W3 - Lecture prep
November 24, 2022 1:31 PM
Title: The internationalization of currencies
Intro video
• This week reflect upon:
WR the key • why some currencies are internationally accepted as payments, but some others
reflections of this aren't
week?
• Exchange rate: price at which currencies are accepted
WI money? • Money: ultimate means of settlements (what you need to make payments, liquidity)
WI the survival • Survival constraint: you need to make payments when they come due. Everyone needs
constraint? to have liquidity to pay their way.
• Central in both papers of this week.
WD the survival • Angrick claims that satisfying the survival constraint means that economies need to
constraint mean for
economies? adapt their economic structures
• Export orientation: to pay your way in the world you need dollars. To get the
WI the idea behind dollars you need a strong export sector
export orientation?
○ Export oriented model has become a standard development model for
H popular is this? many developing economies
○ This model hinders the capacity of emerging countries (esp. China) to
WI its limitation?
internationalize their currencies (get it accepted by others as payments)
▪ Network effects:
WR the 2 main reasons □ By receiving USD as payment for one exports, the USD
why the export-led
model D hinders the becomes more important in the int'l payment system
local currency's □ Many export oriented economies (e.g.: East Asian economies)
int'lization? have interwoven their economies in a 'Flying geese
development models' to trigger structural change
• Flying geese development model reinforces dependence
on the USD
▪ Providing liquidity is key: If a country wants its money to be
accepted as payment in the rest of the world, it must import (rather
than export)
□ Implication: for CN's renminbi to circulate in the rest of the
world, it needs:
to rebalance its current accounts and import more
(boost domestic consumption and domestic investment
and decrease exports).
To develop its financial markets so that their currency
can be held as a foreign investment
WR the implications • Constraints imposed on the US economy by being the supplier of the world's
for the US of being
the center country? money
○ Partly explains US BoP deficit and growing debt (public and private)
○ Attempts to reduce CA deficit might strengthen some US sectors at the
expense of weakening the int'l role of the USD
WD Mehrling's article • Mehrling's article discusses why some currencies are important internationally and
focus on?
others are not, based on the money view
WI the money view • Money view perspective of forex: currencies are liquidity instruments
perspective on money? • USD is the top currency in the world: importers and exporters need to exchange
YR forex traders their respective currencies from/into dollars
needed? ○ These transactions have foreign exchange (forex) traders as counterparties
○ Forex as a hybrid market:
YI the forex market a □ Forex market is a hybrid market because the price of currencies (XR)
Global Finance and Growth Page 30
,YI the forex market a □ Forex market is a hybrid market because the price of currencies (XR)
hybrid one? is determined in two ways:
*WR the 2 ways in
Organically: in these trades (supply and demand)
which the price of XR Agent: private forex traders
is determined? ◊ Face survival constraint: must have enough USD to
**WI the survival pay int'l bills.
constraint faced by They have liquidity risk
private forex – e.g.: In deficit countries, they provide
traders?
USD to importers and accept local
**W type of risk do currency. The more local currency
they run? they hold (the least USD), the more
risk they will run of not being able to
meet international payments (survival
constraint)
**HD this risk To compensate for said risk, they charge a
translate into 'price risk premium
distortions'? – The money markets partly explains
exchange rates, aside from the goods
market (demand for currency due to
imports and exports)
Exchange rates originate in
money markets and goods
markets.
◊ Private forex traders hedge their exchange risk by
buying dollar forwards from speculative dealers
**HD the private Shown in balance sheets in the paper
dealer hedge against
exchange/currency Speculative dealers bear said exchange risk:
risk? they need to make a profit that compensate
**Who bears said
it
exchange risk? – To compensate for the risk, they
would demand a lower price for local
**WI the implication
of this? currency in their forwards to make a
profit
The more local currency they
**HD the forward promise to buy via forwards (to
price change when pay for larger trade imbalances),
more risk is taken? the lower the price they will be
willing to pay for it given the
increased liquidity risk
Forward price of local
currency falls relative to
forward price of USD
**WI the conclusion XR is changing!
of this?
Artificially: government interventions to influence XRs
◊ Agent: CBs acting as public forex traders
□ Essential hybridity: It is not hybrid by accident but by design
Can markets function Market needs both public and private traders to function
without both players? □ Mehrling illustrates this hybrid market with the Treynor diagram:
Axes:
Treynor's diagram? ◊ X axis: volume of the traders' local currency inventory
*WI plotted on the X ◊ Y axis: price of local currency
axis? And Y axis?
Slope falling: more inventories of local currency translate into
lower prices
*YI the slope Expected profit: difference between a given point on the slope
falling?
and the expected spot rate at the time the forward contract is
*WI the speculative executed
dealer's expected Role of gov't: CB intervenes at the bounds at which the private
profit?
forex traders function (risk is too high)
Global Finance and Growth Page 31
, forex traders function (risk is too high)
*WI the gov't's role? ◊ At some point (bottom right corner) private traders
would not accept more local currency because the
*Y would the market liquidity risk is too large for them to bear.
break? ◊ If gov't did not intervene, the XR would plunge
◊ The gov't avoids this by stepping in: here they
start buying up local currency and providing USD
This requires cooperation between deficit
(local) country's CB and surplus (foreign)
WI required for the country's CB, which provides USD to them.
deficit CB to
intervene?
Summary:
Global Finance and Growth Page 32
November 24, 2022 1:31 PM
Title: The internationalization of currencies
Intro video
• This week reflect upon:
WR the key • why some currencies are internationally accepted as payments, but some others
reflections of this aren't
week?
• Exchange rate: price at which currencies are accepted
WI money? • Money: ultimate means of settlements (what you need to make payments, liquidity)
WI the survival • Survival constraint: you need to make payments when they come due. Everyone needs
constraint? to have liquidity to pay their way.
• Central in both papers of this week.
WD the survival • Angrick claims that satisfying the survival constraint means that economies need to
constraint mean for
economies? adapt their economic structures
• Export orientation: to pay your way in the world you need dollars. To get the
WI the idea behind dollars you need a strong export sector
export orientation?
○ Export oriented model has become a standard development model for
H popular is this? many developing economies
○ This model hinders the capacity of emerging countries (esp. China) to
WI its limitation?
internationalize their currencies (get it accepted by others as payments)
▪ Network effects:
WR the 2 main reasons □ By receiving USD as payment for one exports, the USD
why the export-led
model D hinders the becomes more important in the int'l payment system
local currency's □ Many export oriented economies (e.g.: East Asian economies)
int'lization? have interwoven their economies in a 'Flying geese
development models' to trigger structural change
• Flying geese development model reinforces dependence
on the USD
▪ Providing liquidity is key: If a country wants its money to be
accepted as payment in the rest of the world, it must import (rather
than export)
□ Implication: for CN's renminbi to circulate in the rest of the
world, it needs:
to rebalance its current accounts and import more
(boost domestic consumption and domestic investment
and decrease exports).
To develop its financial markets so that their currency
can be held as a foreign investment
WR the implications • Constraints imposed on the US economy by being the supplier of the world's
for the US of being
the center country? money
○ Partly explains US BoP deficit and growing debt (public and private)
○ Attempts to reduce CA deficit might strengthen some US sectors at the
expense of weakening the int'l role of the USD
WD Mehrling's article • Mehrling's article discusses why some currencies are important internationally and
focus on?
others are not, based on the money view
WI the money view • Money view perspective of forex: currencies are liquidity instruments
perspective on money? • USD is the top currency in the world: importers and exporters need to exchange
YR forex traders their respective currencies from/into dollars
needed? ○ These transactions have foreign exchange (forex) traders as counterparties
○ Forex as a hybrid market:
YI the forex market a □ Forex market is a hybrid market because the price of currencies (XR)
Global Finance and Growth Page 30
,YI the forex market a □ Forex market is a hybrid market because the price of currencies (XR)
hybrid one? is determined in two ways:
*WR the 2 ways in
Organically: in these trades (supply and demand)
which the price of XR Agent: private forex traders
is determined? ◊ Face survival constraint: must have enough USD to
**WI the survival pay int'l bills.
constraint faced by They have liquidity risk
private forex – e.g.: In deficit countries, they provide
traders?
USD to importers and accept local
**W type of risk do currency. The more local currency
they run? they hold (the least USD), the more
risk they will run of not being able to
meet international payments (survival
constraint)
**HD this risk To compensate for said risk, they charge a
translate into 'price risk premium
distortions'? – The money markets partly explains
exchange rates, aside from the goods
market (demand for currency due to
imports and exports)
Exchange rates originate in
money markets and goods
markets.
◊ Private forex traders hedge their exchange risk by
buying dollar forwards from speculative dealers
**HD the private Shown in balance sheets in the paper
dealer hedge against
exchange/currency Speculative dealers bear said exchange risk:
risk? they need to make a profit that compensate
**Who bears said
it
exchange risk? – To compensate for the risk, they
would demand a lower price for local
**WI the implication
of this? currency in their forwards to make a
profit
The more local currency they
**HD the forward promise to buy via forwards (to
price change when pay for larger trade imbalances),
more risk is taken? the lower the price they will be
willing to pay for it given the
increased liquidity risk
Forward price of local
currency falls relative to
forward price of USD
**WI the conclusion XR is changing!
of this?
Artificially: government interventions to influence XRs
◊ Agent: CBs acting as public forex traders
□ Essential hybridity: It is not hybrid by accident but by design
Can markets function Market needs both public and private traders to function
without both players? □ Mehrling illustrates this hybrid market with the Treynor diagram:
Axes:
Treynor's diagram? ◊ X axis: volume of the traders' local currency inventory
*WI plotted on the X ◊ Y axis: price of local currency
axis? And Y axis?
Slope falling: more inventories of local currency translate into
lower prices
*YI the slope Expected profit: difference between a given point on the slope
falling?
and the expected spot rate at the time the forward contract is
*WI the speculative executed
dealer's expected Role of gov't: CB intervenes at the bounds at which the private
profit?
forex traders function (risk is too high)
Global Finance and Growth Page 31
, forex traders function (risk is too high)
*WI the gov't's role? ◊ At some point (bottom right corner) private traders
would not accept more local currency because the
*Y would the market liquidity risk is too large for them to bear.
break? ◊ If gov't did not intervene, the XR would plunge
◊ The gov't avoids this by stepping in: here they
start buying up local currency and providing USD
This requires cooperation between deficit
(local) country's CB and surplus (foreign)
WI required for the country's CB, which provides USD to them.
deficit CB to
intervene?
Summary:
Global Finance and Growth Page 32
