International

Importance of Currency in Foreign Investment

• Currency conversion is crucial for foreign investments.

  • Example: A country like the United Kingdom wanting to invest in US real estate must exchange pounds for US dollars.

Role of Currency in Monetary Policy

• Currency impacts how central banks, like the Federal Reserve, manage monetary policy by adjusting interest rates.

Speculation and Hedging

• Currency markets allow for speculation on currency movements, enabling investors to bet on fluctuations due to factors like tariffs.

Types of Foreign Exchange Markets

• Spot Market

  • Immediate exchange of currencies at current market prices (spot rates).

  • Example: Visiting a bank or currency exchange booth to convert currency at the current rate.

• Forward Market

  • Agreements to exchange currencies at a predetermined future date, allowing for price certainty despite future market changes.

• Options Market

  • Provides the option, but not the obligation, to exchange currency at a set rate by a future date.

  • Contrasts with the forward market which requires action at the future date.

• Swap Market

  • Facilitate simultaneous borrowing and lending of currencies, important for central banks managing reserves.

Major Players in Forex Markets

• Central Banks and Government Treasuries

  • Manage national monetary policy and currency stability.

• Multinational Corporations

  • Companies like McDonald's use forex to hedge against currency risk in their global operations.

• Retail Investors

  • Individuals using platforms like Fidelity or E-Trade to invest in foreign currencies occasionally.

Concept of Global Reserve Currency

• Global Reserve Currency is an unofficial title generally held by the US dollar.

  • Reasons for Dollar’s Importance:

    • High level of trust in the US government and economy.

    • Security and demand for transactions internationally (83% of global debt in dollars).

    • Stability: US hasn't defaulted on its debt, maintaining confidence.

Gold Standard Historical Context

• The gold standard involved tying currency value to gold reserves (e.g., $100 in circulation had $100 worth of gold).

  • Pros: Prevents excessive debt and irresponsible money printing.

  • Cons: Limits government intervention during economic hardships (unable to respond to recessions).

Purchasing Power Parity (PPP)

• Theory stating that prices of identical goods should be equal when expressed in a common currency.

  • Real-world implementation is challenging due to market imperfections, transportation costs, and tariffs.

Balance of Payments

• Framework summarizing a country's economic transactions, consisting of:

  • Current Account: Trade balance (surplus or deficit based on imports and exports).

  • Capital Account: Accounts for foreign direct investments and financial transactions.

Relationship Between US Debt and Dollar Strength

• The relationship between national debt (e.g., $37 trillion) and interest rates influences the US dollar's value.

  • Increased debt leads to increased demand for borrowing, raising long-term interest rates, which can strengthen the dollar.

Currency Valuation and Interest Rates

• When US interest rates rise, the value of the dollar tends to increase (attracting more foreign investment).

  • A strong dollar can benefit consumers by making imports cheaper, but hurt exporters due to lower international competitiveness.

Effects of Tariffs on Currency Value

• Implementation of tariffs can have mixed effects on the dollar value:

  • Short-term: Might increase dollar value due to protective measures.

  • Medium/Long-term: Retaliation and economic consequences may lower demand for US goods, potentially weakening the dollar.

Floating vs Fixed Exchange Rates

• Floating Exchange Rate: Changes based on market forces without direct government intervention.

• Fixed Exchange Rate: Pegged to another currency or commodity, held constant to provide stability.

  • Example: Hong Kong Dollar pegged at a fixed rate against the US Dollar to prevent fluctuations.

Conclusion and Next Steps

• Key points for future study include:

  1. Understanding fixed vs floating exchange policies.

  2. Importance of trade relationships in currency valuation.

  3. The relationship between currency demand and pricing for goods.