Y669 International Political
Economy
September 21, 2010
What is an exchange rate?
• The price of a currency
expressed in terms of
other currencies or
gold.
What the International Monetary
System Has to Do
• Assure currency convertibility
• Maintain sufficient availability of
cu...
Definitions
• Balance of Trade
– Exports minus Imports
• Balance of Payments
– trade balance minus net financial flows
• B...
Figure 2-12. U.S. Balance of Trade in Goods and
Services and Balance of Payments on Current
Account, 1946-2006, in Billion...
U.S. Balance of Trade, 2008-2009
Structural Imbalance
• When a trade or balance of payments deficit
or surplus persists over a relatively long
period of ti...
What is a Key Currency?
• Currency used in international trade
settlement, or as a reference currency in
setting exchange ...
Source: International Monetary Fund, Annual Reports, various
years.
Figure 2-6. The Dollar as Percent of Total Official Fo...
Special Status of Key Currency
Country
• A key currency country does not have to
worry as much as others about dealing wit...
Structural Surplus Countries
• Germany and Japan maintained structural
surpluses from late 1960s on.
• They refused to upw...
Figure 2.14. US-China and US-Japan Bilateral Trade Deficits, in
Billions of Dollars,1991-2006
Source: Economic Report of t...
Source: World Bank, World Development Indicators 2001 on CD-ROM;
OECD.StatExtracts, http://webnet.oecd.org/wbos/Index.aspx...
The Nixon Shock of 1971
• August 1971, US has a small balance of
payments deficit (first for many years)
• Nixon and Treas...
Nixon, Connally, and the
Smithsonian Agreement
Figure 2-6. Volatility in Deutsche Mark (DM) and
Yen Exchange Rates with the U.S. Dollar, 1965-
1979, Percentage Changes f...
Plaza Accord
Agreement signed on September 22, 1985
at the Plaza Hotel in New York City by 5
nations - France, West German...
Yen-Dollar and DM-Dollar
Exchange Rates, 1964-1993
0
50
100
150
200
250
300
350
400
1964
1966
1968
1970
1972
1974
1976
197...
Figure 2-13. DM-Dollar, Yen-Dollar, and Euro-Dollar Exchange
Rates, 1985-2007
Source: Economic Report of the President 200...
Shift in the Monetary Regime
After 1971
1945-71 1973-present
Exchange
Rates
Fixed Dirty Floating
Dollar/Gold $35/ounce Mar...
Predictions of Doom
• End of fixed exchange rates would lead to
“competitive devaluations” -- as in the
1930s -- which cou...
Alternative View
• Flexible exchange rates came just in time to
deal with the shock created by the OPEC
price increases of...
Financial Crises
• Often begin with structural deficit problem
accentuated by a severe downturn in the
domestic economy
• ...
The Peso Crisis of 1994
• Mexico admitted to OECD in May 1994
• Huge balance of payments deficit financed
by Tesobonos (bo...
The Asia Crisis of 1997-98
• Frontline video of origins
• Starts with collapse of Thai currency, the
baht
• Crisis spreads...
Russian Crisis of 1998
• Delayed impact of Asia Crisis
• Oil prices on the decline, government
unable to collect taxes
• U...
Global Financial Crisis 2008
• Led by bursting of housing bubble in the
US
• Made worse by near collapse of US
financial m...
House Prices in the UK 1975-2005
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Y669 International Political Economy, lecture #4, focusing on the international monetary system.

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  1. 1. Y669 International Political Economy September 21, 2010
  2. 2. What is an exchange rate? • The price of a currency expressed in terms of other currencies or gold.
  3. 3. What the International Monetary System Has to Do • Assure currency convertibility • Maintain sufficient availability of currencies for trading and capital flows (liquidity) • Maximize stability of exchange rates given changes in demand and supply • Allow balances of payments to equilibrate over time via changes in exchange rates
  4. 4. Definitions • Balance of Trade – Exports minus Imports • Balance of Payments – trade balance minus net financial flows • Budgetary Balance – govt. revenues minus govt. expenditures “surplus” means balance is positive “deficit” means balance is negative
  5. 5. Figure 2-12. U.S. Balance of Trade in Goods and Services and Balance of Payments on Current Account, 1946-2006, in Billions of Current Dollars Source: Economic Report of the President 2008, http://www.gpoaccess.gov/eop/tables08.html.
  6. 6. U.S. Balance of Trade, 2008-2009
  7. 7. Structural Imbalance • When a trade or balance of payments deficit or surplus persists over a relatively long period of time, it is called a “structural imbalance.” • If a country has a structural deficit, it needs to import less and export more, especially after it can no longer borrow funds to “finance” its deficit.
  8. 8. What is a Key Currency? • Currency used in international trade settlement, or as a reference currency in setting exchange rates. The current key currency is the U.S. Dollar. Central banks hold a portion of their reserves in a key currency.
  9. 9. Source: International Monetary Fund, Annual Reports, various years. Figure 2-6. The Dollar as Percent of Total Official Foreign Currency Holdings, 1978, 1986, 1996, and 2007
  10. 10. Special Status of Key Currency Country • A key currency country does not have to worry as much as others about dealing with a structural deficit, since its currency is needed for international transactions. • A key currency country can “export its inflation” to other countries by keeping domestic demand high during a period of structural deficits.
  11. 11. Structural Surplus Countries • Germany and Japan maintained structural surpluses from late 1960s on. • They refused to upwardly revalue their currencies so that their payments would come into balance. • They did this because the growth of their economies depended heavily on exports.
  12. 12. Figure 2.14. US-China and US-Japan Bilateral Trade Deficits, in Billions of Dollars,1991-2006 Source: Economic Report of the President 2000 and 2008.
  13. 13. Source: World Bank, World Development Indicators 2001 on CD-ROM; OECD.StatExtracts, http://webnet.oecd.org/wbos/Index.aspx. Figure 2-10. Balance of Payments in the G-5 Countries, 1970-2007, in Billions of Current Dollars
  14. 14. The Nixon Shock of 1971 • August 1971, US has a small balance of payments deficit (first for many years) • Nixon and Treasury Secretary John Connally agree on new policy: – dollar no longer tied to gold – import surcharge of 10 percent on all imports – US will withdraw surcharge if surplus countries (Germany and Japan) agree to revalue currencies
  15. 15. Nixon, Connally, and the Smithsonian Agreement
  16. 16. Figure 2-6. Volatility in Deutsche Mark (DM) and Yen Exchange Rates with the U.S. Dollar, 1965- 1979, Percentage Changes from the Previous Month -12 -10 -8 -6 -4 -2 0 2 4 6 8 1965 1967 1969 1971 1973 1975 1977 1979 DM Yen Source: International Financial Statistics CD-ROM (Washington, D.C.: IMF, January 2002.
  17. 17. Plaza Accord Agreement signed on September 22, 1985 at the Plaza Hotel in New York City by 5 nations - France, West Germany, Japan, the United States and the United Kingdom. The five agreed to, amongst others, depreciate the US dollar in relation to the Japanese yen and German Deutsche Mark by intervening in currency markets.
  18. 18. Yen-Dollar and DM-Dollar Exchange Rates, 1964-1993 0 50 100 150 200 250 300 350 400 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 Year YenperDollar 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 DMperDollar Yen-Dollar DM-Dollar Nixon Shock Plaza Accords
  19. 19. Figure 2-13. DM-Dollar, Yen-Dollar, and Euro-Dollar Exchange Rates, 1985-2007 Source: Economic Report of the President 2000 and 2008, http://www.gpoaccess.gov/eop/tables08.html.
  20. 20. Shift in the Monetary Regime After 1971 1945-71 1973-present Exchange Rates Fixed Dirty Floating Dollar/Gold $35/ounce Market price Dealing with Structural Imbalances Periodic adjustments of exchange rate Continual adjustments of exchange rate
  21. 21. Predictions of Doom • End of fixed exchange rates would lead to “competitive devaluations” -- as in the 1930s -- which could lead to another Great Depression. • End of U.S. hegemony would result in an unstable world economy.
  22. 22. Alternative View • Flexible exchange rates came just in time to deal with the shock created by the OPEC price increases of the 1970s. • Although there would be greater volatility in exchange rates, there would be fewer crises brought on by delayed devaluations. • Many countries would continue to peg their currencies against the dollar.
  23. 23. Financial Crises • Often begin with structural deficit problem accentuated by a severe downturn in the domestic economy • Country may default on its international obligations (loans, other foreign investments) • All this occurs in a general atmosphere of panic, currency value may fall rapidly
  24. 24. The Peso Crisis of 1994 • Mexico admitted to OECD in May 1994 • Huge balance of payments deficit financed by Tesobonos (bonds denominated in dollars) • Zedillo replaces Salinas as President • Sudden devaluation of the peso in December 1994 • GDP contracted by 7 percent in 1995
  25. 25. The Asia Crisis of 1997-98 • Frontline video of origins • Starts with collapse of Thai currency, the baht • Crisis spreads to Indonesia, South Korea, and other East Asian countries • IMF criticized for bad advice/pressure during the crisis
  26. 26. Russian Crisis of 1998 • Delayed impact of Asia Crisis • Oil prices on the decline, government unable to collect taxes • Use of dollar-denominated GKO bonds to finance budget deficits • Ruble suddenly devalued in August 1998 • Economy recovered quickly when oil prices increased
  27. 27. Global Financial Crisis 2008 • Led by bursting of housing bubble in the US • Made worse by near collapse of US financial markets connected with mortgage- backed securities and credit default swaps • Response revives Keynesian approach to preventing deep recessions
  28. 28. House Prices in the UK 1975-2005

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