bimetallism

Bimetallism: Before 1875Bimetallism: Before 1875A “double standard” in the sense that both gold A “double standard” in the sense that both gold and silver were used as money.and silver were used as money.

Some countries were on the gold standard, Some countries were on the gold standard, some on the silver standard, some on both.some on the silver standard, some on both.

Both gold and silver were used as international Both gold and silver were used as international means of payment and the exchange rates means of payment and the exchange rates among currencies were determined by either among currencies were determined by either their gold or silver contents. their gold or silver contents.

Gresham’s LawGresham’s Law implied that it would be the least implied that it would be the least valuable metal that would tend to circulate.valuable metal that would tend to circulate.

Classical Gold Standard: Classical Gold Standard: 1875-19141875-1914

During this period in most major countries:During this period in most major countries:– Gold alone was assured of unrestricted Gold alone was assured of unrestricted

coinagecoinage– There was two-way convertibility between There was two-way convertibility between

gold and national currencies at a stable ratio.gold and national currencies at a stable ratio.– Gold could be freely exported or imported.Gold could be freely exported or imported.

The exchange rate between two country’s The exchange rate between two country’s currencies would be determined by their currencies would be determined by their relative gold contents.relative gold contents.


For example, if the dollar is pegged to gold For example, if the dollar is pegged to gold at U.S.$30 = at U.S.$30 = 1 ounce 1 ounce of gold, and the of gold, and the British pound is pegged to gold at British pound is pegged to gold at £6 = 1 £6 = 1 ounce of gold, it must be the case that the ounce of gold, it must be the case that the exchange rate is determined by the exchange rate is determined by the relative gold contents:relative gold contents:

$30 = £6

$5 = £1


Highly stable exchange rates under the Highly stable exchange rates under the classical gold standard provided an classical gold standard provided an environment that was conducive to environment that was conducive to international trade and investment.international trade and investment.

Misalignment of exchange rates and Misalignment of exchange rates and international imbalances of payment were international imbalances of payment were automatically corrected by the automatically corrected by the price-price-specie-flow mechanism.specie-flow mechanism.

Price-Specie-Flow MechanismPrice-Specie-Flow Mechanism

Suppose Great Britain exported more to France Suppose Great Britain exported more to France than France imported from Great Britain.than France imported from Great Britain.This cannot persist under a gold standard.This cannot persist under a gold standard.– Net export of goods from Great Britain to France will Net export of goods from Great Britain to France will

be accompanied by a net flow of gold from France to be accompanied by a net flow of gold from France to Great Britain.Great Britain.

– This flow of gold will lead to a lower price level in This flow of gold will lead to a lower price level in France and, at the same time, a higher price level in France and, at the same time, a higher price level in Britain.Britain.

The resultant change in relative price levels will The resultant change in relative price levels will slow exports from Great Britain and encourage slow exports from Great Britain and encourage exports from France.exports from France.


There are shortcomings:There are shortcomings:– The supply of newly minted gold is so restricted The supply of newly minted gold is so restricted

that the growth of world trade and investment that the growth of world trade and investment can be hampered for the lack of sufficient can be hampered for the lack of sufficient monetary reserves.monetary reserves.

– Even if the world returned to a gold standard, Even if the world returned to a gold standard, any national government could abandon the any national government could abandon the standard.standard.

Interwar Period: 1915-1944Interwar Period: 1915-1944

Exchange rates fluctuated as countries Exchange rates fluctuated as countries widely used “predatory” depreciations of widely used “predatory” depreciations of their currencies as a means of gaining their currencies as a means of gaining advantage in the world export market.advantage in the world export market.Attempts were made to restore the gold Attempts were made to restore the gold standard, but participants lacked the standard, but participants lacked the political will to “follow the rules of the political will to “follow the rules of the game”.game”.The result for international trade and The result for international trade and investment was profoundly detrimental.investment was profoundly detrimental.

Bretton Woods System: Bretton Woods System: 1945-19721945-1972

Named for a 1944 meeting of 44 nations at Named for a 1944 meeting of 44 nations at Bretton Woods, New Hampshire.Bretton Woods, New Hampshire.

The purpose was to design a postwar The purpose was to design a postwar international monetary system.international monetary system.

The goal was exchange rate stability The goal was exchange rate stability without the gold standard.without the gold standard.

The result was the creation of the IMF and The result was the creation of the IMF and the World Bank.the World Bank.


Under the Bretton Woods system, the U.S. Under the Bretton Woods system, the U.S. dollar was pegged to gold at $35 per ounce dollar was pegged to gold at $35 per ounce and other currencies were pegged to the and other currencies were pegged to the U.S. dollar.U.S. dollar.Each country was responsible for Each country was responsible for maintaining its exchange rate within maintaining its exchange rate within ±1% of ±1% of the adopted par value by buying or selling the adopted par value by buying or selling foreign reserves as necessary.foreign reserves as necessary.The Bretton Woods system was a dollar-The Bretton Woods system was a dollar-based gold exchange standard.based gold exchange standard.


German markBritish

poundFrench franc

U.S. dollar

Gold

Pegged at $35/oz.

Par Value

Par ValuePar

Value

The Flexible Exchange Rate The Flexible Exchange Rate Regime: 1973-Present.Regime: 1973-Present.

Flexible exchange rates were declared Flexible exchange rates were declared acceptable to the IMF members.acceptable to the IMF members.– Central banks were allowed to intervene in the Central banks were allowed to intervene in the

exchange rate markets to iron out unwarranted exchange rate markets to iron out unwarranted volatilities.volatilities.

Gold was abandoned as an international reserve Gold was abandoned as an international reserve asset.asset.

Non-oil-exporting countries and less-developed Non-oil-exporting countries and less-developed countries were given greater access to IMF countries were given greater access to IMF funds.funds.

Current Exchange Rate Current Exchange Rate ArrangementsArrangements

Free Float Free Float – The largest number of countries, about 48, allow The largest number of countries, about 48, allow

market forces to determine their currency’s value.market forces to determine their currency’s value.

Managed Float Managed Float – About 25 countries combine government intervention About 25 countries combine government intervention

with market forces to set exchange rates.with market forces to set exchange rates.

Pegged to another currency Pegged to another currency – Such as the U.S. dollar or euro (through franc or Such as the U.S. dollar or euro (through franc or

mark).mark).

No national currencyNo national currency– Some countries do not bother printing their own, they Some countries do not bother printing their own, they

just use the U.S. dollar. For example, Ecuador, just use the U.S. dollar. For example, Ecuador, Panama, and El Salvador have Panama, and El Salvador have dollarizeddollarized..

European Monetary SystemEuropean Monetary SystemEleven European countries maintain Eleven European countries maintain exchange rates among their currencies exchange rates among their currencies within narrow bands, and jointly float within narrow bands, and jointly float against outside currencies.against outside currencies.Objectives:Objectives:– To establish a zone of monetary stability in To establish a zone of monetary stability in

Europe.Europe.– To coordinate exchange rate policies vis-à-vis To coordinate exchange rate policies vis-à-vis

non-European currencies.non-European currencies.– To pave the way for the European Monetary To pave the way for the European Monetary

Union.Union.

What Is the Euro?What Is the Euro?

The euro is the single currency of the The euro is the single currency of the European Monetary Union which was European Monetary Union which was adopted by 11 Member States on 1 adopted by 11 Member States on 1 January 1999. January 1999.

These original member states were: These original member states were: Belgium, Germany, Spain, France, Ireland, Belgium, Germany, Spain, France, Ireland, Italy, Luxemburg, Finland, Austria, Italy, Luxemburg, Finland, Austria, Portugal and the Netherlands.Portugal and the Netherlands.

What are the different denominations of the What are the different denominations of the euro notes and coins ?euro notes and coins ?

There are 7 euro notes and 8 euro coins. There are 7 euro notes and 8 euro coins.

€€500, 500, €€200, 200, €€100, 100, €€50, 50, €€20, 20, €€10, and 10, and €€5. 5.

The coins are: 2 euro, 1 euro, 50 euro The coins are: 2 euro, 1 euro, 50 euro cent, 20 euro cent, 10, euro cent, 5 euro cent, 20 euro cent, 10, euro cent, 5 euro cent, 2 euro cent, and 1 euro cent. cent, 2 euro cent, and 1 euro cent.

The euro itself is divided into 100 cents, The euro itself is divided into 100 cents, just like the U.S. dollar.just like the U.S. dollar.

How did the euro affect contracts How did the euro affect contracts denominated in national currency?denominated in national currency?

All insurance and other legal contracts All insurance and other legal contracts continued in force with the substitution of continued in force with the substitution of amounts denominated in national amounts denominated in national currencies with their equivalents in euro. currencies with their equivalents in euro.

Euro AreaEuro AreaAustria Austria BelgiumBelgiumCyprus Cyprus Czech RepublicCzech RepublicEstoniaEstoniaFinland Finland FranceFranceGermany Germany Greece Greece HungaryHungaryIreland Ireland

22 Countries participating in the euro:Italy Italy LatviaLatviaLithuaniaLithuaniaLuxembourg Luxembourg MaltaMaltaPolandPolandPortugal Portugal Slovak RepublicSlovak RepublicSloveniaSloveniaSpainSpainThe NetherlandsThe Netherlands

The Long-Term Impact of the EuroThe Long-Term Impact of the Euro

If the euro proves successful, it will If the euro proves successful, it will advance the political integration of Europe advance the political integration of Europe in a major way, eventually making a in a major way, eventually making a “United States of Europe” feasible.“United States of Europe” feasible.

It is likely that the U.S. dollar will lose its It is likely that the U.S. dollar will lose its place as the dominant world currency.place as the dominant world currency.

The euro and the U.S. dollar will be the The euro and the U.S. dollar will be the two major currencies.two major currencies.

The Mexican Peso CrisisThe Mexican Peso Crisis

On 20 December, 1994, the Mexican On 20 December, 1994, the Mexican government announced a plan to devalue government announced a plan to devalue the peso against the dollar by 14 percent.the peso against the dollar by 14 percent.This decision changed currency trader’s This decision changed currency trader’s expectations about the future value of the expectations about the future value of the peso.peso.They stampeded for the exits. They stampeded for the exits. In their rush to get out the peso fell by as In their rush to get out the peso fell by as much as 40 percent.much as 40 percent.

The Mexican Peso CrisisThe Mexican Peso Crisis

The Mexican Peso crisis is unique in that it The Mexican Peso crisis is unique in that it represents the first serious international represents the first serious international financial crisis touched off by cross-border financial crisis touched off by cross-border flight of portfolio capital.flight of portfolio capital.Two lessons emerge:Two lessons emerge:– It is essential to have a multinational safety It is essential to have a multinational safety

net in place to safeguard the world financial net in place to safeguard the world financial system from such crises.system from such crises.

– An influx of foreign capital can lead to an An influx of foreign capital can lead to an overvaluation in the first place.overvaluation in the first place.

The Asian Currency CrisisThe Asian Currency Crisis

The Asian currency crisis turned out to be The Asian currency crisis turned out to be far more serious than the Mexican peso far more serious than the Mexican peso crisis in terms of the extent of the crisis in terms of the extent of the contagion and the severity of the resultant contagion and the severity of the resultant economic and social costs.economic and social costs.Many firms with foreign currency bonds Many firms with foreign currency bonds were forced into bankruptcy.were forced into bankruptcy.The region experienced a deep, The region experienced a deep, widespread recession.widespread recession.

The Argentinean Peso CrisisThe Argentinean Peso Crisis

In 1991 the Argentine government passed In 1991 the Argentine government passed a convertibility law that linked the peso to a convertibility law that linked the peso to the U.S. dollar at parity.the U.S. dollar at parity.The initial economic effects were positive:The initial economic effects were positive:– Argentina’s chronic inflation was curtailedArgentina’s chronic inflation was curtailed– Foreign investment poured inForeign investment poured in

As the U.S. dollar appreciated on the As the U.S. dollar appreciated on the world market the Argentine peso became world market the Argentine peso became stronger as well.stronger as well.


The strong peso hurt exports from The strong peso hurt exports from Argentina and caused a protracted Argentina and caused a protracted economic downturn that led to the economic downturn that led to the abandonment of peso–dollar parity in abandonment of peso–dollar parity in January 2002.January 2002.– The unemployment rate rose above 20 The unemployment rate rose above 20

percentpercent– The inflation rate reached a The inflation rate reached a monthlymonthly rate of 20 rate of 20

percentpercent


There are at least three factors that are There are at least three factors that are related to the collapse of the currency related to the collapse of the currency board arrangement and the ensuing board arrangement and the ensuing economic crisis:economic crisis:– Lack of fiscal discipline Lack of fiscal discipline – Labor market inflexibilityLabor market inflexibility– Contagion from the financial crises in Brazil Contagion from the financial crises in Brazil

and Russiaand Russia

Currency Crisis ExplanationsCurrency Crisis ExplanationsIn theory, a currency’s value mirrors the In theory, a currency’s value mirrors the fundamental strength of its underlying economy, fundamental strength of its underlying economy, relative to other economies. relative to other economies. In the long runIn the long run..In the short runIn the short run, currency trader’s expectations , currency trader’s expectations play a much more important role.play a much more important role.In today’s environment, traders and lenders, using In today’s environment, traders and lenders, using the most modern communications, act by fight-or-the most modern communications, act by fight-or-flight instincts. For example, if they expect others flight instincts. For example, if they expect others are about to sell Brazilian are about to sell Brazilian realsreals for U.S. dollars, for U.S. dollars, they want to “get to the exits first”. they want to “get to the exits first”. Thus, fears of depreciation become self-fulfilling Thus, fears of depreciation become self-fulfilling prophecies.prophecies.

Fixed versus Flexible Exchange Rate Fixed versus Flexible Exchange Rate RegimesRegimes

Arguments in favor of flexible exchange Arguments in favor of flexible exchange rates:rates:– Easier external adjustments.Easier external adjustments.– National policy autonomy.National policy autonomy.

Arguments against flexible exchange Arguments against flexible exchange rates:rates:– Exchange rate uncertainty may hamper Exchange rate uncertainty may hamper

international trade.international trade.– No safeguards to prevent crises.No safeguards to prevent crises.

Fixed versus Flexible Fixed versus Flexible Exchange Rate RegimesExchange Rate Regimes

Suppose the exchange rate is $1.40/Suppose the exchange rate is $1.40/£ £ today.today.

In the next slide, we see that demand for In the next slide, we see that demand for British pounds far exceed supply at this British pounds far exceed supply at this exchange rate.exchange rate.

The U.S. experiences trade deficits.The U.S. experiences trade deficits.