A general rise in prices (ok, but not useful) </li></ul>...
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Transcript of "Part 4 finance class summer 2010 forum nexus"

  1. 1. Class #4 Last class in Spain
  2. 2. Brian David Butler Professor of international finance and global entrepreneurship with Forum-Nexus Study Abroad. Guest lecturer with the IQS Business School of the Ramon Llull University in Barcelona, and the Catholic University of Milan . Previously, Brian taught finance, economics and global trade courses at Thunderbird’s Global MBA program in Miami, and worked as a research analyst with the Columbia Business School in New York City. Brian currently lives in Recife, Brazil where he is teaching classes at the university Faculdade Boa Viagem . A global citizen, Brian was born in Canada, raised in Switzerland (where he attended international British school), educated through university in the U.S., started his career with a Japanese company, moved to New York to work as an analyst, married a Brazilian, and has traveled extensively in Latin America, Asia, Europe and North America. [email_address] LinkedIn/briandbutler Skype: briandbutler
  3. 3. Brian Butler is a specialist in international economic analysis, and is founder of the prestigious “GloboTrends“ ( www.globotrends.com ) online economics site, which has been featured as syndicated content on Nouriel Roubini’s RGE Monitor, Emerginvest.com, Business Week Exchange, Wikinvest.com, and other leading news outlets. http:// globotrends.pbworks.com / , http:// blog.globotrends.com /
  4. 4. Lecture Schedule* * Does not include professional visits, *Subject to change, modification without warning <ul><li>Tues 22 th – boat to Greece </li></ul><ul><li>Mon 26 th – Athens </li></ul><ul><li>Tues 27 th – Rhodes </li></ul><ul><li>Wed 28 th – Rhodes </li></ul><ul><li>Thurs 29 th – Rhodes EXAM </li></ul>
  5. 5. Observations while in Spain… <ul><li>This class – </li></ul><ul><li>Each student - tell one thing about Spanish economy ( or about the Euro, Greece, etc ) they noticed so far + class discuss </li></ul><ul><li>Note: observations should come from reading ( wall street journal , etc)… any other sources? </li></ul>
  6. 6. Review…
  7. 7. Who can tell me… what is the difference between a liquidity crisis, and a solvency crisis for banks?
  8. 8. Liquidity Solvency Money flows? Enough $? (to cover short term debts?) (more than expenses?) Who can tell me… what is the difference between a liquidity crisis, and a solvency crisis for banks?
  9. 9. Competitive Devaluations Dr. Kishore Dash, January 20, 2007 “ Beggar thy neighbor” Last class we talked about “competitive devaluations”… what did we mean? When was this a problem? What is the danger?
  10. 10. http://mohammedfikri.files.wordpress.com/2010/02/bretton_woods_sign.jpg Who can tell me what happened at Bretton Woods ? Did the financial world become more or less stable afterward? When did it fail? Why?
  11. 11. “ As Good as Gold” Dr. Kishore Dash, Thunderbird, January 20, 2007 <ul><li>U.S. Dollar Pegged to Gold ($35 per ounce) </li></ul><ul><li>All Other Currencies Pegged to the dollar </li></ul>During the Bretton Woods era…
  12. 12. Fixed vs. Flexible exchange rates <ul><li>What system is Better? Why? </li></ul><ul><ul><li>Groups of 2-3 students, answer </li></ul></ul>
  13. 13. Brief History – Key points <ul><li>Key point: there is NO “best” system </li></ul><ul><li>It all depends on what you want to achieve… </li></ul><ul><li>History: Cycle from Fixed to Flexible to Fixed to Flexible……(future?) </li></ul>Fixed Fixed Flexible Flexible The gold standard (~1850–1914) Fixed exchange rates during the 1920s Great Depression era Post WWII Bretton Woods / IMF system (1944–1971) 1970’s –today: since U.S. left the gold/dollar standard ?????
  14. 14. Brief History – Key points <ul><li>QUESTION: </li></ul><ul><ul><li>Why change from flexible to fixed? (give 1 reason) </li></ul></ul><ul><ul><li>Why change from fixed to flexible? </li></ul></ul>Fixed Fixed Flexible Flexible The gold standard (~1850–1914) Fixed exchange rates during the 1920s Inter-war period Great Depression era Post WWII Bretton Woods / IMF system (1944–1971) 1970’s –today: since U.S. left the gold/dollar standard
  15. 15. Brief History – Key points <ul><li>ANSWER: </li></ul><ul><ul><li>Why change from flexible to fixed? </li></ul></ul><ul><ul><ul><li>CONTROL, STABILITY, LOWER INFLATION, END CHAOS </li></ul></ul></ul><ul><ul><ul><li>Note: Too chaotic in depression… so fixed for stability </li></ul></ul></ul><ul><ul><ul><li>Note: Argentina = fixed to dollar was “brilliant” at the time…but should have dropped sooner (not just in 2002) </li></ul></ul></ul><ul><ul><li>Why change from fixed to flexible? </li></ul></ul><ul><ul><ul><li>EASE ADJUSTMENT PROCESS, IMPROVE LOCAL MONETARY CONTROL, INCREASE GLOBAL FLOW OF FUNDS </li></ul></ul></ul>
  16. 16. FIXED system… <ul><li>KEY QUESTION: </li></ul><ul><ul><li>Under a fixed system, how do you increase exports? </li></ul></ul><ul><ul><ul><ul><ul><li>… .Group answer </li></ul></ul></ul></ul></ul>
  17. 17. FIXED system… <ul><li>Answer </li></ul><ul><ul><li>need to decrease prices, wages </li></ul></ul><ul><ul><li>So exports more competitive </li></ul></ul><ul><ul><li>Can’t adjust FX rates, so adjustment has to be painfully with wages, prices </li></ul></ul><ul><li>KEY POINT: </li></ul><ul><ul><li>adjustment in fixed system is = painful process, slow, very unpopular! </li></ul></ul><ul><ul><li>political </li></ul></ul>
  18. 18. What will the future hold? ….Fixed vs. Flexible ?
  19. 19. What will the future hold? ….Fixed vs. Flexible ? <ul><li>Future… if crisis brought terrible volatility… </li></ul><ul><li>Will we move toward era of FIXED FX? </li></ul><ul><ul><li>emerging markets DOLLARIZE? </li></ul></ul><ul><ul><li>More countries to join the EURO? </li></ul></ul><ul><ul><li>US / euro move to fixed? </li></ul></ul><ul><ul><li>New Breton Woods? </li></ul></ul><ul><li>Or, move toward more flexibility? </li></ul><ul><ul><li>“ Dollar Bloc” move toward flexibility? </li></ul></ul><ul><ul><li>Europe abandon the Euro? </li></ul></ul><ul><ul><li>Answer: no body knows what will happen, but HISTORY tells us the CHANGE = the only CONSTANT!! </li></ul></ul>
  20. 20. Take away: Key points <ul><li>History: systems change </li></ul><ul><li>Business leaders NEED to watch carefully for SHIFTS in political attitude, and be READY for potential shifts in the system </li></ul><ul><li>Protect yourself!! </li></ul>Fixed Fixed Flexible Flexible The gold standard (~1850–1914) Fixed exchange rates during the 1920s Great Depression era Post WWII Bretton Woods / IMF system (1944–1971) 1970’s –today: since U.S. left the gold/dollar standard ?????
  21. 21. Mundell Trilemma Decisions countries must make…
  22. 22. Difficult Choices… the “Mundell Trilemma” <ul><li>Countries face a trade-off when deciding whether to fix or be flexible </li></ul><ul><li>Can only have 2 of the following 3 … </li></ul><ul><ul><li>Monetary policy independence (interest rates) </li></ul></ul><ul><ul><li>Fixed exchange rates (predictable, stable) </li></ul></ul><ul><ul><li>Free flow of money (access to global capital) </li></ul></ul>
  23. 23. Mundell Trilemma <ul><li>example of USA - Country wants: </li></ul><ul><li>Monetary Policy control (US wants to have control of interest rates to heat-up / slow-down economy) </li></ul><ul><li>Open access to international finance (US wants access to external funding, example from China) </li></ul><ul><li>Fixed, predictable exchange rates (US would like this, but according to the Mundell Trilemma, they need to give up one, and this is the one that the US lives without) </li></ul>
  24. 24. Mundell Trilemma <ul><li>example of Spain joining Euro-Zone - Country wants: </li></ul><ul><li>Group assignment: discuss which 2 of 3 Mundell Trilemma options that Spain has opted to have, and which 1 of 3 that Spain had to give up (by electing to join the Euro-zone) </li></ul>
  25. 25. Mundell Trilemma <ul><li>Country wants ( example of Spain joining Euro-Zone ) </li></ul><ul><li>Open access to international finance (taken as a given, assumed) </li></ul><ul><li>Fixed, predictable exchange rates (Spain gets this by joining Euro-Zone) </li></ul><ul><li>What’s left over? (ie. What did they have to give up?). What does this mean for Spain? Greece? Ireland? </li></ul>
  26. 26. Review: <ul><li>We talked about fixed and flexible exchange rates, monetary policy, controls of global capital flows, the threats to the Euro, devaluation, “beggar thy neighbor”, competitive devaluations, and more… </li></ul><ul><li>Any thoughts? questions? (this will be on the exam) </li></ul>
  27. 27. GROUP ASSIGNMENT <ul><li>Write down: </li></ul><ul><ul><li>According to the Mundell Trilemma, what are the 3 things that countries want to achieve? </li></ul></ul><ul><ul><li>What 2 of 3 items did Spain elect to maintain? (which 1 did they give up?) </li></ul></ul>
  28. 28. GROUP ASSIGNMENT <ul><li>Write down: </li></ul><ul><ul><li>After WWII, at the Breton Woods conference, which 1 of 3 was given up (by the USA, and most western countries)? </li></ul></ul>
  29. 29. China + Mundell Trilemma <ul><li>China: </li></ul><ul><ul><li>Which 2 of 3 that they have selected. Who can guess? Why did they choose these 2? (and not the 3 rd )? </li></ul></ul><ul><ul><li>Hint: peg with dollar </li></ul></ul><ul><li>(do you think it will last 20 years from now?) </li></ul>
  30. 30. International money markets Arbitrage + international money markets
  31. 31. Borrowing in Foreign Currencies…. Where would you prefer to borrow? <ul><li>You have a factory in Brazil, and want to borrow money to expand. You could… </li></ul><ul><li>Borrow money locally at 10% </li></ul><ul><li>Borrow money abroad (in US) at 5% </li></ul><ul><li>Which would you choose? </li></ul><ul><li>What is the risk of borrowing abroad (in the US)? – general comment 20 words or less </li></ul><ul><li>Note: fictional data based on current loan rates Brazil… </li></ul><ul><li>LIBOR + 1.5% for US = 2.5+1.5 = 4% </li></ul><ul><li>CDI + 2% for Brazil = 9.75 +2 = 11.75% </li></ul>
  32. 32. New problem…
  33. 33. Question: If you were a US based investor, with dollars to invest for 12 months…..where would you choose to deposit your money (to make the most return)? Note: You can assume you have an account with a bank in London (HSBC, etc)… and its easy to switch from one account to the other (click of a button)
  34. 34. Where would you invest?? International Money Market Rates (Bid Side) United States dollar England sterling Europe euro Switzerland franc Japan yen Eurocurrency Rate LIBOR 12 months 3.2% 6.0% 5.3% 3.2% 1.1%
  35. 35. Right?? … maybe not!! International Money Market Rates (Bid Side) United States dollar England sterling Europe euro Switzerland franc Japan yen Eurocurrency Rate LIBOR 12 months 3.2% 6.0% 5.3% 3.2% 1.1%
  36. 36. Need to consider…. <ul><li>You might be temped to choose the England (sterling) option of 6% because it’s the highest… </li></ul><ul><li>but that currency might be expected to lose value (depreciate) over the next year…wiping out the expected gains. </li></ul>
  37. 37. Need to consider…. <ul><li>Answer: it DEPENDS not just on the interest rate, but also on the expected change in foreign exchange rate as well. </li></ul>
  38. 38. Which would you choose now?? International Money Market Rates (Bid Side) United States dollar England sterling Europe euro Switzerland franc Japan yen Eurocurrency Rate LIBOR 12 months 3% 6.0% 5% 3.5% 1.1% Expected appreciation / depreciation vs. US Dollar to EQUATE choices… x -3% -2% -0.5% +1.9%
  39. 39. Answer… <ul><li>You wouldn’t care (all investment options would appear neutral) </li></ul><ul><li>Foreign exchange markets are in “equilibrium” </li></ul>
  40. 40. Controlling the economy 2 tools – monetary + fiscal policy
  41. 41. Monetary vs. Fiscal Policy <ul><li>Group assignment; </li></ul><ul><li>Who can describe the difference? </li></ul>
  42. 42. Monetary vs. Fiscal Policy <ul><li>Monetary Policy: </li></ul><ul><ul><li>Think “interest rates”, </li></ul></ul><ul><ul><li>Central Bank (FED, ECB, etc) </li></ul></ul><ul><ul><li>Issue: inflation </li></ul></ul><ul><ul><li>Milton Friedman </li></ul></ul><ul><li>Fiscal Policy </li></ul><ul><ul><li>Think “government spending” </li></ul></ul><ul><ul><li>Fiscal Stimulus </li></ul></ul><ul><ul><li>Issue: budget deficits </li></ul></ul><ul><ul><li>John M. Keynes </li></ul></ul>
  43. 43. Fiscal Policy <ul><li>Fiscal Policy </li></ul><ul><ul><li>Think “tax & spend” </li></ul></ul><ul><ul><li>Trouble is = gov’t often spends, but forgets about the tax part. </li></ul></ul><ul><ul><li>Democracy, voters, upcoming election </li></ul></ul><ul><ul><li>Question- if government spends, doesn’t tax enough, runs deficits, and gets into debt trouble, what can they do?..... Leads to our discussion on the IMF (Breton Woods institution) </li></ul></ul>
  44. 44. Monetary policy <ul><li>“ interest” = cost of money </li></ul><ul><li>Increase interest = increased cost of money </li></ul><ul><ul><ul><li>Leads to slow down of economy </li></ul></ul></ul><ul><li>Decrease interest = decreased cost of money </li></ul><ul><ul><ul><li>Leads to speed up of economy </li></ul></ul></ul>
  45. 45. Monetary policy – to speed up economy (lower interest rates, print money) http://www.daily-bourse.fr/images/analyses/2009/03/30/Cartoon%20Emergency.gif
  46. 47. Monetary policy <ul><li>Group Question: </li></ul><ul><ul><li>“ why would a government EVER want to increase interest (increase the cost of money) and SLOW down the economy?” answer, turn in, then discuss </li></ul></ul>
  47. 48. Inflation <ul><li>2 ways to think about it: </li></ul><ul><ul><li>A general rise in prices (ok, but not useful) </li></ul></ul><ul><ul><li>A decrease in the value of money (better)… less purchasing power for $1 in future (than now) </li></ul></ul><ul><ul><ul><li>Example: $1 will buy 1 apple now, but only 1/10 th of an apple in the future. This is inflation! Money is worth less (in terms of real goods) in the future </li></ul></ul></ul><ul><ul><ul><li>Question: if you think your money will be worth less in the future, what would you do today? </li></ul></ul></ul>
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