国际财务管理ER7eSM-Ch02

CHAPTER2INTERNATIONALMONETARYSYSTEMANSWERS&SOLUTIONSTOEND-OF-CHAPTERQUESTIONSANDPROBLEMSQUESTIONSExplainGresham’sLaw.Answer:Gresham’slawreferstothephenomenonthatbad(abundant)moneydrivesgood(scarce)moneyoutofcirculation.Thiskindofphenomenonwasoftenobservedunderbimetallicstandardunderwhichbothgoldandsilverwereusedasmeansofpayments,withtheexchangeratebetweenthetwofixed.Explainthemechanismwhichrestoresthebalanceofpaymentsequilibriumwhenitdisturbedunderthegoldstandard.Answer:Theadjustmentmechanismunderthegoldstandardisreferredtoastheprice-specie-flowmechanismexpoundedbyDavidHume.Underthegoldstandard,abalanceofpaymentdisequilibriumwillbecorrectedbyacounter-flowofgold.SupposethattheU.S.importsmorefromtheU.K.thanitexportstothelatter.Undertheclassicalgoldstandard,gold,whichistheonlymeansofinternationalpayments,willflowfromtheU.S.totheU.K.Asaresult,theU.S.(U.K.)willexperienceadecrease(increase)inmoneysupply.ThismeansthatthepricelevelwilltendtofallintheU.S.andriseintheU.K.Consequently,theU.S.productsbecomemorecompetitiveintheexportmarket,whileU.K.productsbecomelesscompetitive.ThischangewillimproveU.S.balanceofpaymentsandatthesametimehurttheU.K.balanceofpayments,eventuallyeliminatingtheinitialBOPdisequilibrium.Supposethatthepoundispeggedtogoldat6poundsperounce,whereasthefrancispeggedtogoldat12francsperounce.This,ofcourse,impliesthattheequilibriumexchangerateshouldbetwofrancsperpound.Ifthecurrentmarketexchangerateis2.2francsperpound,howwouldyoutakeadvantageofthissituation?Whatwouldbetheeffectofshippingcosts?Answer: Supposethatyouneedtobuy6poundsusingFrenchfrancs.Ifyoubuy6poundsdirectlyintheforeignexchangemarket,itwillcostyou13.2francs.Alternatively,youcanfirstbuyanounceofgoldfor12francsinFranceandthenshipittoEnglandandsellitfor6pounds.Inthiscase,itonlycostsyou12francstobuy6pounds.Itisthusbeneficialtoshipgoldduetotheoverpricingofthepound.Ofcourse,youcanmakeanarbitrageprofitbyselling6poundsfor13.2francsintheforeignexchangemarket.Thearbitrageprofitwillbe 1.2francs.Sofar,assumedthatshippingcostsdonotexist.Ifitcostsmorethan1.2francstoshipanounceofgold,therewillbenoarbitrageprofit.Discusstheadvantagesanddisadvantagesofthegoldstandard.Answer:Theadvantagesofthegoldstandardinclude:(I)sincethesupplyofgoldisrestricted,countriescannothavehighinflation;(2)anyBOPdisequilibriumcanbecorrectedautomaticallythroughcross-borderflowsofgold.Ontheotherhand,themaindisadvantagesofthegoldstandardare:(I)theworldeconomycanbesubjecttodeflationarypressureduetorestrictedsupplyofgold;(ii)thegoldstandarditselfhasnomechanismtoenforcetherulesofthegame,and,asaresult,countriesmaypursueeconomicpolicies(likede-monetizationofgold)thatareincompatiblewiththegoldstandard.WhatwerethemainobjectivesoftheBrettonWoodssystem?Answer: ThemainobjectivesoftheBrettonWoodssystemaretoachieveexchangestabilityandpromoteinternationaltradeanddevelopment.CommentonthepropositionthattheBrettonWoodssystemwasprogrammedtoaneventualdemise.Answer:TheanswertothisquestionisrelatedtotheTriffinparadox.Underthegold-exchangesystem,thereserve-currencycountryshouldrunBOPdeficitstosupplyreservestotheworldeconomy,butifthedeficitsarelargeandpersistent,theycanleadtoacrisisofconfidenceinthereservecurrencyitself,eventuallycausingthedownfallofthesystem.Explainhowspecialdrawingrights(SDR)areconstructed.Also,discussthecircumstancesunderwhichtheSDRwascreated.Answer: SDRwascreatedbytheIMFin1970asanewreserveasset,partiallytoalleviatethepressureontheU.S.dollarasthekeyreservecurrency.TheSDRisabasketcurrencycurrentlycomprisedoffourmajorcurrencies,i.e.,U.S.dollar,euro,Japaneseyen,andBritishpound.Currently,thedollarreceivesa41.9%weight,euro37.4%,yen9.4%,andpound11.3%.Theweightsfordifferentcurrenciestendtochangeover time,reflectingtherelativeimportanceofeachcurrencyininternationaltradeandfinance.ExplainthearrangementsandworkingsoftheEuropeanMonetarySystem(EMS).Answer: EMSwaslaunchedin1979inorderto(i)establishazoneofmonetarystabilityinEurope,(ii)coordinateexchangeratepoliciesagainstthenon-EMScurrencies,and(iii)pavethewayfortheeventualEuropeanmonetaryunion.ThemaininstrumentsofEMSaretheEuropeanCurrencyUnit(ECU)andtheExchangeRateMechanism(ERM).LikeSDR,theECUisabasketcurrencyconstructedasaweightedaverageofcurrenciesofEUmembercountries.TheECUworksastheaccountingunitofEMSand playsanimportantroleintheworkingsoftheERM.TheERMistheprocedurebywhichEMSmembercountriesmanagetheirexchangerates.TheERMisbasedonaparitygridsystem,withparitygridsfirstcomputedbydefiningtheparvaluesofEMScurrenciesintermsoftheECU.Ifacountry’sECUmarketexchangeratedivergesfromthecentralratebyasmuchasthemaximumallowabledeviation,thecountryhastoadjustitspoliciestomaintainitsparvaluesrelativetoothercurrencies. EMSachievedacompletemonetaryunionin1999whenthecommonEuropeancurrency,theeuro,wasadopted.Thereareargumentsforandagainstthealternativeexchangerateregimes.Listtheadvantagesoftheflexibleexchangerateregime.Criticizetheflexibleexchangerateregimefromtheviewpointoftheproponentsofthefixedexchangerateregime.Rebuttheabovecriticismfromtheviewpointoftheproponentsoftheflexibleexchangerateregime.Answer:a.Theadvantagesoftheflexibleexchangeratesysteminclude:(I)automaticachievementofbalanceofpaymentsequilibriumand(ii)maintenanceofnationalpolicyautonomy.b.Ifexchangeratesarefluctuatingrandomly,thatmaydiscourageinternationaltradeandencouragemarketsegmentation.This,inturn,mayleadtosuboptimalallocationofresources.c.Economicagentscanhedgeexchangeriskbymeansofforwardcontractsandothertechniques.Theydon’thavetobearitiftheychoosenotto.Inaddition,underafixedexchangerateregime,governmentsoftenrestrictinternationaltradeinordertomaintaintheexchangerate.Thisisaself-defeatingmeasure.What’sgoodaboutthefixedexchangerateifinternationaltradeneedtoberestricted?Inanintegratedworldfinancialmarket,afinancialcrisisinacountrycanbequicklytransmittedtoothercountries,causingaglobalcrisis.WhatkindofmeasureswouldyouproposetopreventtherecurrenceofanAsia-typecrisis.Answer:First,thereshouldbeamultinationalsafetynettosafeguardtheworldfinancialsystemfromtheAsia-typecrisis.Second,internationalinstitutionslikeIMFandtheWorldBankshouldmonitorproblematiccountriesmorecloselyandprovidetimelyadvicetothosecountries.Countriesshouldberequiredtofullydiscloseeconomicandfinancialinformationsothatdevaluationsurprisescanbeprevented.Third,countriesshoulddependmoreondomesticsavingsandlong-termforeigninvestments,ratherthanshort-termportfoliocapital.Therecanothersuggestions.Discussthecriteriafora‘good’internationalmonetarysystem.Answer:Agoodinternationalmonetarysystemshouldprovide(i)sufficientliquiditytotheeconomy,(ii)smoothadjustmentstoBOPdisequilibriumasitarises,and(iii)safeguardagainstthecrisisofconfidenceinthesystem.Oncecapitalmarketsareintegrated,itisdifficultforacountrytomaintainafixedexchangerate.Explainwhythismaybeso.Answer:Oncecapitalmarketsareintegratedinternationally,vastamountsofmoneymayflowinandoutofacountryinashorttimeperiod.Thiswillmakeitverydifficultforthecountrytomaintainafixedexchangerate.AssessthepossibilityfortheeurotobecomeanotherglobalcurrencyrivalingtheU.S.dollar.Iftheeuroreallybecomesaglobalcurrency,whatimpactwillithaveontheU.S.dollarandtheworldeconomy?Answer:Inlightofthelargetransactionsdomainoftheeuro,whichiscomparabletothatoftheU.S.dollar,andthemandatefortheEuropeanCentralBank(ECB)toguaranteethemonetarystabilityinEurope,theeuromaypotentiallybecomeanotherglobalcurrencyovertime.Amajoruncertaintyaboutthisprospectisthelackofpolitical(andfiscal)integrationofEurope.IfEuropebecomespoliticallymoreintegrated,theeuroismorelikelytobecomeaglobalcurrency.Iftheeurobecomesaglobalcurrency,itwillcomeattheexpenseofthedollar.Currently,theU.S.derivessubstantialbenefitsfromthedollar’sstatusasthedominantglobalcurrency–forinstance,theU.S.canruntradedeficitswithouthavingtomaintainsubstantialforeignexchangereserves,cancarryoutinternationalcommercialandfinancialtransactionsindollarswithoutbearingexchangerisk,etc.Iftheeuroistobeusedasamajordenomination,reserve,andinvoicecurrencyintheworldeconomy,dollar-basedagentswillstarttobearmoreexchangerisk,amongotherthings.MINICASE:WILLTHEUNITEDKINGDOMJOINTHEEUROCLUB?WhentheeurowasintroducedinJanuary1999,theUnitedKingdomwasconspicuouslyabsentfromthelistofEuropeancountriesadoptingthecommoncurrency.AlthoughthepreviousLaborgovernmentledbyPrimeMinisterTonyBlairappearedtobereceptivetoideajoiningtheeuroclub,thecurrentTorygovernmentisclearlynotinfavorofadoptingtheeuroandthusgivingupmonetarysovereigntyofthecountry.Thepublicopinionisalsodividedontheissue.WhethertheUnitedKingdomwilleventuallyjointheeuroclubisamatterofconsiderableimportanceforthefutureofEuropeanUnionaswellasthatoftheUnitedKingdom.ThejoiningoftheUnitedKingdomwithitssophisticatedfinanceindustrywillmostcertainlyhelppropeltheeurointoaglobalcurrencystatusrivalingtheU.S.dollar.TheUnitedKingdomonitspartwillfirmlyjointheprocessofeconomicandpoliticalunionizationofEurope,abandoningtraditionalbalancingrole.Investigate the political, economic and historical situations surrounding the participation in the European economic and monetary integration and write your ownassessmentoftheprospectofBritainjoiningtheeuroclub.Indongso,assessfromtheBritishperspective,amongotherthings,(1)potentialbenefitsan