?2012byMcGraw-HillEducation.Thisisproprietarymaterialsolelyforauthorizedinstructoruse.Notauthorizedforsaleordistributioninanymanner.Thisdocumentmaynotbecopied,scanned,duplicated,forwarded,distributed,orpostedonawebsite,inwholeorpart.

CHAPTER1GLOBALIZATIONANDTHEMULTINATIONALFIRM

ANSWERS&SOLUTIONSTOEND-OF-CHAPTERQUESTIONSANDPROBLEMS

QUESTIONS

1.Whyisitimportanttostudyinternationalfinancialmanagement?

Answer:Wearenowlivinginaworldwhereallthemajoreconomicfunctions,i.e.,consumption,production,andinvestment,arehighlyglobalized.Itisthusessentialforfinancialmanagerstofullyunderstandvitalinternationaldimensionsoffinancialmanagement.Thisglobalshiftisinmarkedcontrasttoasituationthatexistedwhentheauthorsofthisbookwerelearningfinancesometwentyyearsago.Atthattime,mostprofessorscustomarily(andsafely,tosomeextent)ignoredinternationalaspectsoffinance.Thismodeofoperationhasbecomeuntenablesincethen.

Howisinternationalfinancialmanagementdifferentfromdomesticfinancialmanagement?

Answer:Therearethreemajordimensionsthatsetapartinternationalfinancefromdomesticfinance.Theyare:

1.foreignexchangeandpoliticalrisks,

2.marketimperfections,and

3.expandedopportunityset.

3.Discussthemajortrendsthathaveprevailedininternationalbusinessduringthelasttwodecades.

Answer:The1990sbroughtarapidintegrationofinternationalcapitalandfinancialmarkets.Impetusforglobalizedfinancialmarketsinitiallycamefromthegovernmentsofmajorcountriesthathadbeguntoderegulatetheirforeignexchangeandcapitalmarkets.Theeconomicintegrationandglobalizationthatbeganintheeightiesispickingupspeedinthe1990sviaprivatization.Privatizationistheprocessbywhichacountrydivestsitselfoftheownershipandoperationofabusinessventurebyturningitovertothefreemarketsystem.Tradeliberalizationandeconomicintegrationcontinuedtoproceedatboththeregionalandgloballevels.InEurope,manyEUmembercountrieshaveadoptedthecommoncurrency,euro,thathasbecomethesecondglobalcurrencyaftertheU.S.dollar.

4.Howisacountry’seconomicwell-beingenhancedthroughfreeinternationaltradeingoodsandservices?

Answer:AccordingtoDavidRicardo,withfreeinternationaltrade,itismutuallybeneficialfortwocountriestoeachspecializeintheproductionofthegoodsthatitcanproducerelativelymostefficientlyandthentradethosegoods.Bydoingso,thetwocountriescanincreasetheircombinedproduction,whichallowsbothcountriestoconsumemoreofbothgoods.Thisargumentremainsvalidevenifacountrycanproducebothgoodsmoreefficientlythantheothercountry.Internationaltradeisnota‘zero-sum’gameinwhichonecountrybenefitsattheexpenseofanothercountry.Rather,internationaltradecouldbean‘increasing-sum’gameatwhichallplayersbecomewinners.

5.Whatconsiderationsmightlimittheextenttowhichthetheoryofcomparativeadvantageisrealistic?

Answer:ThetheoryofcomparativeadvantagewasoriginallyadvancedbythenineteenthcenturyeconomistDavidRicardoasanexplanationforwhynationstradewithoneanother.Thetheoryclaimsthateconomicwell-beingisenhancedifeachcountry’scitizensproducewhattheyhaveacomparativeadvantageinproducingrelativetothecitizensofothercountries,andthentradeproducts.Underlyingthetheoryaretheassumptionsoffreetradebetweennationsandthatthefactorsofproduction(land,buildings,labor,technology,andcapital)arerelativelyimmobile.Totheextentthattheseassumptionsdonothold,thetheoryofcomparativeadvantagemaylnotrealisticallydescribeinternationaltrade.

6.Whataremultinationalcorporations(MNCs)andwhateconomicrolesdotheyplay?

Answer:Amultinationalcorporation(MNC)canbedefinedasabusinessfirmincorporatedinonecountrythathasproductionandsalesoperationsinseveralothercountries.Indeed,someMNCshaveoperationsindozensofdifferentcountries.MNCsobtainfinancingfrommajormoneycentersaroundtheworldinmanydifferentcurrenciestofinancetheiroperations.Globaloperationsforcethetreasurer’sofficetoestablishinternationalbankingrelationships,toplaceshort-termfundsinseveralcurrencydenominations,andtoeffectivelymanageforeignexchangerisk.

7.RossPerot,aformerPresidentialcandidateoftheReformParty,whichisathirdpoliticalpartyintheUnitedStates,hadstronglyobjectedtothecreationoftheNorthAmericanTradeAgreement(NAFTA),whichnonethelesswasinauguratedin1994.PerotfearedthelossofAmericanjobstoMexicowhereitismuchcheapertohireworkers.WhatarethemeritsanddemeritsofPerot’spositiononNAFTA?ConsideringtherecenteconomicdevelopmentsinNorthAmerica,howwouldyouassessPerot’spositiononNAFTA?

Answer:SincetheinceptionofNAFTA,manyAmericancompaniesindeedhaveinvestedheavilyinMexico,sometimesrelocatingproductionfromtheUnitedStatestoMexico.AlthoughthismighthavetemporarilycausedunemploymentofsomeAmericanworkers,theywereeventuallyrehiredbyotherindustriesoftenforhigherwages.Atthesametime,Mexicohasbeenexperiencingamajoreconomicboom.ItseemsclearthatbothMexicoandtheU.S.havebenefitedfromNAFTA.Perot’sconcernappearstohavebeenillfounded.

8.In1995,aworkinggroupofFrenchchiefexecutiveofficerswassetupbytheConfederationofFrenchIndustry(CNPF)andtheFrenchAssociationofPrivateCompanies(AFEP)tostudytheFrenchcorporategovernancestructure.Thegroupreportedthefollowing,amongotherthings:“TheboardofdirectorsshouldnotsimplyaimatmaximizingsharevaluesasintheU.K.andtheU.S.Rather,itsgoalshouldbetoservethecompany,whoseinterestsshouldbeclearlydistinguishedfromthoseofitsshareholders,employees,creditors,suppliersandclientsbutstillequatedwiththeirgeneralcommoninterest,whichistosafeguardtheprosperityandcontinuityofthecompany”.Evaluatetheaboverecommendationoftheworkinggroup.

Answer:TherecommendationsoftheFrenchworkinggroupclearlyshowthatshareholderwealthmaximizationisnotauniversallyacceptedgoalofcorporatemanagement,especiallyoutsidetheUnitedStatesandpossiblyafewotherAnglo-SaxoncountriesincludingtheUnitedKingdomandCanada.Tosomeextent,thismayreflectthefactthatshareownershipisnotwidespreadinmostothercountries.InFrance,about15%ofhouseholdsownshares.

9.Emphasizingtheimportanceofvoluntarycompliance,asopposedtoenforcement,intheaftermathofsuchcorporatescandalsasthoseinvolvingEnronandWorldCom,U.S.PresidentGeorgeW.Bushstatedthatwhiletougherlawsmighthelp,“ultimately,theethicsofAmericanbusinessdependsontheconscienceofAmerica’sbusinessleaders.”Describeyourviewonthisstatement.

Answer:Therecanbedifferentanswerstothisquestion.Ifbusinessleadersalwaysbehavewithahighethicalstandard,manyofthecorporatescandalswehaveseenlatelymightnothavehappened.Sincewecannotfullydependontheethicalbehavioronthepartofindividualbusinessleaders,thesocietyshouldprotectitselfbyadoptingtherules/regulationsandgovernancestructurethatwouldinducebusinessleaderstobehaveintheinterestofthesocietyatlarge.

10.SupposeyouareinterestedininvestinginsharesofNokiaCorporationofFinland,whichisaworldleaderinwirelesscommunication.Butbeforeyoumakeinvestmentdecision,youwouldliketolearnaboutthecompany.VisitthewebsiteofYahoo(

)andcollectinformationaboutNokia,includingtherecentstockpricehistoryandanalysts’viewsofthecompany.Discusswhatyoulearnaboutthecompany.Alsodiscusshowtheinstantaneousaccesstoinformationviainternetwouldaffectthenatureandworkingsoffinancialmarkets.

Answer:Asstudentsmighthavelearnedfromvisitingthewebsite,informationisreadilyavailableevenforforeigncompanieslikeNokia.Readyaccesstointernationalinformationhelpsintegratefinancialmarkets,dismantlingbarrierstointernationalinvestmentandfinancing.Integration,however,mayhelpafinancialshockinonemarkettobetransmittedtoothermarkets.

MiniCase:NikeandSweatshoplabor

Nike,acompanyheadquarteredinBeaverton,Oregon,isamajorforceinthesportsfootwearandfashionindustry,withannualsalesexceeding$12billion,morethanhalfofwhichnowcomefromoutsidetheUnitedStates.Thecompanywasco-foundedin1964byPhilKnight,aCPAatPriceWaterhouse,andBillBowerman,collegetrackcoach,eachinvesting$500tostart.Thecompany,initiallycalledBlueRibbonSports,changeditsnametoNikein1971andadoptedthe“Swoosh”logo—recognizablearoundtheworld—originallydesignedbyacollegestudentfor$35.Nikebecamehighlysuccessfulindesigningandmarketingmass-appealingproductssuchastheAirJordan,thebestsellingathleticshoeofalltime.

NikehasnoproductionfacilitiesintheUnitedStates.Rather,thecompanymanufacturesathleticshoesandgarmentsinsuchAsiancountriesasChina,Indonesia,andVietnamusingsubcontractors,andsellstheproductsintheU.S.andinternationalmarkets.IneachofthoseAsiancountrieswhereNikehasproductionfacilities,theratesofunemploymentandunder-employmentarequitehigh.ThewagerateisverylowinthosecountriesbyU.S.standards—thehourlywagerateinthemanufacturingsectorislessthan$1ineachofthosecountries,comparedwithabout$20intheUnitedStates.Inaddition,workersinthosecountriesoftenoperateinpoorandunhealthyenvironmentsandtheirrightsarenotparticularlywellprotected.Understandably,hostcountriesareeagertoattractforeigninvestmentslikeNike’stodeveloptheireconomiesandraisethelivingstandardsoftheircitizens.Recently,however,Nikecameunderworldwidecriticismforitspracticeofhiringworkersforsuchalowrateofpay—“nexttonothing”inthewordsofcritics—andcondoningpoorworkingconditionsinhostcountries.

Initially,Nikedeniedthesweatshopchargesandlashedoutatcritics.Butlater,thecompanybeganmonitoringthelaborpracticeatitsoverseasfactoriesandgradingthefactoriesinordertoimprovelaborstandards.Nikealsoagreedtorandomfactoryinspectionsbydisinterestedparties.

Discussionpoints

DoyouthinkthecriticismofNikeisfair,consideringthatthehostcountriesareindireneedsofcreatingjobs?

WhatdoyouthinkNike’sexecutivesmighthavedonedifferentlytopreventthesensitivechargesofsweatshoplaborinoverseasfactories?

Dofirmsneedtoconsidertheso-calledcorporatesocialresponsibilitiesinmakinginvestmentdecisions?

SuggestedSolutiontoNikeandSweatshopLabor

Obviously,Nike’sinvestmentsinsuchAsiancountriesasChina,Indonesia,andVietnamweremotivatedtotakeadvantageoflowlaborcostsinthosecountries.WhileNikewascriticizedforthepoorworkingconditionsforitsworkers,thecompanyhasrecognizedtheproblemandhassubstantiallyimprovedtheworkingenvironmentsrecently.AlthoughNike’sworkersgetpaidverylowwagesbytheWesternstandard,theyprobablyaremakingsubstantiallymorethantheirlocalcompatriotswhoareeitherunder-orunemployed.WhileNike’sdetractorsmayhavevalidpoints,oneshouldnotignorethefactthatthecompanyismakingcontributionstotheeconomicwelfareofthoseAsiancountriesbycreatingjobopportunities.

APPENDIX1A.GAINFROMTRADE:THETHEORYOFCOMPARATIVEADVANTAGE

PROBLEMS

1.CountryCcanproducesevenpoundsoffoodorfouryardsoftextilesperunitofinput.Computetheopportunitycostofproducingfoodinsteadoftextiles.Similarly,computetheopportunitycostofproducingtextilesinsteadoffood.

Solution:Theopportunitycostofproducingfoodinsteadoftextilesisoneyardoftextilesper7/4=1.75poundsoffood.Apoundoffoodhasanopportunitycostof4/7=.57yardsoftextiles.

2.Considertheno-tradeinput/outputsituationpresentedinthefollowingtableforCountriesXandY.Assumingthatfreetradeisallowed,developascenariothatwillbenefitthecitizensofbothcountries.

INPUT/OUTPUTWITHOUTTRADE

_______________________________________________________________________



Country

X Y Total

________________________________________________________________________

I.UnitsofInput(000,000)

_______________________ ______________________________

Food 70 60

Textiles 40 30

________________________________________________________________________

II.OutputperUnitofInput(lbsoryards)

____________________________________________________

Food 17 5

Textiles 5 2

________________________________________________________________________

III.TotalOutput(lbsoryards)(000,000)

____________________________________________________

Food 1,190 300 1,490

Textiles 200 60 260

________________________________________________________________________

IV.Consumption(lbsoryards)(000,000)

___________________________________________________

Food 1,190 300 1,490

Textiles 200 60 260

________________________________________________________________________

Solution:

Examinationoftheno-tradeinput/outputtableindicatesthatCountryXhasanabsoluteadvantageintheproductionoffoodandtextiles.CountryXcan“tradeoff”oneunitofproductionneededtoproduce17poundsoffoodforfiveyardsoftextiles.Thus,ayardoftextileshasanopportunitycostof17/5=3.40poundsoffood,orapoundoffoodhasanopportunitycostof5/17=.29yardsoftextiles.Analogously,CountryYhasanopportunitycostof5/2=2.50poundsoffoodperyardoftextiles,or2/5=.40yardsoftextilesperpoundoffood.Intermsofopportunitycost,itisclearthatCountryXisrelativelymoreefficientinproducingfoodandCountryYisrelativelymoreefficientinproducingtextiles.Thus,CountryX(Y)hasacomparativeadvantageinproducingfood(textile)iscomparisontoCountryY(X).

Whentherearenorestrictionsorimpedimentstofreetradetheeconomic-wellbeingofthecitizensofbothcountriesisenhancedthroughtrade.SupposethatCountryXshifts20,000,000unitsfromtheproductionoftextilestotheproductionoffoodwhereithasacomparativeadvantageandthatCountryYshifts60,000,000unitsfromtheproductionoffoodtotheproductionoftextileswhereithasacomparativeadvantage.Totaloutputwillnowbe(90,000,000x17=)1,530,000,000poundsoffoodand[(20,000,000x5=100,000,000)+(90,000,000x2=180,000,000)=]280,000,000yardsoftextiles.FurthersupposethatCountryXandCountryYagreeonapriceof3.00poundsoffoodforoneyardoftextiles,andthatCountryXsellsCountryY330,000,000poundsoffoodfor110,000,000yardsoftextiles.Underfreetrade,thefollowingtableshowsthatthecitizensofCountryX(Y)haveincreasedtheirconsumptionoffoodby10,000,000(30,000,000)poundsandtextilesby10,000,000(10,000,000)yards.

INPUT/OUTPUTWITHFREETRADE

__________________________________________________________________________



Country

X Y Total

__________________________________________________________________________

I.UnitsofInput(000,000)

_______________________________________________________

Food 90 0

Textiles 20 90

__________________________________________________________________________

II.OutputperUnitofInput(lbsoryards)

______________________________________________________

Food 17 5

Textiles 5 2

__________________________________________________________________________

III.TotalOutput(lbsoryards)(000,000)

_____________________________________________________

Food 1,530 0 1,530

Textiles 100 180 280

__________________________________________________________________________

IV.Consumption(lbsoryards)(000,000)

_____________________________________________________

Food 1,200 330 1,530

Textiles 210 70 280

CHAPTER2INTERNATIONALMONETARYSYSTEM

ANSWERS&SOLUTIONSTOEND-OF-CHAPTERQUESTIONSANDPROBLEMS

QUESTIONS

1.ExplainGresham’sLaw.

Answer:Gresham’slawreferstothephenomenonthatbad(abundant)moneydrivesgood(scarce)moneyoutofcirculation.Thiskindofphenomenonwasoftenobservedunderthebimetallicstandardunderwhichbothgoldandsilverwereusedasmeansofpayments,withtheexchangeratebetweenthetwofixed.

2.Explainthemechanismwhichrestoresthebalanceofpaymentsequilibriumwhenitisdisturbedunderthegoldstandard.

Answer:Theadjustmentmechanismunderthegoldstandardisreferredtoastheprice-specie-flowmechanismexpoundedbyDavidHume.Underthegoldstandard,abalanceofpaymentdisequilibriumwillbecorrectedbyacounter-flowofgold.SupposethattheU.S.importsmorefromtheU.K.thanitexportstothelatter.Undertheclassicalgoldstandard,gold,whichistheonlymeansofinternationalpayments,willflowfromtheU.S.totheU.K.Asaresult,theU.S.(U.K.)willexperienceadecrease(increase)inmoneysupply.ThismeansthatthepricelevelwilltendtofallintheU.S.andriseintheU.K.Consequently,theU.S.productsbecomemorecompetitiveintheexportmarket,whileU.K.productsbecomelesscompetitive.ThischangewillimproveU.S.balanceofpaymentsandatthesametimehurttheU.K.balanceofpayments,eventuallyeliminatingtheinitialBOPdisequilibrium.

3.Supposethatthepoundispeggedtogoldat6poundsperounce,whereasthefrancispeggedtogoldat12francsperounce.This,ofcourse,impliesthattheequilibriumexchangerateshouldbetwofrancsperpound.Ifthecurrentmarketexchangerateis2.2francsperpound,howwouldyoutakeadvantageofthissituation?Whatwouldbetheeffectofshippingcosts?

Answer:Supposethatyouneedtobuy6poundsusingFrenchfrancs.Ifyoubuy6poundsdirectlyintheforeignexchangemarket,itwillcostyou13.2francs.Alternatively,youcanfirstbuyanounceofgoldfor12francsinFranceandthenshipittoEnglandandsellitfor6pounds.Inthiscase,itonlycostsyou12francstobuy6pounds.Itisthusbeneficialtoshipgoldduetotheoverpricingofthepound.Ofcourse,youcanmakeanarbitrageprofitbyselling6poundsfor13.2francsintheforeignexchangemarket.Thearbitrageprofitwillbe1.2francs.Sofar,weassumedthatshippingcostsdonotexist.Ifitcostsmorethan1.2francstoshipanounceofgold,therewillbenoarbitrageprofit.

4.Discusstheadvantagesanddisadvantagesofthegoldstandard.

Answer:Theadvantagesofthegoldstandardinclude:(I)sincethesupplyofgoldisrestricted,countriescannothavehighinflation;(2)anyBOPdisequilibriumcanbecorrectedautomaticallythroughcross-borderflowsofgold.Ontheotherhand,themaindisadvantagesofthegoldstandardare:(I)theworldeconomycanbesubjecttodeflationarypressureduetorestrictedsupplyofgold;(ii)thegoldstandarditselfhasnomechanismtoenforcetherulesofthegame,and,asaresult,countriesmaypursueeconomicpolicies(likede-monetizationofgold)thatareincompatiblewiththegoldstandard.

5.WhatwerethemainobjectivesoftheBrettonWoodssystem?

Answer:ThemainobjectivesoftheBrettonWoodssystemaretoachieveexchangeratestabilityandpromoteinternationaltradeanddevelopment.

6.CommentonthepropositionthattheBrettonWoodssystemwasprogrammedtoaneventualdemise.

Answer:TheanswertothisquestionisrelatedtotheTriffinparadox.Underthegold-exchangesystem,thereserve-currencycountryshouldrunBOPdeficitstosupplyreservestotheworldeconomy,butifthedeficitsarelargeandpersistent,theycanleadtoacrisisofconfidenceinthereservecurrencyitself,eventuallycausingthedownfallofthesystem.

7.Explainhowspecialdrawingrights(SDR)areconstructed.Also,discussthecircumstancesunderwhichtheSDRwascreated.

Answer:SDRwascreatedbytheIMFin1970asanewreserveasset,partiallytoalleviatethepressureontheU.S.dollarasthekeyreservecurrency.TheSDRisabasketcurrencycurrentlycomprisedoffourmajorcurrencies,i.e.,U.S.dollar,euro,Japaneseyen,andBritishpound.Currently,thedollarreceivesa41.9%weight,euro37.4%,yen9.4%,andpound11.3%.Theweightsfordifferentcurrenciestendtochangeovertime,reflectingtherelativeimportanceofeachcurrencyininternationaltradeandfinance.

8.ExplainthearrangementsandworkingsoftheEuropeanMonetarySystem(EMS).

Answer:EMSwaslaunchedin1979inorderto(i)establishazoneofmonetarystabilityinEurope,(ii)coordinateexchangeratepoliciesagainstthenon-EMScurrencies,and(iii)pavethewayfortheeventualEuropeanmonetaryunion.ThemaininstrumentsofEMSaretheEuropeanCurrencyUnit(ECU)andtheExchangeRateMechanism(ERM).LikeSDR,theECUisabasketcurrencyconstructedasaweightedaverageofcurrenciesofEUmembercountries.TheECUworksastheaccountingunitofEMSandplaysanimportantroleintheworkingsoftheERM.TheERMistheprocedurebywhichEMSmembercountriesmanagetheirexchangerates.TheERMisbasedonaparitygridsystem,withparitygridsfirstcomputedbydefiningtheparvaluesofEMScurrenciesintermsoftheECU.Ifacountry’sECUmarketexchangeratedivergesfromthecentralratebyasmuchasthemaximumallowabledeviation,thecountryhastoadjustitspoliciestomaintainitsparvaluesrelativetoothercurrencies.EMSachievedacompletemonetaryunionin1999whenthecommonEuropeancurrency,theeuro,wasadopted.

9.Thereareargumentsforandagainstthealternativeexchangerateregimes.

a.Listtheadvantagesoftheflexibleexchangerateregime.

b.Criticizetheflexibleexchangerateregimefromtheviewpointoftheproponentsofthefixedexchangerateregime.

c.Rebuttheabovecriticismfromtheviewpointoftheproponentsoftheflexibleexchangerateregime.

Answer:a.Theadvantagesoftheflexibleexchangeratesysteminclude:(I)automaticachievementofbalanceofpaymentsequilibriumand(ii)maintenanceofnationalpolicyautonomy.

b.Ifexchangeratesarefluctuatingrandomly,thatmaydiscourageinternationaltradeandencouragemarketsegmentation.This,inturn,mayleadtosuboptimalallocationofresources.

c.Economicagentscanhedgeexchangeriskbymeansofforwardcontractsandothertechniques.Theydon’thavetobearitiftheychoosenotto.Inaddition,underafixedexchangerateregime,governmentsoftenrestrictinternationaltradeinordertomaintaintheexchangerate.Thisisaself-defeatingmeasure.What’sgoodaboutthefixedexchangerateifinternationaltradeneedtoberestricted?

10.Inanintegratedworldfinancialmarket,afinancialcrisisinacountrycanbequicklytransmittedtoothercountries,causingaglobalcrisis.WhatkindofmeasureswouldyouproposetopreventtherecurrenceofanAsia-typecrisis.

Answer:First,thereshouldbeamultinationalsafetynettosafeguardtheworldfinancialsystemfromtheAsia-typecrisis.Second,internationalinstitutionslikeIMFandtheWorldBankshouldmonitorproblematiccountriesmorecloselyandprovidetimelyadvicetothosecountries.Countriesshouldberequiredtofullydiscloseeconomicandfinancialinformationsothatdevaluationsurprisescanbeprevented.Third,countriesshoulddependmoreondomesticsavingsandlong-termforeigninvestments,ratherthanshort-termportfoliocapital.Therecanbeothersuggestions.

11.Discussthecriteriafora‘good’internationalmonetarysystem.

Answer:Agoodinternationalmonetarysystemshouldprovide(i)sufficientliquiditytotheworldeconomy,(ii)smoothadjustmentstoBOPdisequilibriumasitarises,and(iii)safeguardagainstthecrisisofconfidenceinthesystem.

12.Oncecapitalmarketsareintegrated,itisdifficultforacountrytomaintainafixedexchangerate.Explainwhythismaybeso.

Answer:Oncecapitalmarketsareintegratedinternationally,vastamountsofmoneymayflowinandoutofacountryinashorttimeperiod.Thiswillmakeitverydifficultforthecountrytomaintainafixedexchangerate.

13.AssessthepossibilityfortheeurotobecomeanotherglobalcurrencyrivalingtheU.S.dollar.Iftheeuroreallybecomesaglobalcurrency,whatimpactwillithaveontheU.S.dollarandtheworldeconomy?

Answer:Inlightofthelargetransactionsdomainoftheeuro,whichiscomparabletothatoftheU.S.dollar,andthemandatefortheEuropeanCentralBank(ECB)toguaranteethemonetarystabilityinEurope,theeuromaypotentiallybecomeanotherglobalcurrencyovertime.Amajoruncertaintyaboutthisprospectisthelackofpolitical(andfiscal)integrationofEurope.IfEuropebecomespoliticallymoreintegrated,theeuroismorelikelytobecomeaglobalcurrency.Iftheeurobecomesaglobalcurrency,itwillcomeattheexpenseofthedollar.Currently,theU.S.derivessubstantialbenefitsfromthedollar’sstatusasthedominantglobalcurrency–forinstance,theU.S.canruntradedeficitswithouthavingtomaintainsubstantialforeignexchangereserves,cancarryoutinternationalcommercialandfinancialtransactionsindollarswithoutbearingexchangerisk,etc.Iftheeuroistobeusedasamajordenomination,reserve,andinvoicecurrencyintheworldeconomy,dollar-basedagentswillstarttobearmoreexchangerisk,amongotherthings.

MINICASE:WilltheUnitedKingdomJointheEuroClub?

WhentheeurowasintroducedinJanuary1999,theUnitedKingdomwasconspicuouslyabsentfromthelistofEuropeancountriesadoptingthecommoncurrency.AlthoughthepreviousLaborgovernmentledbyPrimeMinisterTonyBlairappearedtobereceptivetotheideajoiningtheeuroclub,thecurrentTorygovernmentisclearlynotinfavorofadoptingtheeuroandthusgivingupmonetarysovereigntyofthecountry.Thepublicopinionisalsodividedontheissue.

WhethertheUnitedKingdomwilleventuallyjointheeuroclubisamatterofconsiderableimportanceforthefutureofEuropeanUnionaswellasthatoftheUnitedKingdom.ThejoiningoftheUnitedKingdomwithitssophisticatedfinanceindustrywillmostcertainly