Hey everyone, welcome back. I'm Lon Schiffbauer and we've done it. This is our final installment of our series on international business. And today we are talking about foreign exchange market and monetary system.
Oh my gosh, isn't this exciting? Actually, I know. It doesn't sound terribly exciting, but I'm going to try to help you out. All right.
So let's go ahead and jump into this. Go ahead and get my highlighter set and we'll be good. So functions of a foreign exchange market.
Obviously, we all use different currencies around the world. So we need a foreign exchange market to really make sure that this is done properly, that we can exchange currencies properly. So they oversee the conversion of currency from one country to another and provide some level of insurance against foreign exchange risk.
We're going to talk about what that means. OK, so let's talk about exchange rate. Now, you've probably exchanged money before and you go into a bank or some teller at an airport and you exchange one currency for another. Well. there's really two types of foreign exchange.
One is a fixed exchange rate. This is when the government manipulates the value of a country's currency. It is fixed to whatever the government, the country establishes.
We're going to come back to this. The other is a floating exchange rate. Floating is the value of a country's currency changes based on market forces.
Okay. So free market, a currency is like any other asset. It can increase or decrease in value.
Well, what decides that increase or decrease in value? Whatever the market says. Okay. Now, most countries operate under a freely floating exchange rate system.
In fact, In most cases, a fixed exchange rate is illegal. You're not supposed to do it. There are some exceptions, and we are going to talk about those exceptions.
But in most cases, countries are not supposed to manipulate the value of their currency. Governments are not supposed to do that for the most part. We're going to talk about why they would want to, though.
All right. Now. Why are we talking about this? I got news for you.
This can really affect the bottom line of your international endeavor. All right. So, for example, if you are in India doing business in the Philippines and you have a razor thin profit margin, well, then that profit margin can literally disappear.
If the exchange rate differs even a little bit overnight. OK, so let's let's take it here in the United States and say we're going to go do business in England. OK, so I'm making something with dollars and I sell it in England for pounds and my my my profit margin is only two percent.
That's razor thin. Well, if the currency. fluctuates too much, that 2% could change into nothing. And in fact, I can be taking a loss over the span of just a few weeks if the exchange rate changes drastically. So you need to really understand the market forces that influence exchange rates and factor them into how you're going to do business.
Now, you hear a lot about a strong market force. currency or a weak currency, right? Now, I'm in the United States, so I'm going to go ahead and use the dollar as an example, and we'll use England as a trading partner example. But this is the case with anybody, right? So you hear about a strong dollar or a weak dollar.
The thing is, that's an unfortunate use of the term strong and weak. Because in our mind, strong is good, weak is bad. But that's not the case when it comes to currency. It depends on who you are in the economy and what you're doing. So let's talk about a strong dollar, for example.
But the same principle goes for whatever currency you're using. A strong dollar is great for importers or customers. So since I'm in the United States and I purchase with my dollar, I love a strong dollar because I can say, look at everything I can buy. My dollar is so strong.
However, a strong dollar is really horrible for U.S. exporters. Okay. If I am manufacturing something and exporting it, and my dollar is strong compared to your currency, I'm going to lose money. I can't sell anything. My product is too expensive for Europe because I spent dollars to produce it, but customers are buying it with worthless euros, right?
I just can't afford to sell something I created with strong dollars. in a market that has a weak currency because that currency doesn't go very far. Okay, let's look at it the other way. What if our dollar is weak?
Well, once again, this is horrible for me as a customer and horrible for importers because my dollar is weak. I can't buy anything. Nobody wants these dollars. They're too weak. On the other hand, it's great for exporters.
Exporters love a weak dollar. Look at everything I'm selling. My product is so cheap for Europe because I spent weak dollars to produce it, but customers can buy them with really valuable euros, right? So remember, when you hear about weak currency or strong currency in relation to another currency, all it's really talking about is who has the power. The importers...
or the exporters. Okay. All right.
So there are exchange controls that are generally put in place. Remember, we like a floating exchange rate. However, in some cases, a fixed exchange rate might be used. So let's read this. This is from Investopedia.
Down here is a link if you want to check it out. Exchange controls are government-imposed limitations on the purchase or sale of currencies. These controls allow countries to better stabilize economies by limiting inflows and outflows of currency, which can create exchange rate volatility. This is if they're fixed exchange rates.
Not every nation may employ the measures, at least legitimately. The 14th article of the International Monetary Fund, we're going to talk about them, of the agreement allows only countries with so-called transitional economies to employ exchange controls. Okay, so we mean countries with weak or developing economies may put controls on. how much currency can be exchanged or exported or banned foreign currency altogether to prevent speculation.
So putting that in human terms, it means that floating exchange rate is the way to go, right? That's what is legal. That's what's legitimate.
That's what the market really wants. However, in some rare cases, a country may put in place. Exchange controls if it is like a transitional economy and it's trying to get on its feet. All right. Now, obviously, not every country plays by the rules.
One sort of famous case is China. China is not a transition economy, but they have a habit of placing in place, placing in place. of putting in place exchange controls quite often. Now, I won't go into detail here, but I really invite you to go to National Public Radio, NPR, and check out this podcast on why money is pouring out of China.
Now, if you think about it, China with their RMB, they really want a weak currency. Why do they want a weak currency? currency because their economy right now, it's transitioning, but historically has been based in exports. China is the production and exporting capital of the world. And remember, exporters love when their domestic currency is weak in relation to their customers.
So it is in China's best interest that the RMB is weak compared to, say, the dollar or to the yen. Well, now, if money is pouring out of China. That means that the RMB that are left in China are now more valuable and the currency is weaker.
And China doesn't want that, right? So they try to put in place to keep their currency in place. But now, why would money be pouring out of China?
Well, remember, if you're a customer, if you're an importer and your currency is weak, that's bad for you. So you send your money out of China, buy a stronger currency. So that as the RMB continues to degrade in value, which is what their exporters want, your currency remains strong because you put it into a stronger currency and that's what you want.
So check out the podcast. Very fascinating. All right.
Now, this means that we are going to often compare economies and so forth. The two main ways that we really compare economies is first. gross domestic product.
You've heard of GDP, right? It is the gross domestic product. It's the most widely used measure around the world.
The idea is that it is the value of everything produced in your country, all right? So if I'm looking at the gross domestic product, of Germany, it is every, the value of all the goods and services produced in Germany. Now, what if an American company is in Germany producing something? Does that go to Germany, Germany's gross domestic product or the U.S.?
No, it goes to Germany's because it's everything produced within the borders of Germany and so forth. Okay. Now it's everything. Everything, which means that it's counting things like, you know, if we're doing Germany, it's counting Rolls Royce and Europe and England and so forth, where it's going to count things like Siemens, which makes big, huge, massive medical equipment and so forth.
Engines, motors, things like that. Stuff that, OK, it creates a lot of wealth for the country. but doesn't necessarily reflect in the standard of living of its citizens. So to do that, we have something called purchase power parity, PPP.
What purchase power parity does is it says, listen, instead of looking at everything a country produces in terms of wealth, because that wealth does not reflect itself in the normal person. everyday citizen the same way. We are going to look at a basket of goods. We are going to look at what does the average citizen buy all the time. We're talking about power, vehicles, transportation, food, shelter, education, things of this nature.
These are things that a citizen in the U.S. or India or Germany or the Philippines or Australia, we all buy this stuff to some degree or another. Therefore, if we compare the cost and value of these basket of goods around the world, then we can really see which countries are doing well for its citizenry and which countries are lagging behind. Now, it's not a perfect model by any extent.
I mean, for example, Here in the U.S., we drink a lot of milk. We drink a lot of milk. And in other countries, milk is like, really?
You drink stuff that a cow produced for its calf? What human does that, right? It's not the same degree. Nevertheless, it's a stronger benchmark than a GDP when it comes to the... day in life of a normal citizen.
The last thing I want to do is I want to talk about the three monetary systems that you hear about most often. The first is the International Monetary Fund, the IMF. And it's not the Impossible Mission Force. It is the International Monetary Fund.
Right. Here's the idea. Today, the world economy is highly interconnected and interdependent. We really are. It's one economy.
This means that when there's a financial or monetary crisis in one country, it will before long inevitably affect the entire world economy. So the IMF's job is to monitor, support, and stabilize monetary systems all around the world so that if anything starts to bubble up in one region, it does not affect the entire world economy. Now, what are things that come around?
Well, recessions, natural disasters, wars, things like that. I mean, just one natural disaster in one area can eventually result in the collapse or, you know, a recession around the whole planet. OK, now, one of the main ways it does this is through loans.
All right. It is a fund after all, international monetary fund. And so. It will give loans to countries that are really suffering and to prop up that economy so that they can get on their feet and anything happening in that economy doesn't bleed over to other economies. Now, we also have the World Bank, which is a sister organization of the IMF.
They kind of overlap each other. They have slightly different missions, though. The World Bank.
Bank is an international organization dedicated to providing finance advice and research to developing nations aid in their economic advancement, right? The idea is that the richer the world is, the richer the world can become, right? Developing nations don't have the money to really participate in the world economy.
They don't have the infrastructure to participate in the world economy. And we want them to participate in the world economy. The more developed nations we have, the more customers we have, the more expertise we have access to, the more innovation we have access to. These are just gold mines waiting to, you know, come into their own. be a major player in the world economy.
So the bank predominantly acts as an organization that attempts to fight poverty by offering developmental assistance to middle and low income countries. Now, if you go out to projectsworldbank.org, you'll see this is kind of a cool site that allows you to see what kinds of loans they're making in different countries and regions. And the impact this is having on the local economy, which then has an impact on the regional economy and the world economy. So pretty, pretty cool stuff. If you're interested in that, check it out.
And then finally, we have the World Trade Organization, the WTO. Now, we talked about trade protectionism before, trade barriers, things like tariffs and subsidies and so forth. And to be honest, we probably should have looked at. the WTO when we talked about that. But that's okay.
We're getting it in now. The World Trade Organization regulates international trade by setting and enforcing rules intended to create a level playing field and facilitate smooth commerce between member countries, right? 164 members of the WTO currently. So the idea is the WTO, the World Trade Organization, they want everybody trading, trade, trade, trade, free trade. And we want to make sure that it's smooth, that it's fair, and that nothing really gets in the way of free trade.
Acts as a mediator between countries when disputes arise. And so doing the WTO can impose sanctions on countries that don't abide by the rules. Now, this is an example of a supranational organization, meaning it is a non-elected body that can make rules that the members must follow, okay? So there's always a little bit of controversy there. The idea that the WTO can impose rules and sanctions on a sovereign country doesn't really sit well with everyone.
But remember, their mission is to make it a level playing field. And let's face it, some countries have an advantage over others if there is not somebody there to help mediate, all right? A great example, by the way, if you're interested in a case study that started years and years and years ago but is still continuing today, is around large civil aircraft. Boeing in the United States going to the WTO and saying, hey, we don't like what Airbus is doing.
Airbus, a consortium between, I think it was Germany. France and England. I think Spain played a small part in it as well.
And they created Airbus. And Boeing is saying, hey, you can't do that. You're using government subsidies to create this massive, huge competitor that we can't compete with.
And then Airbus comes back and says, well, the reason that you're really this huge, massive producer of civil aircraft is because during World War II. The government gave you a ton of money to create, you know, aircraft and so forth to fight in the war. So you've been subsidized, too. And it goes back and forth, back and forth, back and forth. This thing is actually still continuing today.
So if you're interested, go out to the World Trade Organization and check that out. All right. And there you go, folks.
You did it. All 12 modules. Congratulations for sticking with it. All right. It's been a real pleasure.
I hope you found at least part of this interesting. I have other lectures if you want to continue to learn more about business, not just internationally, but HR and business in general, business communication. So check out my website. And in our next video, I'll see you there. Have a great day.