Exchange Rates and International Financial Markets

When firms engage in cross-border economic activities such as trade or investment, they encounter the need to deal with foreign currencies and exchange rates. An exchange rate represents the price of one country's currency in terms of another.

Example: Russian-Chinese Business Negotiations

A Russian company purchasing stainless steel flasks from Chinese factories highlights the importance of exchange rates. Price negotiations are influenced by currency values.

Scenario: A Russian company negotiates the price of stainless steel flasks with a Chinese factory.
Issue: The Russian Ruble's value depreciation against the US dollar affects the affordability of the flasks.
Negotiation Point: The Russian company argues they cannot afford $3 USD for a 0.5-liter flask due to the Ruble's decline.

International Financial Markets

International financial markets exist because various entities (businesses, individuals, companies, and governments) need to buy and sell foreign currencies. These markets provide the mechanisms for conducting transactions in different currencies.

International Monetary System

The International Monetary System governs international financial markets. Today's system is an institutional arrangement among central banks of countries belonging to the International Monetary Fund (IMF).

Current System: Known as the post-Bretton Woods system.
Bretton Woods System (1944): The US dollar was the common denominator for other currencies.
- The USA had the most productive economy and favorable currency after World War II.
- Over time, Europe and Asia caught up, necessitating a new order.
Post-Bretton Woods System (Introduced in 1973):
- Built around floating exchange rates between major currencies (dollar, euro, yen).
- Various exchange rate regimes.

The Role of the US Dollar

Despite losing its position as the common denominator, the US dollar remains a key currency and plays a leading role in financial markets. This explains why the US dollar was relevant in the flask negotiations between the Russian and Chinese businesses.