Hi guys, welcome back to Global Business Environment, Course 2.

We're in Module one, and this is Part 4.

And we're going to continue talking about the impact of currency and

exchange rates on the global business environment.

One thing we haven't mentioned is the impact of other factors besides supply and

demand on the determination of exchange rates.

This price of a currency in terms of another currency.

One of the major factors is interest rates.

And so, I've got here on this screen, a, a kind of a confusing looking graph,

which shows long term interest rates in many European nations,

over little over 20 year period of time.

And as you can see there is some fluctuation and some

convergence, different times of these long term exch interest rates.

The point that you want to have as a takeaway and

this is just an introductory course, is that there's a strong relationship and

not to be too complex in my lingo, but there's a strong inverse relationship or

correlation between interest rates and exchange rates.

And what I mean by that is, if you take two countries.

Let's say Greece and Japan.

And the interest rates in Greece are much higher than the interest rates

that are charged in Japan, let's think, let's think for

a minute about a savings account.

we're, we're talking about the interest rate that you can earn by saving.

If you can get a 30% interest rate in Greece, and you

can only get a 2% interest rate by putting your money in a savings account in Japan.

What do you think will be the impact on demand for investing or saving in Greece?

And thereby the Greek currency.

The, the impact would probably be pretty obvious.

Most of us would say, oh, yeah, I think I better save my money there,

because I'm going to earn 30% versus two in my home country Japan.

The same could be done for for getting a loan and interest rates.

Obviously most of us would be

would prefer to take out loans in places with lower interest rates.

But interest rates have their own set of determinations and factors.

And the reason that interest rates might be higher,

could be that there's instability in a place like Greece.

Perhaps political instability perhaps concerns about the, the currency itself.

And, and so it's not always the case that even though the, the savings rate or

the, the interest rate on a savings account in Greece might be 30% and

in Japan it might be 2, it's not always the case that

everyone will immediately put their money in Greek banks.

Because of these other factors.

But everything else held equal,

you would expect as interest rates rise in a, a given economy,

for the value of their currency, in terms of another currency, to also increase.

We would expect their currency to strengthen because we would expect to

see increases in purchases of their currency.

And so that is one important factor to consider.

And again, we're talking about a, a floating exchange rates, and

assuming that there's this market to determine exchange rates.

But that's not always been the case.

In fact for much of history we wouldn't have been

talking about this relationship at all between interest rates and exchange rates.

In fact I've got here on the screen now of different periods of time over the last

100 plus years, where the world has used different systems.

And I'll introduce one, and then in the next part, we'll pick it back up and, and

discuss this further.

But so now we're stepping back, and we're saying what was it like before?

Before we had these floating exchange rates and

we talked about strengthening and weakening and

we, we talked about the impact of supply and demand and interest rates.

What was it like before?

Well, if you go back to the late 1800s currencies, foreign currencies didn't

matter that much at all, because there was something called the gold standard.

And what that meant was you could exchange

any given currency for an amount of gold,

perhaps an, an ounce of gold or a kilogram of gold at a predetermined price.

And you could know the value of currencies before making any purchases.

And there wasn't much going on in terms of manipulation by governments of

exchange rates.

Not so much compared to what we have today.

And so we had a relatively fixed exchange rate system,

when all currencies in the world were set in their value in terms of gold.

And what that meant is each country needed to have a certain amount of gold

in reserve, and that on demand people could go in and

say I would like gold instead of this currency.

And so that, that provided a lot of stability.

But what we see happening in the 20's and 30's, and

we talked about that when we talked about is globalization new,

is a lot of uncertainty and change in the market.

And we saw a, a great depression and

we saw countries abandon the the Gold Standard.

And this is because many countries in the depression

experienced great inflation rates and part of

that was because they were printing money to try to support their economies.

And there was a policy that many countries use to try to

increase employment by increasing exports, but nobody wanted to import.

Everyone wanted to export.

What they did is something called Beggar Thy Neighbor, and they went around

manipulating their currencies they got off the gold standard, and manipulating their

currency made it cheaper, so that it would make or devalue their currencies so

it'd make exports from their economy cheaper for citizens of other countries.

And everyone went around doing this.

So there was this cycle of multiple decreases in values.

And so, this caused new problems.

You might call that a floating system, compared to the gold standard, but

it didn't work either.

So that leads us to the late 1940's, after World War II,

when we talked about again in, in our module on is globalization new.

The changes that happen in this Breton Woods Conference, and

the creation of the International Monetary Fund in the World Bank.

And what happened out of that period was an agreement that the United States

as one of the remaining superpowers, would be the defacto world currency,

and the United States would agree to maintain in reserve gold,

and it would be the only country that had to do that and

would agree to to except these exchanges of the US dollar into gold on demand.

But other countries didn't have that, and so it,

it was this confidence in the US dollar, which led the world to accept this system,

and it made the US dollar become the de facto world currency.

Now in fact, in the early 1970's the United States government abandoned that

gold standard, and that's really the beginning of where we are today.

Where the, the dollar remains somewhat a de

facto currency of importance in the world.

But it no longer has any relation to gold, the amount of gold in reserve, or

anything else.

And the, the rest of the world is on the same is on the same type of system.

And so now we're in a, a floating world in many

countries in a fixed exchange rate world in other countries.

And it depends on all of these factors we've been talking about,

how exchange rates are set.

Either governmental policy if it's a fixed exchange rate, or

a, a market system at work if it's some type of floating exchange rate.

And so this has caused great fluctuations in currencies.

There's a very, very large foreign currency market.

We've seen countries have rapid devaluations,

which has had very negative impacts on their local citizens as they've no

longer been able to buy imports as their currency becomes so weakened.

And so we live in a world of relative instability in terms of

currency prices and

exchange rates today compared to over 100 years ago when we saw this gold standard.

The criticism of having a fixed system is you'd,

your, your prices don't reflect any changes in demand.

You're, you're still paying for in today's world we're still paying for

Chinese goods.

For example, those of us who import Chinese goods at relatively low prices for

the Chinese Yuan.

Those goods are artificially cheap, or artificially inexpensive.

We should be paying more.

In a, in a fixed exchange rate system we don't get the flexibility that we

would get in a floating system.

In a floating system we'd get this, these, these fluctuations that are that are very

hard to predict and very hard to manage for governments and

for individuals and organizations who operate in these economies.

So that's where we are a little bit of history on

the foreign exchange system around the world.

We'll pick this up next time and

talk a little bit more about where we are today, and how this impacts business.

Module 1, part 4

International Business II

Meet the Instructors