46110329_Tsinghua_final_02.pptx

The International Monetary and Finance StructureChap.7

International Political Economy

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JC. Fred Bergsten. “The Dollar and the Deficits: How Washington Can Prevent the Next Crisis” Foreign Affairs 88(November/ December 2009).

Benjamin J. Cohen. The Geography of Money. Ithaca, NY: Cornell University Press, 1998.

Barry Eichengreen. Globalizing Capital: A History of the International Monetary System. Princeton, NI: Princeton University Press,1996.

Barry Eichengreen. “The Dollar Dilemma: The World’s Top Currency Faces Competition” Foreign Affairs 88 (September/October 2009), pp.53-68.

Robert Wade. “The First-World Debt Crisis of 2007-2010 in Global Perspective,” Challenge 51 (July/ August 2008),pp.23-54

Suggested ReadingsChpt.7

Sector 1

Sector 2

Sector 3

Sector 4

Content

Three Foreign Exchange Rate Systems

Structural Management and Alternative Reserve Currencies

Global Financial Crisis: The U.S.Dollar Goes Wobbly

A Primer on Foreign Exchange

Chpt.7

1.1 Introduction

1.2 Who set the exchange rates?

1.3 Interest rates and inflation

1.4 Speculation

1. A Primer on Foreign Exchange

1.1 Introduction Chpt.7

What concerns states the most are short-and long-terms shifts in the values of certain currencies to one another.

• how currency exchange rates work.• how hard or soft certain currencies are.

Foreign or currency exchange affects the value of everything a nation buys and sells on international markets.

A change in the value of one currency can mean huge gains or losses depending on how much markets prices for currencies have changes in the recent past or mighr change in the feature.

Essentially, the exchange rate is just a way of converting the value of one country’s unit of measurement into another’s. What does matter is not the units that are used, but the acceptability of the measurement to the actors involved in a transaction at any given time, and how much values change over time.

1.2 Who set the exchange rates?Chpt.7

• Often exchange rates are set by the market forces of supply and demand. But, there is also considerable temptation for nations to purposefully manipulated currency values so as to achieve a desirable outcome for that state.

• Any number of political and economic forces affect exchange rates: ---- Currency appreciation and depreciation　 　 Currency appreciation--- the currency becomes more valuable relative to other currencies;　 　 Currency depreciation--- the currency becomes less valuable relative to other currencies. ---- Currency-rate manipulation

How to manipulate the exchange rate? ------A central bank can buy (demand) and sell (supply) enough of its own currency to alter the

exchange rare.

1.3 Interest rates and inflationChpt.7

Inflation — a rise in overall prices:　 　 (If all else being equal), higher inflation currency depreciation　 　 　　　　　　　　　　　　　　　　　　　Interest rates: 　 　 Higher interest rates currency appreciation　 　 Lower interest rates currency depreciation

1.4 SpeculationChpt.7

• How bubbles form?

----when hot money moves quickly into a country, bubbles form.

• How bubbles burst?

----when investors rapidly pull their money out in anticipation that market prices will fall.

Speculation—betting that the value of a currency or market price for a certain item or service will go up

and earn the owner a profit when it is sold.Consequence—drive up value of an item or a currency, generate bubble-- “irrational exuberance”.

> As soon as the bubbles burst, it will cause hardship even some financial crisis.

2. Three Foreign Exchange Rate SystemsChpt.7

2.1 Phase I: the Classic Gold Standard

2.2 PhaseII: the Bretton Woods System —— the Qualified Gold Standard

and Fixed Exchange Rates2.3 PhaseIII: Flexible-Exchange-Rate System

—— and the Changing Economic System

2.1 Phase I: the Classic Gold Standard Chpt.7

• Definition — a fixed exchange-rate system that linked currency values to the price of gold.

• Features: a. under the prevailing liberal economic theory b. self-regulating international monetary order. c. different currency values were pegged to the price of gold.

• Advantages: a stabilizing, equilibrating, and confidence-building effect on the international political economy.

Why the Gold Standard failed?

A. America’s omission—After World War I, the U.S.dollar became the world’s strongest and most trust currency, however, the U.S. acted more i its own interests and failed to meet the international responsibility.

B. Domestic pressures—Democratic system produced more government intervention, pressuring governments to avoid the automatic policy adjustments the Gold Standard required in order to meet domestic needs.

C. The failure of economic liberal ideas—many states gradually found the economic liberal ideas of a self-regulating economy did not work. And the negative effects of capitalism led to increased demands for more and different types of protection in various states.

Time: 19th century ----the end of World War I, temporarily resurrected during the Great Depression

2.2 PhaseII: the Bretton Woods System-- (1) An Overview

Chpt.7

Background: the high unemployment conditions of the Great Depression and the malevolent competitive

currency devaluations of the 1930s.-----------”Beggar thy neighbor”

Contents of The Bretton Woods System:

• Set up in July 1944.• Three outcomes: WB, GATT, IMF• A quais self-adjusting mechanism: An ounce of gold as $35, while the value of other national currencies fluctuate against the USD with 1%.

Essence:

• a modified version of the former gold standard’s fixed-exchange-rate system that was more open

to market forces, but not divorced from politics.

• Confidence in the system relied on the fact that dollars could be converted into gold at a set price.

Chpt.7

• Boosted Western European and Japanese recovery from the war and preserved an environment

for trade and foreign investment in Western Europe.

• Helped tie together the allies into a liberal-capitalist, U.S.-dominated monetary and finance

system that complemented U.S.efforts to divide the West from the Soviet-dominated Eastern

Bloc.

• The U.S dollar became the hegemonic currency, or top currency which offered the U.S many

privileges when it came to using the USD as a tool of foreign policy

• Also imposed on America many management responsibilities.

2.2 PhaseII: the Bretton Woods System-- (2) The functions of the Bretton Woods System

Chpt.7

• At Bretton Woods the IMF was set up to create stable and responsive international financial relations. Major policies in IMF are decided on a weighted voting basis. The wight of a state’s vote is related to how much it contributes to the IMF’s reserves.

Ideally, IMF would like to see an equilibrium in a state’s balance of payments.In essence, one state’s falling deficit would be another’s decreased surplus.

The balance of payments

—an accounting of all the international monetary transactions between the residents of one nation and those of other nations in a given year. It reflects what a nation produces, consumes and buys with its money.

• Both of them agree that any state can be regarded as an actor in a global system made of other states.

Three accounts:• A. The current account—records “deposits” or money inflows.• B. The balance of trade—an accounting of a nation’s payments and receipts for the

exchange of goods and services only. • C. The capital and financial account—includes money borrowed or acquired as interest

payment on an investment.

2.2 PhaseII: the Bretton Woods System-- (3) The IMF and the Balance of Payments

Chpt.7

Why the bargain came unstuck?

• There are more and more complaints about the U.S’s privilege, undermining political relations between the allies.

• Western European economies had recovered sufficiently, and no longer wanted USDs.• The fixed-exchange-rate system restricted economic growth of U.S allies and limited the

political choices of state officials.

Both the U.S. and Western Europe accused one another of not sacrificing enough to preserve the fixed-exchange-rate system.

In a word, the structure had become too rigid, making it difficult for states to grow at their own pace and to promote their own interests and values.

To prevent a recession at home, in August 1971 President Richard Nixon unilaterally decided to make dollars nonconvertible to gold. 　 　

2.2 PhaseII: the Bretton Woods System-- (4) the Bargain Comes Unstuck

2.3 PhaseIII: Flexible-Exchange-Rate System and the Changing Economic System - 1

Chpt.7

The rise of OPEC transformed the system into a global financial network.

OPEC states demanded dollars as payment for oil, which helped maintain dollar’s status as the top currency.

In 1973, the float-or flexible-exchange-rate system, or managed float system emerged.

Differences with the Bretton Woods System:• In the early stages of the Bretton Woods system, capital controls and fixed-exchange rates were

manipulated to allow states to respond to domestic political forces .• While at this time, those state officials were pressured to bring down capital controls and to

allow money to move more freely in the international economy.

Reflecting several influential political and economic developments:

• The growing influence of the Japanese and West European economies,• The rise of the Organization of the Petroleum and Exporting Countries(OPEC)• The shift toward a multipolar security structure.

1) 1970s---------------

2.3 PhaseIII: Flexible-Exchange-Rate System and the Changing Economic System - 2

Chpt.7

In the early 1980s trade imbalances contributed to stagflation.Then the main political-economic philosophy turned back to

Keynesianism. e.g: Margaret Thatcher, Ronald Reagan

Measures: privatizing national industries, deregulating financial and

currency exchange markets, cutting taxes at home, liberalizing trade policy, high defense budget

----Helped correct the U.S.current account deficit and sustain the Value of the U.S. dollar.

In 1985: ---- the U.S. Became world’s largest debtor nation; ---- G5 decided to work together to make the dollar depreciate in value so that against other currencies.

2) 1980s-----------------------------

2.3 PhaseIII: Flexible-Exchange-Rate System and the Changing Economic System - 3

Chpt.7

Context: the roaring nineties: globalization and the weakening DollarReagan administration’s neoliberal ideas continued to influence international policies and monetary

structure in the 1990s to early 2000s. By the mid-1990s, U.S. economy had recovered.

Washington Consensus & globalization campaign

These policy changes and efforts to make exchange rates serve state interests caused contradictions.

3) 1990s--------------------------

The Mundell Trilemma:-------only any two of the following three goals are possible at the same time as the third option always cancels out the effectiveness of the other two.

The ability to respond to domestic political forces (ofter referred to as monetary autonomy)International capital mobility (necessary for efficient international finance)Stable exchange rates (desirable for smooth international trade and investment)

3. The Global Financial Crisis: The U.S.Dollar Goes Wobbly

Chpt.7

After the dotcom technology bust 2001, a real estate bubble emerged in the U.S. and many its allies.

The financial crisis has raised a number of issues related to a weakening in the value of the dollar.

E.g. the euro had challenged the USD even before the crisis.

Also there are some concerns about some of the implications of a weak dollar and its role as the top reserve currency in the global political economy, along with the U.S’s leadership’s role in managing the global money and finance structure.

3.1 Peak Dollars?Chpt.7

Despite the financial crisis, the dollar has not crashed.

A. Many countries continue to see investing in the U.S. as safe; B. Many states and individuals view U.S. “T-Bills” as a stable bet with highly liquidity.

Dollar Gap: both the major powers and the emerging nations have a vested

interest in preserving the system as is, but with eyes toward what might lie ahead.

If Not The Dollar, Then What?Some of the most popular recommendations ：

• The dollar remains the reserve currency

• The euro or Chinese yuan replaces the dollar

• A supranational currency such as Special Drawing Rights (SDRs) replaces the dollar.

• A reserve system with a basket of currencies emerges.

4. Structural Management and Alternative Reserve Currencies

Chpt.7

There are other lesser-known IOs that also cooperate

on international financial and branking issues.

E.g. The Basil Committee on Bank Supervision ;

　 The International Organization of Securities

Commissions (IOSCO) ;

　 　 The Bank of International Settlements (BIS) ;

　 　 G20 ;

The BRICs ; etc.

The IMF’s role was weakened significantly. For now, it is likely that the IMF will have a new role helping nations recover from the crisis, including some developed nations.

For states, much like the stag hunt, it’s time for each actor to decide whether to act in his own interest or cooperate to save the group.

Discussion Questions

Affairs,February2011

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Outline the political, economic, institutional, and procedural features of the gold standard, the fixed-exchange-rate, and the flexible-exchange-rate systems. What are some of the political and economic advantages and disadvantages of each system?

Outline the institutional features of the IMF and its role in settling current account deficits.

If U.S. dollar depreciates dramatically relative to Chinese Yuan, what effect would this likely have on consumers and business in each country? When is a falling dollar good or bad for U.S.? How have globalization and economic liberal ideas shaped developments in the monetary and finance structure? Cite specific examples from the chapter and in news articles.

The U.S. has recently experiences huge current account deficits that have made it dependent on investments from other states. What specific political and economic factors contributed to this condition? Who has the U.S.relied on the most to invest in the U.S.? Are these states rational to do this? What impact does this situation have on the value of the U.S dollar? If you were an investor, would you be investing in the U.S.? Why or why not?

Chpt.7

110329_Tsinghua_final_02.pptx

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