When we study the international economy, like domestic activity, requires money and the same forces which lead to convergence on a single domestic money lead to convergence on a single domestic money lead the world to convergence on a limited number of international monies. Before World War I, the pound sterling was the international currency; during the interwar period the pound and the US dollar shared the role; then during the Bretton Woods era the dollar became dominant. Over the past 50 years, it appears that number of currencies in the world have proliferated greatly, but there are a few clearly dominant and some of them are less known(Mundell,2003).
The question then arises what if we had only one currency for the entire world. This question has intrigued economists for quite sometime. Just like language is a medium of expression and transmission of information, in the similar way, currency is a medium for exchange and payment. So, just as a common language is the most efficient way to communicate across the countries, on paper a common unit of currency would be the most effective way to communicate prices. A common currency would bring about transparency of prices and economy of transaction (Mundell, 2003). But, on the other hand having a single currency would mean that the value of the commodity bought and sold would only have the value of its worth of buying other commodities. In simple terms, money would be just become money. Its purchasing power would be the result of the adjustment of interest rates and other monetary policy tools in response to inflation or deflation (Rogoff, 2001). Hence today, we live in a multicurrency world where foreign exchange markets and international monetary systems play a major role in the macroeconomics of international finance. Hence it becomes essential for an international manager to study different relationships of the currencies and the trade markets (Bonpasse, 2007).
[...] The entire well being of every human being in this world depends on the international financial system and therefore it should be clearly understood and is an important aspect in the study of international business (Bonpaase, 2007). If there were one global currency, the theories of International finance would not need to exist, but since we live in a multi currency world, the importance of the international financial theory is clearly seen. References Bonpasse, M The single global currency. Newcastle, Me: Single Global Currency Assoc . Buckley, A Multinational finance. London [u.a.]: Prentice Hall. Buckley, A Multinational Finance. 5th ed. [...]
[...] If a country's nominal exchange rate falls and if this fall is an exact compensation for the difference in inflation rate, then its real effective exchange rate is said to remain constant. This is relative purchasing power parity. Absolute purchasing power parity assumes that the exchange rate between two countries will force their purchasing power to equal. This theory is likely to hold for commodities that are easily transportable between two countries but likely to be false for other goods and services, which cannot easily be transported, because transportation costs will distort the parity. [...]
[...] It suggests that the local interest rates reflects a real expected return adjusted for inflationary expectations, when money is made internationally mobile and imperfections in the market are eliminated, local interest rates will be equal to the international real return adjusted for domestic inflationary expectations The formulae for the fisher effect is (Buckley, 2004): = Where, is the difference in interest rates, and, is the expected difference inflation rates. The fourth theory, the expectations theory describes the spot rates and the forward discount. If an investor using the foreign exchange market were not interested in risk, then the forward rate of exchange would depend on what the investors expect the future spot rates to be. If the expected future spot rate is higher than the current spot rate, nobody would sell at the forward rate. [...]
[...] Pilbeam, K International Finance. Macmillan Educ . Rogoff, K Why not a global currency?. The American Economic Review pp. 243--247. [...]
[...] The reason for this is, in the absence of barriers to international capital movements, there is a relationship between the spot exchange rates, the interest rates, forward exchange rates and inflation rates. This is relationship has been described in figure 1 below. This model is known as the 4-way equivalence model (Buckley, 2004). This model describes 4 variables and 5 relationships. The four variables are difference in interest rates, difference n inflation rates, difference between spot rates and forward rates and expected change in spot rates. The 5 relationships are interest rate parity, purchasing power parity, fisher effect, international fisher effect and the expectations theory. [...]
using our reader.