All Terrain Thinking

A Compendium of things I think are Important

Economics: It's not just whats' in your wallet

Answers for the Day
Exchange Rates and the Balance of Payments

1. What was the Marshall Plan and how did it solve the balance of payments problem in post WW II.

The Marshall Plan was the name of a massive foreign aid program in the aftermath of WWW II that transferred enormous sums of money from the US to Europe to help in the rebuilding after the war.  In addition to helping revive Europe, the program also eased a potential problem in the international financial system.   In the post war period the US was running a substantial balance of payments surplus so that the net flow of currency was into the US - the result being that the world's money supply was being reduced since the dollars were part of the money supply.  The Marshall Plan provided a mechanism for the return of the dollars to the international money market.

2. Under the gold standard, what would happen if a country continued to run a trade deficit?

The gold standard included an automatic adjustment mechanism to correct imbalances.  If there was a trade deficit, then there would be a flow of currency out from the country.  This would reduce the domestic money supply and increase the supply outside of the country.  If you accepted the quantity theory of money that links prices and the supply of money (MV = PY), then the change in the money supplies will bring about changes in prices - higher prices abroad and lower prices at home.  This change in the relative price levels would make exports more attractive and imports less attractive which would tend to increase exports, decrease imports, and improve the balance of payments deficit.

3. What was the Bretton Woods system and why was the US forced off the system in 1971?

The Bretton Woods system was the international monetary system that emerged from deliberations among the allies who recognized the need for such a system if the international flow of goods, services, and capital, the financial was to resume after WW II.  The system was similar to the gold standard in the sense that exchange rates were fixed, the difference here is that dollars were the international reserve.   This was done because there was simply not enough gold to back the supply of money that had become inflated during the war.  In 1971, the US was forced off the Bretton Woods system because the claims on dollars far exceeded the supply of dollars.

4. What would you expect to see happen to the value of the dollar as a result of the Asian crises that has driven down stock markets across Asia?

The Asian crisis has prompted many investors to bring home their funds which had been invested in Asia.  One of the places where they put their money would be the US stock market and this would increase demand for US dollars.   The increase in foreign demand for US stock would increase the value of the dollar.   Similarly, the decrease in US demand for foreign foreign stocks would result in a decrease in supply of dollars to the international money market.  The result would be an increase in the value of the dollar.

5. What would you expect to happen to the dollar if Japan lowered interest rates to get their economy moving?

The Japanese economy has been stuck in a 'rut' for much of the 1990s and this has prompted the Japanese government to attempt to get the economy moving again.  One option would be to lower interest rates so that people would increase their spending - they might buy homes because the monthly payment was lower.  If interest rates in Japan fall, then you will see investors in the US bringing home dollars which used to be invested in Japan.  This would decrease the supply of dollars which would increase the value of the dollar.

The answers to the next questions will not be given here.   You will find similar questions in the Review Quizzes and you should check the answers there.  We will go over these questions in class using current data.. 

7. You have certainly heard much about the Asian crisis.   What has happened to the price of stock on the South Korean market since 1997?  What has happened in Indonesia where Suharto left office in mid 1998?

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