A gold standard currency is a system where the value of money in specific countries straightforwardly depends on a specific weight and number of grams of unadulterated gold. In contrast, Fiat money has no sponsorship from a genuine ware such as gold; its value arises from individuals’ trust in the government issuing it and its capacity to keep up with currency stability. The gold standard also limits how much currency is available for use, as indicated by accessible reserves of gold (Krugman et al., 2014). Governments can issue a currency adding up to the gold they possess. This restriction links the money supply to gold, which prevents central banks from responding to monetary policy on economic needs.
Also, Fiat money gives a ton of room in monetary policy. Central banks can change the money supply to control inflation, foster economic growth, or stabilize financial markets. Fiat money systems can easily oblige shifts in economic movement, as they do not need gold reserves to support the currency (Lazarski Open Courses, 2020). For instance, the Gold Standard dictates that the money supply remains constant; this is a deflationary situation characteristic of economic slumps. In contrast, fiat money systems empower central banks to infuse liquidity in crises, limiting flattening risk.
The Bretton-Woods System was a post-World War II international monetary system made in 1944 that pegged the currencies to the US dollar, fortified with gold. This system sought to ensure economic stability and ease international trade by ensuring fixed exchange rates between currencies. Nevertheless, toward the finish of the 1960s, the US was running trade deficits, and its gold reserves were lessening because of increased spending on the Vietnam War and social programs (Krugman et al., 2014). President Nixon chose to terminate the Bretton-Woods System in 1971 by suspending the convertibility of the US dollar into gold. This activity, the Nixon Shock, actually killed off the gold standard and allowed currencies to drift against one another.
The effects of President Nixon’s decision were sweeping. With floating exchange rates, currencies became more unstable, prompting uncertainty in international trade and investment. Countries needed to adjust their currencies, which implied they required more intervention in controlling the currency and ensuring competitiveness in the global market (Krugman et al., 2014).
In the post-Gold Standard world, currency appreciation refers to a rise in one’s currency relative to other currencies. This might happen for various reasons, from higher interest rates, great economic performance, or more currency demand among international markets. For instance, if a country’s central bank hikes interest rates to contain inflation, it could get foreign capital, resulting in an appreciation of the domestic currency. Also, currency depreciation refers to a situation in which the value of one’s nation is reduced compared with another. Some factors that lead to depreciation are lower interest rates, economic instability, or government intervention in the currency market (Krugman et al., 2014). For instance, if a country’s economy goes into recession, investors might move their investments abroad to safer assets, resulting in the debilitating of domestic currency. These ideas are associated with currency wars and games of competitive downgrading for trade benefits among nations. For instance, if a nation falsely depreciates its currency to make exports less expensive and more competitive in world markets.
All economic transactions between a country’s residents and the rest of the world over some years are reflected in its Balance of Payments (BoP). It includes the current account, capital account, and financial account. The current account illustrates goods, services, income, and transfer transactions, while the capital account transfers non-financial assets (Krugman et al., 2014). The monetary account measures the flow of financial assets and liabilities among residents and non-residents.
Therefore, the BoP measurement is basic in international economics because it explains how a country’s economy interacts with the rest of the world. It assists in assessing economic health, recognizing and distinguishing financial imbalances, and designing fitting policy actions (Krugman et al., 2014). For instance, an enduring current account deficit indicates overconsumption or structural weaknesses in the economy, requiring fiscal and monetary policy adjustments to accomplish balance.
A Balance of Payments deficit arises when a nation’s imports of goods, services, and transfers are bigger than its exports. The significant sources of deficits are overspending by the government, overvalued currency, and low competitiveness in exports. For instance, when a nation imports most of its consumption or investment goods and enjoys such deficits in the BoP. The consequences of running a continuous deficit in the BoP can be perfect. It might result in currency depreciation because of the popularity of foreign currencies, which has a direction on the value of domestic currency (Krugman et al., 2014). Likewise, funds acquired from outside to back a deficit might lead the country to increase levels of external debt, endangering it at whatever point investor sentiments change or when exchange rate fluctuations happen. Besides, constant deficits can show further structural imbalances in the economy, such as low-saving rates or resource misallocation, which could subvert sustainable economic growth.
Assuming that a nation spends more money on bringing in goods and services than sending out trading, that situation is characterized as a trade deficit. Numerous determinants can result in a trade deficit, such as demand patterns of consumers impacted by the exchange rates alongside relative cost advantages (Krugman et al., 2014). For instance, assuming that the demand for imported goods is more than that of domestically created ones by domestic consumers, a trade deficit results.
Disadvantages of a trade deficit include employment losses for industries that rival imports and increased external debt because the nation borrows money to support the shortfall (Krugman et al., 2014). Furthermore, a prolonged adverse trade balance deepens the uncompetitiveness of domestic companies in competitive industries under tension from less expensive imports. However, positives in a trade deficit incorporate the accessibility of diversified goods and services at competitive prices, which benefits consumers and promotes economic efficiency.
The Law of One Price says that goods should be priced similarly when expressed in a common currency in competitive markets. PPP generalizes this plan to the exchange rates, contending that the currency should change over the long haul so that identical products have equivalent prices in various countries when expressed in a single foreign currency (Krugman et al., 2014). The concepts are connected because they manage price equality across various markets and countries. In other words, PPP implies that the exchange rates should reflect relative price levels to ensure equivalent pricing of goods in foreign countries (Lazarski Open Courses, 2020). For instance, when the price of a basket of goods in the US is higher than that in Europe, then PPP would suggest that The dollar should devalue against the euro to even out their prices. Departures from PPP could signal arbitrage opportunities or mispricing inefficiencies that can impact international trade and investment flows.
References
Krugman, P. R., & Obstfeld, M. (2014). International economics: Theory and policy. Pearson Education.
Lazarski Open Courses. (2020, October 3). 01. International Economics and Finance (IEF): Overview of the course. YouTube. https://youtu.be/f0ZVKY360aI
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