Index IntroductionManaged floatUnsterilized interventionSterilized interventionEvolution of the international financial systemIntroductionThe Gold Standard period (1880 - 1914)Bretton Woods system (1945 - 1971)International Monetary Fund (IMF)Reserve currencyReserve management Asian Balance of Payments Introduction Balance of Payments Current Account Capital Account Official Reserve Account Trade Imbalances Impact of Reserve Accumulation Introduction Increase in Foreign Exchange Reserves Growth Balance of Payments Exchange Rates Money Supply Capital Control Conclusion Introduction By studying the financial crises that have taken place since 1997 in Asia, Russia and South America, one can find that in many cases short-term debt The crisis has been worsened by the dumping of stocks, bonds and currencies. Countries with pegged exchange rate systems were the first to be hit hard. Say no to plagiarism. Get a tailor-made essay on "Why Violent Video Games Shouldn't Be Banned"? Get an original essayIndeed, the collapse of the Thai baht in July 1997 was followed by an unprecedented financial crisis in East Asia. The Thai government set the exchange rate of the Thai baht against the US dollar at the level of 24.70 baht to one dollar and this rate has been fixed, not allowing it to fluctuate for the past 14 years (FRBSF Economic Letter August 7, 1998). As everyone knows, Southeast Asian countries operate a fixed exchange rate system linked to US dollars. To prevent the occurrence of a similar financial crisis in Southeast Asia, Asian central banks have accumulated their US dollar reserves. See below: According to the Asian Reserves article (The Economist of 08/02/2003), it is clearly stated that "Governments see their huge reserves as insurance against the vicious oscillations of a globalized economy and against any future crisis of such magnitude as 1997-98."Today's international monetary system is described as a managed float. (Arnold 1998, p. 766) the definition of a managed float is "a system of flexible, managed exchange rates, under which nations intervene from time to time to adjust their official reserves to moderate major fluctuations in exchange rates change". In other words, central banks engage in foreign exchange interventions to influence their countries' exchange rates by buying and selling currencies. (Misbkin 1997, p.502) describes "the intervention of the central bank in the foreign exchange market influences exchange rates is to see the impact on the monetary base resulting from the sale by the central bank on the foreign exchange market of some of its holdings of assets denominated in foreign currency called international reserves. For example: the purchase of domestic currency by a central bank and the corresponding sale of foreign assets in the foreign exchange market leads to an equal decline in its international reserves and monetary base. While the sale of domestic currency by a central bank to purchase foreign assets in the foreign exchange market results in an equal increase in its international reserves and monetary base. Unsterilized intervention The central bank allows the purchase or sale of currency national currency to have an effect on the monetary base as already mentioned, we are talking about unsterilized exchange rate interventions An unsterilized intervention in which the national currency is sold to purchase foreign assets leads to a gain in international reserves, to an increase in supply. of money and a depreciation of the domestic currency. In contrast, an unsterilized intervention in which the domestic currency is purchased by selling foreign assets leads to a decline in reservesinternational markets, a decrease in the money supply and an appreciation of the domestic currency (Misbkin 1997). Exchange intervention with an open market clearing operation that leaves the monetary base unchanged is called sterilized exchange intervention. A sterilized intervention leaves the money supply unchanged and so on has no way of directly influencing interest rates or the expected future exchange rate. Since the expected return schedules remain at RETD1 and RETF1 in the figure below, and the exchange rate remains unchanged at E1 (Misbkin 1997, pg. 505 - 507). Evolution of the international financial system Introduction Before examining the impact of international financial transactions on monetary policy, we must understand the past and current structure of the international financial system. The Gold Standard Period (1880 – 1914) (Salvatore 1998, p.678) described “the gold standard operated from about 1880 until the outbreak of World War I in 1914.” The world economy operated on the gold standard, meaning that the currency of most countries was directly convertible into gold. Tying currencies to gold led to the creation of an international financial system with fixed exchange rates between currencies. Fixed exchange rates under the gold standard had the important advantage of encouraging world trade by eliminating the uncertainty that occurs when exchange rates fluctuate. Bretton Woods System (1945 - 1971) World War I caused massive disruptions to trade. Countries could no longer convert their currencies into gold and the gold standard collapsed. (Misbkin 1997, p.512) said that "as Allied victory in World War II was becoming certain in 1944, the Allies met at Bretton Woods, New Hampshire, to develop a new international monetary system to promote world trade and prosperity after the war" In the agreement made between the Allies, central banks bought and sold their own currencies to keep exchange rates fixed at a certain level called the fixed exchange rate regime. The agreement lasted from 1945 to 1971 and was known as Bretton Woods. “The Bretton Woods system collapsed in 1971. We now have an international financial system that has elements of managed floating and a system of fixed exchange rates. The International Monetary Fund (IMF) (Salvatore 1998, p.682) has also described "The system devised at Bretton Woods called for the establishment of the International Monetary Fund (IMF) to (1) ensure that nations follow an agreed set of rules of conduct in international trade and finance and (2) provide loan facilities to nations experiencing temporary balance of payments difficulties." Reserve currency As the United States emerged from World War II as the world's largest economic power, with more than half the world's manufacturing capacity and most of the world's gold , the Bretton Woods system of fixed exchange rates was based on the convertibility of the U.S. dollar into gold. Fixed exchange rates were to be maintained through intervention in the foreign exchange market by purchasing central banks of countries other than the United States. and sold dollar assets, which they held as international reserves. The US dollar, used by other countries to denominate the assets they held as international reserves, was called a reserve currency (Misbkin 1997). Nowadays, the US dollar still plays the dominant role as a reserve currency as a result of the largest consumer market in the United States. There are no other alternatives that can replace the US dollar at this time. However, this may happen in the future. Management of Asian Reserves Secondarticle in A Golden Moment for Asian Reserve Management (DSG Asia 02/10/2003), Asian central banks have not diversified their foreign exchange reserves much. As can be seen from Appendix I, Table 1, the share of the dollar in the currency composition of global foreign exchange reserves has remained almost unchanged since 1999. According to the article on Asian reserves (The Economist of 02/08/2003), it is he also described "the policy risk of high reserves is a sharp decline in the dollar. Most Asian central bankers still won't hear about it." fixed exchange rate regime. Central banks could intervene in the foreign exchange market by buying and selling their own currencies to keep exchange rates fixed at a certain level. For example: when the national currency is overvalued, the central bank has to buy national currency to keep the exchange rate fixed, but as a result it loses international reserves. In contrast, when the domestic currency is undervalued, the central bank must sell domestic currency to keep the exchange rate fixed, but as a result it gains international reserves. Refer to the figure in chapter 1.4. Under the Bretton Woods system, Asia's high foreign exchange reserve can keep their currencies supported by the fixed exchange rate regime, the strong reserve as insurance for the government against any future financial crisis. On the other hand, in a closed economy, bad debts caused by risky loans may not lead to a run on depositors because depositors know that the government can provide sufficient liquidity to financial institutions to avoid any losses to depositors. In an open economy, the same injection of liquidity can destabilize the exchange rate. Consequently, during times of uncertainty, runs or speculative attacks on a currency can only be avoided if domestic asset holders have confidence that the government can meet demand for foreign currency (FRBSF Economic Letter August 7, 1998). International reserves help it maintain the foreign confidence needed to attract foreign direct investment and secure foreign loans on good terms. However, as mentioned above, Asian central banks have not diversified their foreign exchange reserves much, the US dollar still holds a significant part of them. The big risk to the high reserve policy is a sharp decline in the dollar. Balance of Payments Introduction According to the Asian reserves article (The economist 02/08/2003), a growing body of opinion is starting to question the high foreign exchange reserves of Asia. Increasingly they are seen less as a symbol of virility than as some kind of hidden tax – a cost of the region's unbalanced model of export-led growth and a vulnerable financial sector. These are the reasons behind the accumulation of reserves. Balance of Payments Countries track their level of national production by calculating their gross domestic product (GDP); similarly, they track the flow of their international trade (income and expenditure) by calculating the balance of payments. (Misbkin 1997, p. 507 - 508) defines balance of payments as "an accounting system for recording all payments that have taken place". a direct impact on the movement of funds between a nation (private sector and government) and foreign countries." The balance of payments provides information on a nation's imports and exports, earnings of national residents on assets located abroad, foreign earnings on domestic assets, on donations to and from foreign countries (including foreign aid), and on official government and central bank transactions (Arnold 1998).both debits and credits. A debit is indicated by a minus sign (-), while a credit is indicated by a plus sign (+). Any transaction that supplies the country's currency on the foreign exchange market is recorded as debt. Any transaction that creates demand for the country's currency in the foreign exchange market is recorded as a credit (Arnold 1998). See Appendix I Schedule 1 for a summary of debits and credits. The international transactions summarized in the balance of payments can be grouped into three accounts: the current account, the capital account and the official reserve account. See Appendix I Schedule 2 for the United States balance of payments, 1999. Current account (Arnold 1998, p. 744) describes the current account "includes all payments related to the purchase and sale of goods and services. The components of the account include exports, imports, and net unilateral transfers abroad." The current account balance is the summary statistic of these three elements. Exports of goods and services are referred to as goods exported by Americans.and services, and they receive investment income on goods they own abroad, which leads to the increase in demand for US dollars at the same time as they increase the supply of foreign currencies, so they are recorded as credits (+). Imports of goods and services refers to the fact that Americans import goods and services and foreigners receive income on the goods they own in the United States, which leads to the increase in demand for foreign currencies at the same time as they increase the supply of US dollars in the foreign exchange market, so they are recorded as debts (-). Balance of trade in goods = exports of goods - imports of goods Trade deficit in goods: exports of goods < imports of goods Trade surplus in goods: exports of goods > imports of goods Capital account (Arnold 1998, p. 746) described the account capital "includes all payments related to the purchase and sale of goods and borrowing and lending activities include the outflow of U.S. capital and the inflow of foreign capital. The capital account balance is the summary statistic and equals to the difference between these two items. US capital outflows are referred to as US purchases of foreign assets and US loans to foreigners are US capital outflows. As such, they result in a demand for foreign currency and a supply of dollars US on the foreign exchange market.Therefore, they are considered a debt. Foreign capital inflows are referred to as foreign purchases of US assets and foreign loans to Americans are foreign capital inflows. As such, they give rise to a demand for US dollars and a supply of foreign currency in the foreign exchange market. Hence, they are considered a credit. The Official Reserve Account (Arnold 1998, p. 746) describes "a government has official reserve balances in the form of foreign currencies, gold, its reserve position in the International Monetary Fund, and special drawing rights. Countries that have an deficits in their current account and capital can draw on their reserves." When we refer to a surplus or deficit in the balance of payments, we actually mean a surplus or deficit in the balance of official reserve transactions. Because the balance of payments account must balance, the official reserve transaction balance tells us the net amount of international reserves that must move between central banks to finance international transactions. Movements in international reserves have an important impact on money supply and exchange rates (Misbkin 1997). Trade imbalances Asia's high foreign exchange reserves reflect the development policy of Asian countries. Whilerising foreign exchange reserves are an auspicious development reflecting sustained growth and economic strength. Most of the region's economies are export-driven. Let's say that in China, in 2001, Chinese exports increased by 23% reaching 266 billion dollars and represented 4.4% of all world exports. China's trade surplus in 2001 rose to over $30 billion (The Economist 02/15/2003, vol. 366). Strong trade performance is one of the factors that contributed to China's strong position in foreign payments in 2002. The other element is closely related to the actions of foreign investors in China. During 2002, China emerged as the leading destination for foreign direct investment, absorbing $52.7 billion in inflows, an increase of 12.5 percent from the previous year. These, combined with strong trade performance, increased foreign exchange reserves from $212.2 billion in 2001 to $286.4 billion in 2002 (China.org.cn 04/25/2003). The accumulation of Chinese foreign reserves is a corollary of the surge in exports. and foreign direct investment along with some forms of capital control exercised to safeguard the development of its financial system. The rapid accumulation of foreign reserves is the flip side of China's large balance of payments surplus. Furthermore, China will maintain the value of its currency. Weak currencies can help keep a country's products cheap in international markets, boosting exports. U.S. lawmakers have threatened tariffs on Chinese imports, arguing that currency controls are unfairly contributing to China's $103 billion trade surplus with the United States (Metro Post 09/16/2003). Furthermore, a domestic demand policy will influence the level of the country's reserves. A balance of payments deficit is associated with a loss of international reserves; similarly, a balance of payments surplus is associated with a profit. Impact of Reserve Accumulation Introduction The rapid increase in China's foreign exchange reserves has attracted much attention recently. In this essay, the impact of reserve accumulation on money supply, balance of payments, exchange rates and growth in China will be discussed. Rising Foreign Exchange Reserves China's foreign exchange reserves have expanded at an astonishing rate over the past two years. years. Its foreign reserves nearly doubled from $168.6 billion in January 2001 to $316 billion in March 2003 (Appendix II Chart 1). China is now second only to Japan in reserves held. Covering 12 months of imports and nearly double the country's external debt of $169 billion, China's foreign exchange reserves have now reached a fairly satisfactory level (Hang Seng, June 2003). sustained economic growth and strength. China's national savings rate is now 40% of GDP (Hang Seng, June 2003). Balance of Payments The rapid accumulation of foreign reserves is the flip side of the large balance of payments (BOP) surplus. China's capital account surplus has been buoyed as foreign manufacturers have accelerated the relocation of their manufacturing facilities to its territory to capitalize on its seemingly inexhaustible workforce. Foreign direct investment (FDI) grew at an annual rate of 13.8% during the period 2000-2002 (China.org.cn 04/25/2003). China's current account surplus has also increased as it continues to gain share in the global export market. Exchange Rates Growing confidence in the renminbi is also contributing.