1. page 1-1 #1. Introduction: International Financial Markets 1. History of International Financial System 2. Exchange Rates since 1973 Reading: International Monetary System (Eun and Resnick Chapters 1 and 2)

2. Bimetallism: Before 1875 Classical Gold Standard: 1875-1914 Interwar Period: 1915-1944 Bretton Woods System: 1945-1972 The Flexible Exchange Rate Regime: 1973-Present 1. History of International Financial System

3. Bimetallism: Before 1875 A double standard in the sense that both gold and silver were used as money. Some countries were on the gold standard, some on the silver standard, some on both. Both gold and silver were used as international means of payment and the exchange rates among currencies were determined by either their gold or silver contents. Greshams Law implied that it would be the least valuable metal that would tend to circulate.

4. Greshams Law Suppose Gold and Silver were both used, when the conversion rate is one ounce of gold = 15.5 ounces of silver. Suddenly, discovery of new gold mines causes huge influx of gold into the market. Gold becomes much cheaper to produce than silver is. Producer will produce lots of gold, and everyone will use gold. Bad money (gold) drives out good money (Silver).

5. Classical Gold Standard: 1875-1914 During this period in most major countries: Gold alone was assured of unrestricted coinage There was two-way convertibility between gold and national currencies at a stable ratio. Gold could be freely exported or imported. The exchange rate between two countrys currencies would be determined by their relative gold contents.

6. For example, if the dollar is pegged to gold at U.S.$30 = 1 ounce of gold, and the British pound is pegged to gold at £6 = 1 ounce of gold, it must be the case that the exchange rate is determined by the relative gold contents: Classical Gold Standard: 1875-1914 $30 = £6 $5 = £1

7. Classical Gold Standard: 1875-1914 Highly stable exchange rates under the classical gold standard provided an environment that was conducive to international trade and investment. Misalignment of exchange rates and international imbalances of payment were automatically corrected by the price-specie-flow mechanism.

8. Price-Specie-Flow Mechanism Suppose Great Britain exported more to France than Great Britain imported from France. This cannot persist under a gold standard. Net export of goods from Great Britain to France will be accompanied by a net flow of gold from France to Great Britain. This flow of gold will lead to a lower price level in France and, at the same time, a higher price level in Britain. The resultant change in relative price levels will slow exports from Great Britain and encourage exports from France. Question: Guess whether inflation rate was high or low during the gold standard…

9. Cumulative consumer price index

10. Bretton Woods System: 1945-1972 During the interwar period from 1914 to 1945, exchange rates fluctuated wildly. Bretton Woods system was named after a 1944 meeting of 44 nations at Bretton Woods, New Hampshire. The purpose was to design a postwar international monetary system. The goal was exchange rate stability without the gold standard. In the same meeting, the IMF and the World Bank were created.

11. Bretton Woods System: 1945-1972 Under the Bretton Woods system, the U.S. dollar was pegged to gold at $35 per ounce and other currencies were pegged to the U.S. dollar. Each country was responsible for maintaining its exchange rate within ±1% of the adopted par value by buying or selling foreign reserves as necessary. The Bretton Woods system was a dollar-based gold exchange standard.

12. Bretton Woods System: 1945-1972 German mark British pound French franc U.S. dollar Gold Pegged at $35/oz. Par Value

13. page 1-13 2. Exchange Rates since 1973

14. page 1-14 Exchange Rate Classifications ( Source: Stanley Fisher, Mundell-Fleming Lecture …, IMF conference 2007 )

15. 15 Example of a Crawling Peg Bekaert and Hodrick 2008

16. 16 An Example of a Peg with Horizon Band (Target Zone)

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21. Course This course is distinct from: open economy macroeconomics international trade economic development International corporate finance Most class materials (lecture notes, problems) from Professors Urban Jermann and Amir Yaron.

22. Timing issues The schedule may change as the semester goes along. We may spend more time on some topics and introduce relevant news and research into discussions. Exam 1: February 22 (6-8pm) Exam 2: April 12 (6-8pm)

23. Guessing Game and Group Formation Which exchange rate series are Indonesias, Argentinas, Canadas & Brazils? We use the exchange rate definition of the price of foreign currency in dollars: S($/FC) Analogous to price of shoes: P($/shoe)

24. Indonesia, Argentina, Canada & Brazil

25. Measuring Exchange Rate Movements A decline in a currencys value is referred to as depreciation, while an increase is referred to as appreciation. % in foreign currency value = (S - S t-1 ) / S t-1 A positive % represents appreciation of the foreign currency, while a negative % represents depreciation.

26. Which currency?

27. Our email Professor David Ng (davidng@wharton.upenn.edu)davidng@wharton.upenn.edu Teaching Assistants: Jennifer Grossman: jennifrg@wharton.upenn.edujennifrg@wharton.upenn.edu Florian Hagenbuch: hflorian@wharton.upenn.edu hflorian@wharton.upenn.edu Qi Liu: qiliu@wharton.upenn.eduqiliu@wharton.upenn.edu

28. Administrative Details No class next Monday (Martin Luther King day observed in Penn) Textbooks Eun and Resnick Office Hours Webcafe under FNCE 219 Groups

29. A bit about myself... My Background My Research Interest.