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)

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

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.

Gresham’s Law implied that it would be the least valuable metal that would tend to circulate.

Gresham’s 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).

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 country’s currencies would be determined by their relative gold contents.

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

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.

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…

Cumulative consumer price index

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.

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.

Bretton Woods System: 1945-1972

German mark British

pound French

franc

U.S. dollar

Gold

Pegged at $35/oz.

Par Value

Par Value

Par

Value

page 1-13

2. Exchange Rates since 1973

50

100

150

200

250

300

350

400

450

Jan-7

1

Ju

l-72

Jan-7

4

Ju

l-75

Jan-7

7

Ju

l-78

Jan-8

0

Ju

l-81

Jan-8

3

Ju

l-84

Jan-8

6

Ju

l-87

Jan-8

9

Ju

l-90

Jan-9

2

Ju

l-93

Jan-9

5

Ju

l-96

Jan-9

8

Ju

l-99

Jan-0

1

Ju

l-02

Jan-0

4

Ju

l-05

Jan-0

7

Ju

l-08

DEM (EUR) JPY GBP

page 1-14

Exchange Rate Classifications

( Source: Stanley Fisher, “Mundell-Fleming Lecture …”, IMF conference 2007 )

15

Example of a Crawling Peg

Bekaert and Hodrick 2008

Bekaert and Hodrick 2008

16

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

page 1-17

page 1-18

page 1-19

page 1-20

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.

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)

Guessing Game and Group Formation

Which exchange rate series’ are Indonesia’s, Argentina’s, Canada’s & Brazil’s?

We use the exchange rate definition of the price of foreign currency in dollars: S($/FC) Analogous to price of shoes: P($/shoe)

• Indonesia, Argentina, Canada & Brazil

Measuring Exchange Rate Movements

A decline in a currency’s value is referred to as depreciation, while an increase is referred to as appreciation.

% D in foreign currency value = (S - St-1) / St-1

A positive % D represents appreciation of the foreign currency, while a negative % D represents depreciation.

Which currency?

Our email

Professor David Ng

(davidng@wharton.upenn.edu)

Teaching Assistants:

Jennifer Grossman: jennifrg@wharton.upenn.edu

Florian Hagenbuch: hflorian@wharton.upenn.edu 

Qi Liu:  qiliu@wharton.upenn.edu

Administrative Details

No class next Monday (Martin Luther King day observed in Penn)

Textbooks Eun and Resnick Office Hours Webcafe under FNCE 219 Groups

A bit about myself...

My Background

My Research Interest

.