unit 9_exchange rate key

7/28/2019 Unit 9_Exchange Rate Key

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Unit

Exchange rates

Before you read

Discussion

1. If you keep a banknote in your pocket, you know that it will almost certainly be worth

less after a few months. If you deposit it in a bank, of course, it will be worth a little

more. Why?

2. If you change your bank notes into another currency, you will receive a certain amount of

notes and coins, but this amount can change every day, or more than once a dat. Why?

Reading 1

Exchange rates

The Bretton Woods agreement of 1944 established fixed exchange rates, defined in terms of gold

and the US dollar, i.e. their parities with the US dollar were fixed. In this period, a US dollar was

a promissory note issued by the United States Treasury. If anybody requested it, the Treasury

had to exchange the note for 1/35th of an ounce of gold. Under this system, overvalued or

undervalued currencies could only be adjusted with the agreement of the International MonetaryFund. Such adjustments are called devaluations and revaluations. The Bretton Woods system of

gold convertibility and pegging against the dollar was abandoned in 1971, because following

inflation, the Federal Reserve did not have enough gold to guarantee the American currency.

Gold convertibility was replaced by a system of floating exchange rates. ( Today, the US dollar-

the unofficial world currency- is merely a piece of paper on which is written In God We Trust.

God, not gold!) A freely (or clean) floating exchange rate is determined purely by supply and

demand. Theoretically, in the absence of speculation, exchange rates should reflect purchasing

power parity- the cost of a given selection of goods and services in different countries.

Proponents of floating exchange rates, such as Milton Friedman, argued that currencies wouldautomatically establish stable exchange rates which would reflect economic realities more

precisely than calculations by central bank officials. Yet they underestimated the impact of

speculation, and the fact that companies and investors frequently follow short-term money

market trends even if these are contrary to their own long-term interests.


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In the late 1970s and early 1980s, the American, British and other governments deregulated their

financial systems, and abolished all exchange controls. Residents in these countries are now able

to exchange any amount of their currency for any other convertible currency. This has led to the

current situation in which 95% of the worlds currency transactions are unrelated to transactions

in goods but are purely speculative. Enormous amounts of money move round the world, chasing

high interest rates or capital gains, as investors- including rich individuals, companies and

pension funds- seek to maximize the value of their assets. In London alone, in the late 1990s,

over $300 billion worth of currency was traded on an average day- the equivalent of about

30%of the value of the goods Britain produces each year. Banks, of course, make a profit from

the spread between a currencys buying and selling prices.

Few governments, however, leave exchange rates wholly at the mercy of market forces. Most of

them attempt to influence the level of their currency when necessary. Managed (or dirty) floating

exchange rate are more common than freely floating ones. For example, in the 1980s, most

Western European government joint the EMS ( European Monetary System) which established

parities between member currencies. There was also an Exchange Rate Mechanism (ERM): if the

rate diverged by more than plus or minus 2 per cent from the central parity, central banks had

to intervene in exchange market, buying and selling in order to increase or decrease the value of

their currency.

Yet international speculators can be more powerful than governments. For example, on a single

day in September 1992 the Bank of England lost five billion pounds in a hopeless attempt to

support the pound sterling. For weeks, all the worlds financial institutions and rich individuals

had been selling their pounds, as everyone except the British Government believed that the

pound had been seriously overvalued ever since it belatedly joined the ERM in 1990. When the

British central bank ran out of reserves and could no longer buy pounds, the currency was

withdrawn from the ERM and allowed to float, instantly losing about 15% of its value against

the D-mark. The next year, speculators attacked five other European currencies, and the

European Monetary System was suspended. It was later reintroduced in a looser form.

Many manufacturers are in favor of fixed exchange rates, or a single currency. Although it is

possible to some extent to hedge against currency fluctuations by way of futures contracts,

forward planning is difficult when the price of raw materials bought from abroad, or the price of

your products in export markets, can rise or fall by 50% in only a few months. (Since exchange

controls were abolished, currencies including the US$ and the sterling have in turn appreciated

by up to 100% and then depreciated by more than 50% against the currencies of major trading

partners).

Pressure from industrialists and government led to the introduction of the euro. Twelve countries

fixed their exchange rates against the new currency, and beginning in 1999 the new currency was

used as a mean of payment between companies and in foreign trade, and bonds were


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denominated in it. The euro came into existence as a real currency in 2002, when the old notes

and coins in the twelve member countries were withdrawn.

Reading comprehension tasks

Are the following statements TRUE or FALSE?

1. Gold convertibility was abandoned because there was too much gold.F

2. It is now impossible to exchange dollars for gold.F

3. Only a pegged currency can be devalued or revalued.T

4. A floating currency can either appreciate or be devalued.F

5. Central banks sometimes attempt to decrease the value of their currency.T

6. The EMS was designed to stabilize exchange rate.T

7. To speculate is to take risks; to hedge is to try to avoid risks.T

8. Under the system of floating exchange rates, currencies can depreciate 100% in a short

time.F

Reading 2

What is the gold standard?

What is gold, and why is it so important? Is it still the basis that our modern monetary systemrests on? First, a little history.

Gold is thought to be one of the first known metals. The word gold came from an old Englishword geolo, meaning yellow. The ancient Egyptians were very proficient goldsmiths hammering gold into leaf so thin that it took 367,000 leaves to make a one inch pile. Gold hasbeen a valuable metal throughout the ages because it is scarce. It is a beautiful metal that has alovely yellow color and a soft metallic glow. It is soft and easy to work with. It can be drawn intoa fine wire, and as the Egyptians discovered, hammered into thin leaf. It is very malleable and canbe easily shaped into various forms. It is highly resistant to rust and is corrosion-resistant.

Because of golds versatility, it can be used in many applications. One of its primary uses is asjewelry and adornment. In Mesopotamia (now Iraq) gold cups and jewelry have been excavatedthat date back to 3500 B.C. In the Egyptian tombs, jewelry and masks made of gold have beendiscovered. During the Middle Ages a science called alchemy evolved as a way to try toartificially create gold.

Worldwide, the gold rush led to the development of frontiers. The largest U.S. gold strikeoccurred in the 1900s near Carlin, Nevada. In 1965 an open-pit mine began operating there and


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the Carlin mine added about 10 percent to the annual gold production of the U.S. United Stateswasnt the only country to have gold rushes. In 1851 gold was discovered in Australia and thatrush saw the population of Australia triple in the following nine years. New Zealand experienceda gold rush in 1861 and their population also grew tremendously. Johannesburg in South Africa

was founded as a result of the 1886 gold rush. Canadas Yukon Territory was developed as resultof a gold rush that started in 1897. It appears that gold rushes played an important part indeveloping territories in many parts of the world.

Gold (AU is the chemical symbol) is also used today in many electrical components. But itsmost well-known use as money as a medium of exchange. Money used to actually be madeout of gold. Gold coins were traded for goods and services. In todays market, what place doesgold maintain?

The phrase gold standard is defined as the use of gold as the standard value for the money of acountry. If a country will redeem any of its money in gold it is said to be using the gold standard.

The U.S. and many other Western countries adhered to the gold standard during the early 1900s.Today, however, golds role in the worldwide monetary system is negligible. Britain abandonedthe gold standard 1931; the USA abandoned it 1971. Holdings of gold are still retained because itis an internationally recognized commodity, which cannot be legislated upon or manipulated byinterested countries. On August 15, 1971, the world entered the first era in its history in which nocirculating paper anywhere was redeemable in gold, by anyone. At one point in time it was illegalfor a U.S. citizen to own gold. President Richard Nixon of U.S. closed the gold window. Thisaction broke the last tie between gold and circulating currency, resulting in our modern financialsystem which is called a floating currency system.

Since 1976 gold the U.S. government no longer sets the gold value of a dollar. The price of gold

rises and falls in relation to the demand for the metal. Gold coins have not been minted as legalcurrency since 1933. In 1986 the U.S. Mint did begin to issue gold coins for collectors fourdenominations: $50, $20, $10, and $5. And there really is a Fort Knox! Since 1937 most of thenations gold has been stored there, underground.

Even though the worlds monetary systems are no longer based on the value of gold, people arestill intrigued and impressed with it. It is a valuable metal with many high-tech uses, and abeautiful metal that still adorns the artifacts of kings.

Reading comprehension tasks

1. Briefly describe the importance of gold and gold standard.

2. Under the gold standard, currencies were convertible into gold. This convertibility was

abolished for most currencies in early 1970s. Why?

Gold convertibility ended because the Federal Reserve no longer had enough gold to back to

dollar, due to inflation
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Exercises

Exercise 1: Vocabulary

A. Match up the half-sentences below

1. To peg a currency

against something

means to B

2. A clean floating

exchange rate D

3. Exchange controls used

to limit A

4. Speculators buy or sell

currencies in order to C

5. Market forces means F

6. Hedging means E

A the amount of a countrys money that residents were

able to change into foreign currencies

B fix its value in relation to it.

C make a profit by making capital gains or by investing

at higher interest rates

D is determined by supply and demand

E trying to insure against unfavorable price movements

by way of futures contract

F the determination of price by supply and demand ( the

quantity available and the quantity bought and sold).

B. Which six of these verbs are defined below?

Abolish adjust appreciate convert diverge establish fluctuate peg suspend

revalue

1 to make changes to something adjust

2 to change something into something else convert

3 to end something permanently Abolish

4 to end something temporarily suspend

5 to go up or down (in quantity, value, etc.) fluctuate

6 to move away from what is considered normal diverge

Exercise 2

Add appropriate words to these sentences:

1. Another verb for fixing exchange rates against something else is to

............peg...................... them.


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2. Increasing the value of an otherwise fixed exchange rate is called

............revaluation......................

3. Gold ..............convertibility.................... ended in the early 1970s.

4. The current system is one of .............floating..................... exchange rates.

5. A currency can appreciate if lots of ..............speculators.................... buy it.

6. In fact we have managed floating exchange rates, because governments and

...............central................... banks sometimes intervene on currency markets.

7. Bartering is based on the exchange of .............goods............... for goods.

8. The Bretton Woods Agreement stipulated that all members would express their

currencies in ............gold................

9. When central banks intervene in the foreign exchange markets at the intervention points,this is called the system of ...........foreign................. exchange rates. The opposite is

called the system of ............floating................ exchange rates.

10. If dealers buy currency forward but do not sell forward simultaneously, their position is

said to be ..............open..............

Exercise 3

There are some key dates in the development of exchange rate systems around the world (1994,

1971,1973,1992,2002). Match the dates with the events below:

1. Most industrialized countries switched to a system of floating rates. However,

governments and central banks occasionally attempted to influence exchange rates by

intervening in the markets. So there was a system of managed floating exchange rates. -

1973

2. The Bank of England lost over 5 billion in one day attempting to protect the value of the

pound sterling. After this, governments and central banks intervened much less, so there

was almost a freely floating system.- 1992

3. A fixed exchange rate system was started. The values of many major currencies werepegged to the value of the US dollar. The American central bank, the Federal Reserve,

guaranteed that it could exchange an ounce of gold for $35.- 1944

4. Twelve states of the European Union introduced a single currency, the euro, to replace

their national currencies.- 2002


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5. Gold convertibility ended because the Federal Reserve no longer had enough gold to

back to dollar, due to inflation.- 1971

unit 9_exchange rate key

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