FAQ: Forces in the Global Market

Transcription

1 Question 1: How did the European Union evolve, and how is it evolving now? Answer 1: The evolution of trade agreements within Europe, commencing with the Treaty of Rome, was a methodical process encompassing more than half a century. Formerly, if a company was to deliver products by road from Italy to the United Kingdom, the goods would have to check through customs (with the associated paperwork and time), leave Italy, enter France, leave France, and enter the United Kingdom. This was an enormous expense in time and administrative costs. The European Union, formerly known as the European Economic Community (EEC) and then simply the European Community (EC), had a plan to create a single market within Europe by the early 1990s to eliminate customs and the duties. It eliminated individual country border controls, including tariffs and taxes on the passage of people, products, and services within the member states. It has been hugely successful in lowering costs and increasing trade and cooperation among member states. The European Union consists of 27 nations with the largest GDP in the world with over 490 million people (Size and Population, n.d.). In addition, other countries have applied to join the EU in the future. The EU has engaged several initiatives to increase economic and social cooperation with the goal of increasing economic prosperity. The Euro- Mediterranean Process (formerly known as the Barcelona Process) is an arrangement with the countries surrounding the Mediterranean Sea to achieve free trade with the European Union, as well as other economic and environmental objectives. The European Union is also in discussions with the Association of South Eastern Asian Nations (ASEAN) plus South Korea, China, and Japan to enter into trade agreements. Along the same lines, the European Union and Canada signed a joint political declaration in The European Union's influence in South America has also been growing in recent decades. The success of the European Union is largely due to the ability of member nations to reach compromises on many very sensitive and nationalistic issues. Question 2: What are the benefits and challenges associated with North American Free Trade Agreement (NAFTA)? Answer 2: Identifying the benefits and challenges associated with NAFTA depends largely on one's location, position, and political perspective. In the United States, NAFTA is an overwhelming success for businesses. This is based on the ability to ship parts across the U.S. border to Mexico and have them used in manufacturing plants in Mexico, and then the final product is shipped back across the border to the United States for sale all with zero or very low 1

2 tariffs. This takes advantage of the lower labor costs, lower social costs, and virtually nonexistent medical and retirement costs in Mexico. With the trade barriers virtually eliminated, it is just like having a division located in the United States with very low human resource costs. Businesses argue that the lowest cost is necessary to remain competitive in the world marketplace. They also argue and that without NAFTA, the U.S. jobs would be lost anyway. From the worker's point of view in the United States, it appears that 800,000 manufacturing jobs have been eliminated in the United States, and over one million jobs created in Mexico within just a couple of miles of the U.S. border. In addition, NAFTA allows the businesses to play the "Mexico Card" when negotiating with U.S. employees on new contracts. The "Mexico Card" is the threat of moving operations to Mexico unless they accept lower wages and benefits. From the Mexican worker's point of view, there are over one million jobs already created near the U.S. border with more becoming available every year that offer employment and pay that was not largely available before. The Mexican Government views NAFTA as very positive because it provides jobs and the associated tax income. It also reduces the risk of social unrest. Question 3: When and why did Eurodollars begin to be used? Answer 3: With the rebuilding of Europe after World War II and the rising imports of the United States, U.S. dollars flowed out of the United States to various foreign countries. A Eurodollar is any dollar deposited in a bank outside the United States. The bank can either be foreign owned or a foreign branch of the U.S. bank. Since the dollars are outside the United States, they are not subject to the Federal Reserve Board regulations. The reason they are called Eurodollars is because the first deposits of U.S. dollars were placed in Europe. Today it refers to any U.S. dollars on deposit outside the United States, regardless of location. In fact, there are euroyen, which depict Japanese yen on deposit outside of Japan. Since dollars on deposit outside the United States are free of Federal Reserve Board regulations, the bank's costs are lower because it does not have to abide by the rules of the Federal Reserve Board. The Chicago Mercantile Exchange started offering Eurodollar futures and options in the early 1980s. The Eurodollar futures market has developed into the largest futures market in the world. The majority of the Eurodollar futures are usually 6 months and below. The trade in Eurodollars takes place 24 hours a day, is well over $400 trillion per year, and is used to hedge short-term 2

3 financial positions. Question 4: What is the status of the Eurozone? Answer 4: The Eurozone consists of the 16 of 27 European Union countries that use the euro for their currency (Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, and Spain). Several of the countries have mounting deficits. The most significant member of the European Union not to adopt the euro is the United Kingdom. A host of reasons are cited a few of which are as follows: The United Kingdom's economic performance has been much better than the Eurozone countries. The population in the United Kingdom is not declining as it is in the Eurozone countries, creating concern over the payment of pensions in the future. The British created economic tests they feel need to be passed prior to their entry into the Eurozone. The U.K. is concerned over how a switch to the euro will affect other countries part of the British Commonwealth. Question 5: What is the international Fisher effect? Answer 5: The original Fisher effect is that nominal interest rates are equal to the real rate of return plus the forecasted inflation. This formula has been in use for years. Nominal rates are the rates that have not been adjusted for inflation while real rates are the rates that have been adjusted for inflation. Mathematically, the Fisher effect explains the relationship between nominal rates (R), real rates (r), and inflation (h): 1 + R = (1 + r)(1 + h) For example, if the nominal rate is 11% and the inflation rate is 4%, then what is the real rate? = (1 + r)( ) Transposing: 1 + r = 1.11/1.04 3

4 r = r = 6.73% Therefore, the real rate is 6.73%. In many applications, an approximation for the Fisher effect is used because it is so close the equation answer: R ~ r + h Therefore, the real rate would be approximately 7% rather than the 6.73% calculated above. The international Fisher effect posits that a nation with relatively high interest rates will experience decreasing value of its currency and a nation with relatively low interest rates will experience increasing value of its currency, causing the spot rate to change in an equal and opposite direction. Mathematically, the international Fisher effect is as follows: (S 1 S 2 )/ S 2 * 100 = i $ i Where: S 1 = spot exchange rate S 2 = expected spot exchange rate i $ = U.S. interest rate i = EU interest rate For example, if the U.S. and the European Union spot exchange rate is 1$ per 0.81, with the United States interest rate at 7% and the European Union interest rate of 4%, you can expect the value of the U.S. dollar to depreciate by about 3% and thus achieve equilibrium. The reason for the depreciation in the U.S. dollar value is as follows: Because the U.S. has an interest rate of 7%, the expected inflation rate will be 3% higher than the European Union; therefore, it is more expensive to hold U.S. dollars by about 3% per year. Because the difference in interest rates is 3%, here is the example mathematically: (0.81 S 2 )/S 2 = S 2 = 0.03S = 1.03S = S 2 4

5 Therefore, to equalize the interest rate differential, the spot rate changes to $1 per 0.786, which is a depreciation of the U.S. dollar by 3% against the euro. In the long view, there is some evidence that supports the international Fisher effect, with several studies demonstrating currency value decreases in nations with high interest rates. However, demonstrating consistency of the international Fisher effect in the short term is more problematic. The shortterm issues are related to the ability of the capital markets to react quickly and to the multitude of other influences on exchange rates. There is also a distinction that needs to be made between fixed exchange rates and floating exchange rates. If a currency s value with a fixed rate regime goes down, it is called devaluation. On the other hand, if the currency's value with a floating rate regime goes down, it is called depreciation. Question 6: What is the United States posture on establishing trade agreements? Answer 6: Through the offices of the United States Trade Representative (USTR), the United States has been actively engaged in negotiating free trade agreements around the world. The United States requires that any candidate who wishes to enter into a free trade agreement (FTA) with the United States be a member of the WTO and have a trade and investment framework agreement (TIFA) with the United States. Between 2001 and 2006, the United States entered into 12 free trade agreements, with more pending Congressional approval or waiting to be introduced. The first free trade agreement with a South American nation was in 2003, when the Chile free trade agreement was signed. The Chile free trade agreement and other agreements were in negotiations for 13 years, and the free trade agreement went into effect January 1, The Central American free trade agreement Dominican Republic (CAFTA-DR) was signed on August 2, Question 7: Why are free trade agreements controversial? Answer 7: When examining the claims of both free trade and fair trade, each side contends that it reduces poverty. If so, there should be no problem. However, each side claims that the other side does not reduce poverty, but 5

6 increases it. Fair trade advocates contend that free trade is very lopsided, with the advantage going to the richer, larger nation in the agreement. The smaller or poorer nation in the agreement is forced to concede to points that make the agreement unfair, and it becomes dependent on the trade with the larger, richer nation. Furthermore, that poorer nation's natural resources are depleted, making it even poorer. This is dependency theory: Imagine a circle or sphere, and in this sphere we will place all the nations of the world, with the richer nations in the center or at the core. The poorer a nation is, the further from the core it is. So the further from the core the nation is, the more coercive and lopsided the trade agreement will become; therefore, the more dependent that nation on the periphery will become on the core. There are charges that the poor nation s people must work very long hours for very little money. Another point of contention is subsidies. For example, both the EU and United States provide the largest subsidies for agriculture (their farmers), which place other nations at a disadvantage. The free trade advocates say that the best way to reduce poverty is to use the free choice of free trade. They point to the results thus far, which seem to bear this out. They also contend that making decisions to penalize a trading partner or to place tariffs, subsidies, or controls on trade interferes with the efficiency of free trade and the development of prosperity for all nations involved. The free trade argument for long working hours and poor wages in poor nations is that prior to the trade, there was not even this opportunity for the people because there was no work, no wages, and thus greater poverty. Question 8: Why was European Monetary System (EMS) established, and has it been successful? Answer 8: The European monetary system started toward a single currency in 1979, and it took until the end of the 20th century to introduce the euro. In the late 1970s, the U.S. dollar had been weakening, and the world was losing confidence in its strength. Additionally, the U.S. dollar was no longer tied to gold, and currency exchange rates had become much more volatile. Europeans were also experiencing volatility in the exchange rates from one country to another as a result of differing economic and monetary policies in each country. The Europeans also wanted to reestablish Europe to its former economic powerhouse status and center of trade. The Europeans understood that as separate countries, they would never be able to achieve parity with the economic domination of the United States. Therefore, in 1979, the European 6

7 Community (as it was then known) agreed to work toward becoming one market and using one currency. The Treaty of Maastricht, which went into effect in 1993, agreed to the introduction of a single currency (euro) and European Central Bank and, therefore, a common monetary policy. The central bank would be located in Frankfurt, Germany, probably because the Germans demonstrated the strictest fiscal policies and were more or less the most consistent economic engine of the European Community. In 1999, the euro was introduced as the common European currency, and the European Union countries that adopted it are now considered part of the Eurozone. Since the euro's introduction, it has demonstrated more stability in value and strength than the independent European currencies did. The exchange rate to the U.S. dollar continued to improve from , going from 1.17 per dollar to 0.81 per dollar, which represents an increase in value of 32% against the U.S. dollar. Any time the dollar weakens in this manner, there are discussions to move to another currency for international business and the buying and selling of oil. The United States has had an unwritten agreement with Saudi Arabia that oil transactions would be carried out in U.S. dollars, and this has held until recently. Iraq converted its U.S. dollars into euros in 2000 and started transactions in oil using euros as the currency. Iran and China have started transactions using euros instead of U.S. dollars. Venezuela has transacted the sale of oil using bartering rather than using U.S. dollars. In addition, the largest share of the oil from the Middle East goes to Europe. Therefore, the reasons are increasing to move away from the U.S. dollar as the main currency for international business and oil. In 2001, 75% of the monetary reserves of the oil-producing nations in the Middle East were U.S. dollars. At the end of 2004, this had fallen to 61% with much of the balance invested in euros (Kaplan, 2004). The strongest alternative to the U.S. dollar at the moment is the euro. The Chinese yuan is also a possible contender moving forward. Reference Kaplan, F. (2004, December). China expands. Europe rises. And the United States. New York Times, 4(6). Size and population. (n.d.). Retrieved from the European Union Web site: 7