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Chapter 2, International Financial Mgmt, Eun et al 3460.02 notes by A.P. Palasvirta, PhD.

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Presentation on theme: "Chapter 2, International Financial Mgmt, Eun et al 3460.02 notes by A.P. Palasvirta, PhD."— Presentation transcript:

1 Chapter 2, International Financial Mgmt, Eun et al 3460.02 notes by A.P. Palasvirta, PhD

2 Bronze Silver Gold U.S. Dollar Standard June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 2

3 Bank of Amsterdam (15 th century) 100% reserves of gold and silver Depositors brought gold, silver Were given warehousing certificates for the amount of gold, silver minus a charge Depositors would use the warehousing certificates as money Lower transactions costs Easier to use June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 3

4 Gold 1 00% Warehouse receipts June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 4 AssetsLiabilities

5 Queen Elizabeth I 1563 to 1603 Created the Bank of England Held partial reserves of gold and silver The rest were in treasury bills This was not a strict gold standard, but a gold exchange standard This bank could not refund all claims for gold with gold June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 5

6 Gold 30 – 40% T-bills 60 – 70% http://www.gata.org/node/104 June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 6 currency AssetsLiabilities

7 Fix the value of the unit of account Something immutable Ounce of silver Ounce of gold Gold standard Unit of account the troy ounce Medium of exchange Coinage Gold certificates June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 7

8 If the cost of mining gold increases deflation Value of gold increases Value of other goods remain constant Prices decrease If the cost of mining gold decreases Inflation Value of gold decreases Value of other goods remain constant Prices increase June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 8

9 June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 9 1/P Gold 1/P Demand Supply

10 June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 10 1/P Gold 1/P Supply Demand

11 Two markets for gold official government market Legal unofficial private markets Parity Price greater than market price governments price (parity) the high price external markets price the low price trader buys low sells high buys externally sells to government June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 11

12 June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 12 Par D1D1 S1S1 PgPg PgPg QgQg D2D2 S2S2 Government Market Private Market

13 Private market gold supplies decrease holders of gold will sell first to the government arbitrageurs will buy up stocks and sell to the government excess supply will dry up bringing market price to equal the parity price Government gold supplies will increase increases the money supply decrease the value of money (inflation) June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 13

14 Countries fix parity price of gold usd parity price = $20.67/ounce uk parity price = 4.2474£/ounce usd/uk£ = 4.8665$/£ They allow arbitrage between two markets parity price of gold at Central Bank free market price of gold De facto single currency the ounce of gold many units of account periodic falling off of the gold standard Balance of Payments deficits settled with gold June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 14

15 Mechanism which mitigates BOT surplus gold is paid to pay for excess of exports to imports gold coming into the central bank increases money supply inflation in the economy your goods now more expensive in foreign markets foreign goods less expensive to you Price-specie flow mechanism BOP balances settled in gold Money adjusts Prices adjust International prices converge June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 15

16 Gold T-bills gold increases due to BOT surplus cash currency Money supply increases June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 16 Assets Liabilities

17 Gold backs all money prices move relative to excess demand for gold (economic growth) deflation excess supply of gold (new gold finds) inflation Treasuries have no independent monetary policy June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 17

18 Fixed parity price (not fixed value) Unit of account varied with the cost of mining gold Often the unit of account appreciated (increased in value) as gold supplies were harder to mine With new gold discoveries, the unit of account depreciated (decreased in value) as the cost of mining gold decreased June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 18

19 All currencies fixed to gold Gold is the de facto currency single world wide currency all international trade is denominated in gold No need to hedge exchange rate volatility since exchange rates are constant June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 19

20 When CBs execute a monetary policy discipline of the gold standard is gone after WWII governments ran inflationary policies interest rate policies employment policies inflation sometimes running at 200% or more Exchange rates fluctuate creating uncertainty for trade June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 20

21 Colonizers (France, Spain, England, Portugal) Gold standard Colonies Silver standard Greshams Law Bad money drives out good June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 21

22 Germany reparations heavy and denominated in Deutsche Marks not gold Germany inflated their currency in order to reduce the cost of reparations Inflation 1 trillion% United States had most of the gold France, England paid for war materials bought from the U.S. in gold Stock market crash of 1929 Led to protectionism Sterilization polices Depression June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 22

23 WWII U.S. again the supplier of arms got most of the gold in the world 1944 end of the was the Gold Exchange Standard The U.S. dollar became the reserve currency Traded at par value with all currencies part of system Balance of payments imbalances were cleared with U.S. dollars instead of gold Cheaper to ship dollars instead of gold Countries could earn interest on their foreign exchange reserves Special Drawing Rights (SDRs) June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 23

24 Creation of the International Monetary Fund (IMF) International clearing house for exchange transactions with SDRs and dollars Special Drawing Rights Exchange reserves held at the IMF Value weighted average of basket of major currencies Deutsche Mark (20%), franc (12%), pound (12%), yen (16%), us dollar (42%) The SDR as well as the U.S. dollar became the reserve currencies June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 24

25 U.S. had to run a chronic BOP deficit to supply us dollars to the worlds economies The fixed parities between currencies dependent on certain assumptions for all economies Monetary policies aligned Fiscal policies aligned Revaluations necessary periodically Monetary policies of many countries very expansionary June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 25

26 US running inflationary monetary policy to finance Vietnamese war US increase the dollar parity price (devalued) twice DeGaulle demanded payment of BOP surplus with the U.S. in gold June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 26

27 January 1976 All currencies will float with respect to each other June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 27

28 Gold = $1,212.1 Silver = $18.411 Platinum = $1,548.7 Paladium = $462.7 June 13, 2014 3460.02 gold standard notes: a.p. palasvirta, ph.d. 28


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