INTERNATIONAL MONEY MARKET. Foreign Exchange Market Foreign exchange rate Balance of payments International money market

INTERNATIONAL MONEY MARKET Foreign Exchange Market Foreign exchange rate Balance of payments International money market Foreign Exchange Market  F...
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INTERNATIONAL MONEY MARKET Foreign Exchange Market Foreign exchange rate Balance of payments International money market

Foreign Exchange Market 

Foreign exchange market (or FX or FOREX market) exists wherever one currency is traded for another



FX market includes trading between    

 

large international banks (main participants) central banks, currency speculators, multinational corporations, governments and other institutions

Exchange Rate and Quotation 

Exchange rate (or foreign-exchange rate or FX rate)  



between two currencies specifies how much one currency is worth in terms of the other For example an exchange rate of 22,5 Czech Crown (CZK) to the United States dollar (USD, $) means that CZK 22,5 is worth the same as USD 1.

Exchange rate quotation 

is given by stating the number of units of a price currency that can be bought in terms of 1 unit currency  Direct quotation: which is ratio of 1 foreign exchange to appropriate amount of national currency, e.g. 1 USD = 22,5 CZK  Indirect quotation: as reverse ratio, e.g. 1 CZK = 0,044

Fluctuation in Exchange Rates 

Market based exchange rate will change whenever the values of either of the two component currencies change



Devaluation  is a reduction in the value of a currency with respect to other monetary units  currency will become less valuable whenever demand is less than available supply (this does not mean people no longer want money, it just means they prefer holding their wealth in some other form, possibly another currency)



Revaluation  means a rise of currency to the relation with a foreign currency  currency will tend to become more valuable whenever demand for it is greater than the available supply 

Example: exchange rate of USD and CZK:  October 2000 ... 1 USD = 41,8 CZK  October 2006 … 1 USD = 22,4 CZK

Factors Affection Exchange Rate 

Foreign trade  e.g. if export of Czech products to France increases, a demand for Czech Crowns increases as well, since Crown is needed to pay for Czech goods



Capital investments  in the form of investment purchases abroad



Changes in real interest rates  money invested in countries with high interest rates are called “hot money”



Inflationary depreciation  high inflation tends to deprecation and demand for foreign currencies increases

Purchasing Power Parity 

Purchasing power parity exchange rate 

equalizes the purchasing power of different currencies in their home countries for a given basket of goods



these special exchange rates are often used to compare the standards of living of two or more countries

Pja … price of j-th good in country A  Pjb … price of j-th good in country B  Qj … amount of j-th good in a market basket 

R

A p  j * Qj B p  j * Qj

Systems of exchange rates 





Fixed exchange rate  is a type of exchange rate regime wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold. Exists from first half of 1930s  [the People's Republic of China's fixed exchange rate with the US dollar until 2005 led to China's rapid accumulation of foreign reserves, placing an appreciating pressure on the Chinese yuan.] Free floating exchange rate  is a type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market. The rate results from demand and supply interaction without institutionary interventions. Managed floating exchange rate  the rate is formed by market interaction and also by interventions on foreign exchange markets. Those interventions are done through purchases and sales of foreign exchanges.

CNB intervention 2013 



The aim of using the exchange rate as an additional monetary policy instrument – and therefore of using foreign exchange interventions to weaken the koruna – is the same as in the case of interest rates. In line with the CNB’s statutory mandate, the objective is to maintain price stability in the Czech economy, which is expressed by the CNB’s inflation target of 2%. In other words, the aim is to prevent deflation, to ensure that the 2% inflation target is achieved in a sustainable manner and to accelerate the return to a situation where the CNB will again be able to use its standard tool, i.e. interest rates. The CNB Bank Board decided to use the exchange rate as a monetary policy instrument, and therefore to commence foreign exchange interventions, on 7 November 2013.

Concert about deflation Automatic & unlimited interventions Increase import prices Support of Czech export

recovery in production

ensure that the 2% inflation target is achieved in a sustainable manner

Selling koruna and buying foreign currencies Boost domestic economic activity, reduce households’ purchasing power > households’ demand may be redirected towards domestic goods and services profitability of corporations and their willingness to invest

contributes to a rise in employment and wages, which increases the purchasing power of households

CNB intervention 2013 



CNB will not allow the koruna to appreciate to levels it would no longer be possible to interpret as “close to CZK 27/EUR”. The CNB prevents such appreciation by means of automatic and potentially unlimited interventions, i.e. by selling koruna and buying foreign currency. If the exchange rate departs from CZK 27/EUR on the weaker side, the CNB allows the koruna exchange rate to move according to supply and demand on the foreign exchange market. A weakening of the exchange rate of the koruna leads to an increase in import prices and thus also in the domestic price level. To a lesser extent, it also boosts domestic economic activity. The rise in import prices can be expected to reduce households’ purchasing power, but households’ demand may be redirected towards domestic goods and services to a greater extent and additionally supported by lower real interest rates as a result of higher inflation expectations. At the same time, the weaker exchange rate supports Czech exports and the profitability of corporations and their willingness to invest. The recovery in production then contributes to a rise in employment and wages, which increases the purchasing power of households.

Balance of Payments 

Balance of payments (or BOP) 

measures the payments that flow between any individual country and all other countries



it is used to summarize all international economic transactions for that country during a specific time period, usually a year.



BOP is determined by the country's exports and imports of goods, services, and financial capital, as well as financial transfers.



it reflects all payments and liabilities to foreigners (debits) and all payments and obligations received from foreigners (credits). BOP has three parts:   

current account balance (C/A), capital account balance (K/A), official transaction account (change in foreign exchange reserves) (OT/A)

Current Account Balance 

The balance of trade is a statement of export and import of a country over some period, usually a year



Therefore, it’s balance of export and import, the difference is called net export.

1993

v mld. Kč

13,3



Ex – Im > 0 …… balance is in surplus



Ex – Im < 0 …… balance is in deficit



Ex – Im = 0 …… balance is in equilibrium

1994

-22,6

1995

-36,3

1996

1997

-111,9

-113,0

1998

-40,5

1999

-50,6

2000

2001

2002

2003

2004

-104,9

-124,5

-136,4

-160,6

-147,5

2005

-39,8

2006

-77,2

2007

-113,1

2008

-22,9

2009

2010

-114,8

-139,2

Capital Account Balance

mld. Kč



Net change in foreign ownership of domestic assets



If foreign ownership of domestic assets has increased more quickly than domestic ownership of foreign assets in given year capital account surplus



If domestic ownership of foreign assets has increased more quickly than foreign ownership of domestic assets in given year capital account deficit

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

88,2

97,0

218,3

113,6

34,3

94,3

106,6

148,0

172,8

347,8

157,1

177,3

154,8

92,4

125,8

59,0

154,2

182,1



Official Transaction Account: 

1993 v mld. Kč

-88,3

Gold reserves, IMF Special Drawing Rights, foreign exchange reserves

1994 -68,3

1995 -197,9

1996 22,5

1997 56,0

1998 -62,6

1999 -57,1

2000 -31,6

2001 -67,2

2002 -216,9

2003 -12,9

2004 -6,8

2005 -92,9

2006 -2,1

2007 -15,7

2008 -40,1

2009 -60,6

2010 -41,4

International Monetary System 

International monetary system  



is represented by system of standards and institutions that form monetary relations development in its international scale system existing after WWII up to beginning of 1970s is called Bretton Woods system after the conference held in Bretton Woods.

Bretton Woods Conference  

was held from 1 July to 22 July 1944 agreements were signed to set up the International Bank for Reconstruction and Development, the General Agreement on Tariffs and Trade (GATT), and the International Monetary Fund (IMF)  conference also proposed the creation of an International Trade Organization (ITO) to establish rules and regulations for international trade.

International Monetary Fund 

International Monetary Fund 

is an international organization that oversees the global financial system by observing exchange rates and balance of payments, as well as offering financial and technical assistance when requested. Its headquarters are located in Washington, D.C.



In order to make responsible decisions about financial aid fund needs relevant economic data on the country to help (mainly about foreign trade and assets reserves).



In 1953 Czechoslovakia refused to provide those information and was asked to leave IMF. In 1990 Czechoslovakia has been accepted back into IMF.

International Bank for Reconstruction and Development 

International Bank for Reconstruction and Development (or World Bank) 

is an international organization whose original mission was to finance the reconstruction of nations devastated by WWII.



The IBRD provides loans to governments, and public enterprises, always with a government (or "sovereign") guarantee of repayment.



The funds for this lending come primarily from the issuing of World Bank bonds on the global capital markets - typically $12-15 billion per year.



These bonds are rated AAA (the highest possible) because they are backed by member states' share capital, as well as by borrowers' sovereign guarantees. Because of the IBRD's credit rating, it is able to borrow at relatively low interest rates.

EURO 

Eurozone







Precedessor of Euro: ECU (European currency unit) till 1998

Use of EURO outside EU 

With formal agreements:  Monaco, San Marino, Vatican City, Saint Pierre and Miquelon, Mayotte, Akrotiri and Dhekelia



Those countries outside the EU have adopted the euro as their currency. For formal adoption, including the right to mint their own coins, a monetary agreement must be concluded. Monaco, San Marino and Vatican City previously used versions of yielded member state currencies (Italian lira and Monegasque Franc pegged to the French Franc). Agreements were also concluded for two overseas territories of France. They are outside the EU but have been allowed to use the euro as their currency. However, they are not allowed to mint any coins.





Use of EURO outside EU 

Without formal agreements:  Andorra, Kosovo, Montenegro, Saint Barthélemy, Saint Martin 

Andorra: Does not have an official currency and hence no specific euro coins. It previously used the French franc and Spanish peseta as de facto legal tender currency. There has never been a monetary arrangement with either Spain or France; however, the EU and Andorra are currently in negotiations regarding the official status of the euro in Andorra.



Montenegro and Kosovo: have also used the euro since its launch, as they previously used the German mark rather than the Serbian dinar. This was due to political concerns that Serbia would use the currency to destabilise these provinces (Montenegro was then in a union with Serbia) so they received western help in adopting and using the mark (though there was no restriction on the use of the dinar or any other currency).

Maastricht criteria 

mainly 

budget deficit of less than 3 % of their GDP



debt ratio of less than 60 %of GDP



low inflation,



interest rates close to the EU average.

EURO 

Introduced in 1999



Physical coins and banknotes in 2002



Eventual use of Euro is mandatory for all new EU members



Managed and administrated by  European Central Bank (ECB) and  European System of Central Banks (ESCB)



ECB has sole authority to set monetary policy

Pegged Currencies  



a total of 23 countries and territories that do not belong to the EU have currencies that are directly pegged to the euro In Europe:  Bosnia and Hercegovina,  Bulgaria  Denmark  Macedonia Outside Europe:  Morocco, Cape Verde, African currency unions, …