International Finance & Exchange Rates — Quick Review

International business adds complexity due to currency fluctuations and policy actions by governments.
Governments can influence exchange rates and financial conditions; policy shifts can alter trade dynamics.

Gold standard: currency value tied to gold; limited inflation but inflexibility during shocks. Allegory: moving from gold to silver to fiat; gold scarcity can drive currency value up while prices fall for borrowers.
Fiat currency: currency with value because the government says so; has no intrinsic value but is accepted for transactions.
Bretton Woods 1945–1971: fixed-but-adjustable system; currencies pegged to the USD, USD backed by gold; IMF and SDR created to support cooperation.
End of Bretton Woods (1971): shift to floating exchange rates; currencies determined by market forces.
Triffin paradox: as the reserve-currency issuer, a country’s deficits may undermine confidence in its currency over time.

No separate legal tender (currency boards/arrangements): use another country’s currency; example: Ecuador uses USD; minimal local currency management.
Currency board arrangements: hold foreign reserves to back domestic currency; aim to stabilize value (e.g., Hong Kong, Bosnia).
Conventional fixed peg arrangement: fixed par value with small allowable fluctuations.
Stabilized arrangement: minor fluctuations around a target rate.
Crawling peg: gradual, periodic adjustments to align with inflation/differences.
Peg within horizontal bands: rates allowed to move within a defined band around a central value (wider bands than fixed pegs).
Free-floating: supply and demand determine value with wide fluctuations.
China example: moved from a fixed peg to a crawl-like arrangement; previously pegged below the USD to keep price advantages. Current rule: rate stays within a ±2% band around a trend for six months.

Value of a currency is driven by supply and demand for that currency in foreign exchange markets.
Cross-border shopping and travel affect demand for currencies; e.g., Canada: more demand for CAD when buying Canadian goods, CAD appreciates; reduced demand leads to depreciation.
Policy actions (e.g., tariffs, monetary expansion) can shift demand/supply and thus the exchange rate.

USD as the world’s primary reserve currency; central banks hold USD reserves; over time this can create Triffin-like pressures if deficits grow.
IMF Special Drawing Rights (SDRs): a notional unit of account to supplement reserves.
Currency manipulation concerns: pegged or semi-pegged regimes can be used to gain trade advantages; e.g., China’s past peg to USD led to persistent price advantages for its exports.
Country examples show both benefits and risks of pegs: stability vs. vulnerability during shocks (e.g., Greece’s euro integration, Mexico in the 1990s, etc.).

Fiat currency dominates; commodity money (gold) largely obsolete in modern systems.
Stablecoins: pegged to a fiat currency or commodity to reduce volatility.
CBDCs: digital form of a nation’s official currency; governments debate adoption; current stance varies by leader/administration.
Note: discussions about stablecoins and CBDCs are evolving; stay aware of policy shifts and their potential impact on cross-border trade.

Floating vs fixed pegs: floating exchange rates move with supply and demand; pegs provide stability but can be destabilizing if the anchor is under stress.
Gold standard vs fiat: gold limits inflation but reduces flexibility; fiat allows flexible monetary policy.
Bretton Woods gave the USD a central role and created SDRs; crisis led to a move to floating rates.
The Triffin paradox highlights tension between a reserve-currency role and sustainable external finances.
Currency manipulation and reserve-currency dynamics matter for trade balances and geopolitical relations.
Digital money (stablecoins, CBDCs) may reshape international payments but depend on policy and adoption.

Fixed peg, conventional fixed peg, crawling peg, pegged within bands, free floating, currency board, SDR, fiat currency, intrinsic value, Triffin paradox, stablecoins, CBDC