Lecture 05 Notes

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17 Dec 2010
Multilateral Cooperation and Financial Markets
Lecture 05
Foreign Exchange (FEX) Market
1 base currency/# quote currency, e.g., $ is the dollar value of 1 Euro
oExtremely liquid buyers and sellers at all times
oThis is true dur ing high volatility as well
oMor tgage are deep large quantities have to be sold in order to affect the
oOpen 24/7
Twin pr ices
oQuoted prices allows us to analyze reciprocal pr ices
Crash proof
oReciprocity disallows crashes
oWhen one decreases the other increases; hence no crash
oMost of the foreign exchange market tur nover occurs in the United Kingdon
oUSD is the currency most traded
International Role of the Dollar:
Vehicle currency reduces transaction costs
oTrading goods and assets would be costly if the cur rency of each partner had to be
accepted at each sale
oVehicle currencies are used to combat this; the USD is a natural candidate
Therefore you simply trade your currency for the USD
The dollar against the other currencies in the system
oMedium of exchange
Done through the key cur rency
The key cur rency functions as a means of payment
Most frequently traded currency in the market
Government uses the key cur rency to intervene in the market
Actors will hold the key cur rency because actors believe it will gain value
over time
Future of the Dollar
Dollar supersedes Pound after WWII: Triff in vs. Federal Reserve
Dollar Supersedes Pound 1924, Duopoly Interwar years, Pound Stages ‘Comebacl 1933:
Flandreau & Eichengreen
Challenges thinking about reserve currency stats
Disputes permanency of lost reserve currency status and staying power of reserve
cur rency
Incumbency Advant age
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