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Does
Exchange Flexibility Spread Inflation Internationally or Isolate It? |
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Roger H. Goldberg,
To motivate the necessity of a market for foreign exchange, I offer to purchase a pen at the outset of class. The willing seller who comes forth is given a 1000 lira note in payment. (I stress the "one thousand" denomination for the benefit of the class when concluding the transaction). The recipient of the note invariably asks, "What do I do with this?" This provides the instructor with immediate opportunity to highlight the different mediums of exchange economies use and to suggest the necessity of markets which will allow for exchange between the monetary instruments of different nations. The class is asked as a concluding exercise to research the current exchange value of the lira and other currencies from their daily newspapers. (Postscript: Did the teacher "get a good deal" on the pen?)
Permanent International Seignorage
Robert T. Averitt,
I tell the following story when discussing international
exchange markets. One of four friends dies. The three remaining friends decide
to honor their friendship while standing at the open grave. The first friend
drops a $100 bill into the open grave. The second friend does the same. The
third friend does not have a $100 bill, so he writes the deceased a check for
$100 and drops the check in the grave. Then the open grave is covered. The
first two friends have lowered their net worth by $100, the third friend has
not. Dollars in international trade are like checks. If dollars do not return
to the
A Strong Currency for a Net Importer
Gautam Mukerjee,
I explain the need for a strong currency for a country such as
An International Big McTasty Attack
John P. Manzer,
Students frequently do not understand the nature of foreign exchange conversions or the significance of rate changes upon international trade. This short exercise is designed to involve students in a quick analysis demonstrating the importance of the process.
McTasty,
Inc. is a
Pound $ Cost in Mark $
Cost in
United
Kingdom for
Item Price Traveler Price Traveler
Mctasty Burger 1.5 _____ 5 _____
Deluxe Mctasty Burger 2 _____ 8 _____
French Fries 1 _____ 2 _____
Ice Cream Sundae .5 _____ 2.5 _____
Table 37‑1
It appears
that a number of international events may change exchange rates next
season. It is predicted that the pound
will sell for $1.80 and the mark for $.60.
Using the same European prices calculate the dollar costs to
New
$ Cost in New
$ Cost in
for
Item Traveler Traveler
Mctasty Burger _____ _____
Deluxe McTasty Burger _____ _____
French Fries _____ _____
Ice Cream Sundae _____ _____
Table 37‑2
Using the
new exchange rates, complete Table 37‑3 and determine the costs of
McTasty products for
Pound Mark
Cost Pound Cost in
United in
Kingdom for
Item Price Travelers Price Travelers
Mctasty Burger 1.5 _____ 5 _____
Deluxe Mctasty Burger 2 _____ 8 _____
French Fries 1 _____ 2 _____
Ice Cream Sundae .5 _____ 2.5 _____
Table 37‑3
Pound $ Mark Cost in $ Cost in
United
Kingdom for German
Item Price Travelers Price Travelers
Mctasty Burger 1.5 _____ 5 _____
Deluxe Mctasty Burger 2 _____ 8 _____
French Fries 1 _____ 2 _____
Ice Cream Sundae .5 _____ 2.5 _____
How have changes in exchange rates affected the relative prices of McTasty's European products?
What types events may effect the supply and demand for different currencies?
Additional issues of class discussion might include the effects of changing currency values upon a firm’s profitability and the types strategies they might utilize to protect themselves from non‑operating currency fluctuation losses.
The International Trade Triangle
Anthony N. Duruh, Warner Southern College
The International Trade Triangle is
very suitable for clarifying how the imbalance of trade can occur between two
countries. For example, trade imbalance
between the
Figure 37‑1
Winners and Losers
The International Trade Triangle produces a winner and a loser. The winner is the country with trade surplus, while the loser is the country with a trade deficit.
How
A
look at the graph reveals the imbalance of trade between
The Loser
The
Other Uses of the International Trade Triangle
The International Trade Triangle is useful for explaining the following:
1. Comparative Advantage
2. Foreign currency transactions
3. Arbitrage
4. Dumping
5. Non‑restrictive and restrictive foreign currency.
Introducing the Balance of Payments
Jannett K. Highfill,
William V. Weber, Eastern
The foreign exchange market for dollars can be used to help
students understand the economic balance of payments. Foreign agents demand U.S. dollars when they
(1) buy
When these relationships are placed on the supply/demand diagram of the foreign exchange market for dollars (see attached figure), the economic balance of payments is readily seen to be the difference between the quantity demanded and quantity supplied of dollars. The easiest case, of course, corresponds to the supply/demand equilibrium. It is virtually self-evident from the graph that if exchange rates are truly flexible, then the economic balance of payments is neither in surplus nor in deficit at the equilibrium exchange rate. If instead the value of the dollar is above its equilibrium level (which might occur under fixed or managed-float exchange rates), the graph makes it apparent that the sum of current account exports and capital account inflows (i.e., the quantity demanded of dollars) is smaller than the sum of current account imports and capital account outflows (i.e., the quantity supplied of dollars), and thus the balance of payments is in deficit and official transactions on the official settlements balance are required.
Figure 37-2
Are Trade and Payments Deficits Harmful?
Ralph T. Byrns
Many people, including quite a few economists, are alarmed
by the persistence of huge
Argue, further, that foreigners who have absorbed dollars must have perceived that they were gaining from their payments surpluses because they acquired units of an international medium of exchange. The dollar is also highly valued internationally for precautionary reasons because it is considered a secure asset. Suggest to your students that our international "seignorage" has also yielded several kinds of gains to most Americans:
a. American consumers gain from trade deficits because more goods are available in total, and at lower prices.
b. American firms have gained because
c. American policymakers have used the worldwide acceptability of the dollar as leverage in international negotiations, and have often secured concessions by foreign governments. "Dollar diplomacy" is generally preferable to gunboat diplomacy.
The basic question here is whether the persistent outflows of dollars can be viewed as semi‑permanent exports. To rebut the counterargument that foreign holdings of dollars will return and imposes a future burden on Americans, point out that foreigners have demonstrated a huge appetite for dollars; the U.S. has experienced payments deficits in the current account persistently for more than a decade. Japanese use dollars to buy Brazilian coffee, Arabs use dollars to buy Toyotas, etc. The U.S. dollar is the world's major medium of exchange, and it is also perceived as an appropriate store of value by residents of countries that are economically or politically unstable. Thus, most Americans gain through international seignorage when our balance of trade (or payments) is in deficit because our FED is, de facto, the world's banker.
J. Harold McClure, Jr.,
I offer a way to motivate a students' desire to learn interest rate parity theorems found in basic international economics. The international Fisher equivalent gives the market's best forecast of future spot exchange rates under ideal conditions. However, to make profits, one must beat a market (if one can). At the beginning of the second quarter of 1985, Eurosterling interest rates were about three percentage points above Eurodollars rates so the market would be forecasting a 3 percent per year dollar appreciation (its value would go from 1.2443 $/pound to 1.2350 $/pound in 90 days. If one accepted a global monetarist guess that differential money growth determines exchange rate behavior, the fact that U.S. M1 growth was two percentage points higher than U.K. M1 growth suggests dollar devaluation. Holding British assets would earn higher nominal return plus an expected capital gain. One can then warn students of exchange rate risks, failures of predictive models, etc.
NOTE: Sources for recent Eurocurrency rates and forward/spot exchange rates include The Economist and Wall Street Journal.
Exchange Controls and Black Markets
Ralph T. Byrns
The governments of many less developed countries and countries within the Soviet sphere often fix the exchange rates for their currencies at untenably high levels. They will buy foreign currencies at the official rate, but refuse to redeem most privately‑held currency at comparable rates for foreign currencies. The result is that black markets for foreign currencies abound, and fortunes can be made by government insiders who can get domestic currency exchanged at official rates for foreign currency.
For example,
Vietnamese piasters could not legally be redeemed for
Does Exchange Flexibility Spread Inflation Internationally or Isolate It?
Ralph T. Byrns
Point out to your students that standard theory predicts that flexible exchange rates should insulate a domestic economy from foreign inflation. Exchange rates should fall for currencies issued by countries experiencing relatively high inflation, and should rise for currencies where price levels are relatively stable.
Many critics of flexible exchange rates take a contrary position and have blamed flexibility for high rates of inflation. Presumably, their argument rests on high‑inflation countries' inability to export and diffuse their inflationary pressures; the exchange rates of other countries simply appreciate so that a country experiencing rapid inflation is isolated as effectively as quarantined patients in TB wards once were. Classroom discussions of the implications of both approaches tends to be lively.
Notes: