The International Monetary System 553
- Now notice, by reading down the euro column, that one euro was worth 1.4757
Swiss francs. This is the same cross rate that we calculated for the U.S. tourist in
our example.
The tie-in with the dollar ensures that all currencies are related to one another in a
consistent manner. If this consistency did not exist, currency traders could profit by
buying undervalued and selling overvalued currencies. This process, known as arbi-
trage,works to bring about an equilibrium wherein the same relationship described
earlier would exist. Currency traders are constantly operating in the market, seeking
small inconsistencies from which they can profit. The traders’ existence enables the
rest of us to assume that currency markets are in equilibrium and that, at any point in
time cross rates are all internally consistent.
What is an exchange rate?
Explain the difference between direct and indirect quotations.
What is a cross rate?
The International Monetary System
Every nation has a monetary system and a monetary authority. In the United States,
the Federal Reserve is our monetary authority, and its task is to hold down inflation
while promoting economic growth and raising our national standard of living. More-
over, if countries are to trade with one another, we must have some sort of system
designed to facilitate payments between nations.
From the end of World War II until August 1971, the world was on a fixed ex-
change rate systemadministered by the International Monetary Fund (IMF). Under
this system, the U.S. dollar was linked to gold ($35 per ounce), and other currencies
were then tied to the dollar. Exchange rates between other currencies and the dollar
were controlled within narrow limits but then adjusted periodically. For example, in
1964 the British pound was adjusted to $2.80 for £1, with a 1 percent permissible fluc-
tuation about this rate.
Fluctuations in exchange rates occur because of changes in the supply of and de-
mand for dollars, pounds, and other currencies. These supply and demand changes
have two primary sources. First, changes in the demand for currencies depend on
changes in imports and exports of goods and services. For example, U.S. importers
must buy British pounds to pay for British goods, whereas British importers must buy
U.S. dollars to pay for U.S. goods. If U.S. imports from Great Britain exceeded U.S.
TABLE 15-2 Key Currency Cross Rates (December 7, 2001)
Dollar Euro Pound SFranc Peso Yen CdnDlr
Canada 1.5752 1.401 2.2577 0.9494 0.1712 0.0125 —
Japan 125.54 111.66 179.94 75.663 13.643 — 79.698
Mexico 9.2015 8.1838 13.189 5.5457 — 0.0733 5.8415
Switzerland 1.6592 1.4757 2.3781 — 0.1803 0.0132 1.0533
United Kingdom 0.6977 0.6205 — 0.4205 0.0758 0.0056 0.4429
Euro 1.1244 — 1.6115 0.6776 0.1222 0.0090 0.7138
United States — 0.8894 1.4333 0.6027 0.1087 0.0080 0.6348
Source:The Wall Street Journal, http://interactive.wsj.com.
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