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LECTURE 1LECTURE 1INTERNATIONAL TRADE & FINANCEINTERNATIONAL TRADE & FINANCE
Sabur Mollah, PhDAssociate Professor of Finance
Stockholm Business School
Part I: History of Part I: History of International Trade and International Trade and
FinanceFinance
A Brief History of the A Brief History of the International Trade and International Trade and FinanceFinanceBimetalism and Gresham’s Law◦Coinage Act of 1792
1 ounce of gold=15 ounces of silver◦1834: U.S. sets price of gold at $20.67/ounce “De facto” gold standard
◦1873: U.S. demonetizes silver1880: Beginning of the modern international gold standard
1900: U.S. formally joins international gold standard
A brief history of the A brief history of the international financial international financial system & the role of the system & the role of the U.S.U.S.World War I causes countries to leave the gold standard◦ U.S. returns in 1919◦ U.K. returns in 1925, but wartime inflation made a return to the pre-war gold price problematic.
◦ U.K. leaves gold standard again in 1931◦ U.S. raises gold price to $35/ounce in 1933 to stem the outflow
German hyperinflation in 1923 added to the post-war instability
A brief history of the A brief history of the international financial international financial system & the role of the system & the role of the U.S.U.S.1944: Bretton Woods Conference leads to creation of the International Monetary Fund and World Bank.
Bretton Woods creates an international system of fixed exchange rates.◦All currencies are fixed to the U.S. dollar
◦Dollar is defined to be equal to 1/35 ounce of gold. (That is, 1 ounce of gold=$35…same as 1933.)
A brief history of the A brief history of the international financial international financial system & the role of the system & the role of the U.S.U.S.Bretton Woods works well until the late 1960s.◦U.S. begins running balance of payments deficits while Japan and Europe run surpluses.
◦Foreign governments begin piling up dollar assets and want to exchange them for gold.
◦By 1971, foreign claims exceeded the U.S. stock of gold. Nixon suspends convertibility—”closing the gold window”.
A brief history of the A brief history of the international financial international financial system & the role of the system & the role of the U.S.U.S.Thereafter the U.S. devalues the dollar, first to $38/ounce, then to $42.22/ounce, where it remained until the system was finally and permanently abandoned.
A brief history of the A brief history of the international financial international financial system & the role of the system & the role of the U.S.U.S.Post-Bretton Woods there are a variety of exchange rate arrangements. In addition to the completely fixed and flexible regimes, there are:◦Crawling peg◦Currency boards◦Managed float◦And others…
A brief history of the A brief history of the international financial international financial system & the role of the system & the role of the U.S.U.S.European Union◦Treaty of Rome (1957)
Created a customs union among France, Germany, Italy, Belgium, the Netherlands, and Luxembourg.
◦Closer monetary union begins to take shape in the 1970s European Monetary System Maastricht Treaty (1992)
A brief history of the A brief history of the international financial international financial system & the role of the system & the role of the U.S.U.S.Maastricht Treaty established “convergence criteria” for joining the monetary union.
Common currency goes into effect January 1, 1999.
Euro banknotes and coins go into circulation January 1, 2002.
Trade AgreementsTrade AgreementsMany agreements have been made to
reduce trade restrictions:◦1988 U.S. and Canada free trade pact ◦North American Free Trade Agreement
(NAFTA)◦General Agreement on Tariffs and Trade
(GATT)◦Single European Act and the European Union
Trade DisagreementsTrade DisagreementsHowever, even without tariffs and
quotas, governments seem always able to find strategies that can give their local firms an edge in exporting:◦different environmental, labor laws◦bribes, government subsidies (dumping)◦tax breaks for specific industries◦exchange rate manipulations
Trade DisagreementsTrade DisagreementsOther trade-related issues include:◦the outsourcing of services◦the use of trade policies for political reasons◦disagreements within the European Union
Part II: International Part II: International Trade & Finance- Current Trade & Finance- Current
State State
International Trade and International Trade and Finance: Some Key IssuesFinance: Some Key Issues
Many developing countries rely heavily on exports of primary products with attendant risks and uncertainty
Many developing countries also rely heavily on imports (typically of machinery, capital goods, intermediate producer goods, and consumer products)
Many developing countries suffer from chronic deficits on current and capital accounts which depletes their reserves, causes currency instability, and a slowdown in economic growth
Balance of PaymentsBalance of PaymentsThe balance of payments is a summary of
transactions between domestic and foreign residents for a specific country over a specified period of time.
Current AccountCurrent AccountThe current account summarizes the flow
of funds between one specified country and all other countries due to purchases of goods or services, or the provision of income on financial assets.
Key components of the current account include the balance of trade, factor income, and transfer payments.
The U.S. Current Account in 2003The U.S. Current Account in 2003
(1) U.S. exports of goods + $712+ (2) U.S. exports of services + 292+ (3) U.S. income receipts + 275
= (4) Total U.S. exports & income receipts = $1,279
(in billions of $)
(5) U.S. imports of goods – $1,263+ (6) U.S. imports of services – 246+ (7) U.S. income payments – 259
= (8) Total U.S. imports & income payments = $1,768
(9) Net transfers by the U.S. – $68
(10) Current account balance = (4) – (8) – (9) – $557
International Trade FlowsInternational Trade FlowsSome countries are more dependent on
trade than others.◦The trade volume of a European country is
typically between 30 – 40% of its GDP, while the trade volume of U.S. (and Japan) is typically between 10 – 20% of its GDP.
Nevertheless, the volume of trade has grown over time for most countries.
Distribution of U.S. Exports across CountriesDistribution of U.S. Exports across Countries(in billions of $)
The Pace QuickensThe Pace Quickens
Changing U.S. Economy1970…International trade is 7%2000…International trade is 27% 2050…International trade up to 50%
Changing U.S. Life StylesLocal Economy of 19th Century—93% of Work Force
Employed in AgricultureGlobal Economy of 21st Century—3% of Work Force
Employed in Agriculture
The Global Marketplace of the 21The Global Marketplace of the 21stst Century – Looking AheadCentury – Looking Ahead(% of World GDP)(% of World GDP)
2004 2050
Factors AffectingFactors AffectingInternational Trade International Trade FlowsFlowsImpact of Inflation◦A relative increase in a country’s inflation rate
will decrease its current account, as imports increase and exports decrease.
Impact of National Income◦A relative increase in a country’s income level
will decrease its current account, as imports increase.
Factors AffectingFactors AffectingInternational Trade International Trade FlowsFlowsImpact of Government Restrictions◦A government may reduce its country’s
imports by imposing a tariff on imported goods, or by enforcing a quota.
◦Some trade restrictions may be imposed on certain products for health and safety reasons.
Factors AffectingFactors AffectingInternational Trade International Trade FlowsFlowsImpact of Exchange Rates◦If a country’s currency begins to rise in value,
its current account balance will decrease as imports increase and exports decrease.
The factors interact, such that their simultaneous influence on the balance of trade is complex.
Correcting Correcting A Balance of Trade A Balance of Trade DeficitDeficitBy reconsidering the factors that affect
the balance of trade, some common correction methods can be developed.
A floating exchange rate system may correct a trade imbalance automatically since the trade imbalance will affect the demand and supply of the currencies involved.
Why a Weak Home Currency Why a Weak Home Currency Is Not a Perfect SolutionIs Not a Perfect Solution• Counterpricing by competitors• Impact of other weak currencies• Stability of intracompany trade–Many firms purchase products that are produced by their subsidiaries.
• Prearranged international transactions–The lag time between a weaker U.S.$ and increased foreign demand has been estimated to be 18 months or longer.
Menzie Chinn & Hiro Ito, "A New Measure of Financial Openness" (Journal of Comparative Policy Analysis, 2008), updated July 2010
http://web.pdx.edu/~ito/Chinn-Ito_website.htm.
I. Direct Measure of Financial Barriers: Chinn-Ito tally of capital controls, from IMF data
Rapid financial
liberalization in 1990s
ITF220 Prof.J.Frankel
Securitization, internationally
1982 – International debt crisis: Banks lose enthusiasm for lending to developing countries.
1987 – Basel I Agreement sets standards for international banks (e.g., minimum capital requirements).1989 – Brady bonds securitize bad bank loans to developing countries.
1994 – Mexican peso crisis hits when foreign investors lose willingness to hold CETES & tesobonos.
1997 – Thai baht crisis also features a larger role for securities.
2007-08 – International securitization of US mortgages (“MBS”)ends in tears, with the sub-prime mortgage market crisis.
2011 – Basel III: AAA ratings for MBSs, ABSs or CDOs => 0 risk./
““Till debt do us Till debt do us part?part?””- PIIGS- PIIGS
Source: New York TimesEurope’s Web of Debt
The Great Depression and The Great Depression and the recent crisis in the recent crisis in
EuropeEuropeGreat Depression (1930s) Present crisis
Quarters of negative growth: 13-15.
Industrial output: -25 to -30%.
First year: - 8 %.GDP: -5% to -10%.GDP first year: -5%.World trade : -25%World trade first year: -7%.
Unemployment: 15-25%.
Quarters of negative growth: 3- 5.
Industrial output: -10 to -15 %.
First year:-10 to -15%.
GDP: -5%GDP first year: -5%.World trade: -38%.World trade first year:- 38%.
Unemployment: 8-12%
Policy responses in Policy responses in EuropeEurope
Great Depression (1930s) Present Crisis Banking crises not contained.
Money supply response limited by gold standard discipline until 1931 or later for gold bloc nations.
Initial budget deficits were met by attempts to restore budget balance through spending cuts or tax increases.
Discretionay spending and automatic stablizers: weak.
Increase in public debt: small
Banking crises contained by vigorous lender of last resort lending and nationalization of insolvent banks.
Strong automatic stablizers as well as increase in discretionary spending .
Budget deficits as a share of GDP: 5-12 % of which half discretionary.
Public debt/GDP increases by 10-30 percentage points.
References:
Madura, Jeff (2013). International Financial Management. CENGAGE Learning, 12e (Chapters 1, 3, and 19).