The Foreign Excahnge Market
Much of the study of international finance is like a trip to another planet. It is a strange land, far removed from the economics of an ordinary household. It is populatd by strange creatures--- hedgers, arbitrageurs, the Gnomes of Zurich, the Snake in the Tunnel, the gliding band, the crawling peg.
It is an area in which it is unsafe to to rely on ordinary household intuition. In fact, it is an area in which you cannot apply ordinary micro- or macroeconomic theory without major modifications.
Yet the student of international finance is helped by the presence of two familiar forces: profit maximization and competition. The familiar assumption that individuals act as though they are out to maximize the real value of their net incomes ('profits') appears to be at least valid in international financial behavior as in other realms of economics. To be sure, people act as though they are maximizing a subtle concept of profit, one that takes account of a wide variety of economic and political risks.
Yet the parties engaged in international finance do seem to react to changing conditions in the way that a profit-maximizer would.
It also happens that a competition prevails in a most international financial markets, despite a folklore full of tales about how groups of wealthy speculators manage to corner those markets.
There is competition in the markets for foreign exchange and in the international lending markets. Thus, for these markets, once can
repair to variants on the familiar demand and supply analysis of competitive markets. Here again, it is important to make one disclaimer: it is definitely not the case that all markets in the international arena are competitive.
Monopoly and oligopoly are very evident in most of the direct investment activity. Ordinary demand and supply curves would not do justice to the facts in these areas. Yet in the financial markets that play a large role, competitive conditions, do hold, even more so than in most markets usually thought of as competitive.
What gives international finance its esoteric twist, is the existence of national moneys. This makes a big difference. In ordinary microeconomics, one usually discusses how the price of one good in terms of other goods matters and what determines it. Macroeconomics discusses how the money supply relates to goods and bonds and work. Yet there are many money supplies and monetary policies as there are sovereign nations. There are also the same number of separate interest-rate structures and government fiscal policies. It is the existence of these national currencies and financial structures that poses a special challenge to both students and business executives.
