e) This discussion is also a conduit to Chapter 8, in which we analyze in more detail short-and long-term
international debt and two financial crises, including the recent global financial crisis.
f) This structure reflects a complex web of political and economic agreements, understandings, institutions,
and relationships that help determine the values of different national currencies in terms of other currencies,
and that establishes a set of rules as to how much, how often, and under what terms money moves into and
out of national economies.
g) With the background and knowledge this chapter provides, students should be able to grasp the essential
features of the international finance and exchange rate systems.
We have found this history to be especially useful to students because it makes the entire topic easier to
understand. In each period, we inquire into the major actors, the interplay of market forces and social
interests that shape policies, and what accounts for shifts from one system to another. Inter-spliced between
the first and second historical periods, we explain the role of the IMF and why its primary functions have
shifted over time. We also explain the balance-of-payment problem and its connection to management
functions of the IMF.
A PRIMER ON FOREIGN EXCHANGE
a) Foreign or currency exchange rates affect the value of everything a nation buys or sells on international
markets. It also impinges on the cost of credit and debt, and the value of foreign currencies held in national
and private banks.
b) A special vocabulary is used when discussing currency or foreign exchange.
c) Travelers and investors are often exposed to currency exchanges when they decide how much of their
national currency it will cost to buy or invest in another country.
d) Banks and investors buy and sell millions of dollars, British pound sterling, yen, euros, and other
currencies. A change in the value of one currency (contrast 2009 with 2012 in Table 7-1) can mean huge
gains or losses depending on how much market prices for currencies have changed in the recent past or
might change in the future. What concerns states the most are short- and long term shifts in the values of
certain currencies to one another (discussed in more detail later).
e) Currency values are relative to other currencies; for example, if the yen–dollar exchange rate is¥100 per 1
US$, then a ¥1,000 café latte at the Tokyo airport costs a U.S. tourist in Japan $10 (¥1,000 ÷ ¥100 per $ =
f) Currencies are considered to be either hard or soft. Hard currencies are widely traded and accepted for
international payments, while soft currencies are typically only accepted in their country or region of
g) The supply and demand for a currency determines its value.
h) Governments will often intervene in foreign exchange markets through national Central Banks by buying
and selling the nation’s currency to either strengthen or weaken its value.
i) The level of demand for U.S. dollars reflects the attempt of foreigners to buy U.S. goods, services, assets,
and travel to the United States.
j) As the quantity of dollars demanded increases, the dollar appreciates (increases in value relative to other
currencies), which makes U.S. goods less competitive (because more foreign currency is required to buy
the dollars needed to purchase the good).
k) The demand for dollars is also impacted by U.S. interest rates. A rise in U.S. interest rates relative to
foreign countries’ interest rates creates an incentive for foreigners to invest in interest-bearing assets in the
United States. This will increase the demand for U.S. dollars.
l) Slower inflation in the U.S. compared to other countries also increases the demand for dollars.
m) The supply of dollars reflects the desire of U.S. households, businesses, and government entities to buy
foreign goods and services, assets, and to travel in foreign countries.
n) The quantity of dollars supplied is directly related to the price of dollars—as the currency appreciates, it
has more purchasing power in foreign markets (foreign goods become less expensive).
o) The supply of dollars is also influenced by foreign interest rates, inflation, and business expectations
relative to those in the United States.
p) Speculation plays an important role in foreign exchange markets: currency speculators may invest in a
nation’s assets in anticipation of the nation’s currency appreciating. However, the increase in demand for
the foreign currency can actually generate the appreciation anticipated.