International: FX, Flows & the Dollar

Learning objectives

By the end you can:

1. Say what an exchange rate is: the price of one money in units of another. Read both quote conventions without fumbling the direction of appreciation and depreciation, and distinguish the nominal rate from the real rate and the trade-weighted REER that actually measure competitiveness.
2. Explain the five forces that move a currency: interest-rate differentials (and the carry trade), purchasing-power parity as a long-run anchor and why it fails short-run, terms of trade, safe-haven flows, and relative growth/productivity. Say which dominate over which horizon.
3. Compute a no-arbitrage forward rate with covered interest parity (CIP), explain why the higher-yielding currency trades at a forward discount, show the arbitrage that enforces it, and state why uncovered interest parity fails in practice (the reason the carry trade earns money — until it doesn't).
4. State and apply the impossible trinity: a country may have at most two of {a fixed exchange rate, free capital mobility, an independent monetary policy}. Classify real regimes by it (India's managed float, China, the eurozone, a Gulf peg, Hong Kong's currency board), including Rey's argument that it may really be a dilemma.
5. Read the balance of payments: the current account (trade + income + transfers) versus the capital/financial account, why the two must sum to (near) zero, why FDI is sticky and portfolio "hot money" is flighty, and the twin-deficits identity linking the fiscal and external balances.
6. Explain comparative advantage and its gains from trade from a worked numeric, and its distributional caveat (winners and losers, the China shock) presented fairly. Explain who actually bears the cost of a tariff, and describe global value chains and the reshoring/friend-shoring shift.
7. Explain global capital flows and EM sudden stops: Rey's global financial cycle (US monetary policy and risk appetite as the world's factor), the 2013 taper tantrum and the "Fragile Five" (India among them), and the specific buffers India built afterward.
8. Explain the US dollar system: its ~57–58% reserve share (verify), exorbitant privilege, the Triffin dilemma, the de-dollarization debate presented evenhandedly, the eurodollar (offshore-dollar) system, and Fed swap lines as the crisis backstop. Read oil, gold, and copper as macro signals.
9. Quantify the currency risk of cross-border investing: an Indian buying US assets is implicitly long USD/short INR, the INR's structural depreciation follows from the inflation differential, and FX can dominate the equity return in any given year. Reason about hedged versus unhedged for both an Indian in US assets and a US investor in India.

Prerequisites & connections

Builds on. M7.02 (§4.4) set up the FX-intervention and managed-float material, and this is its formal payoff: the impossible trinity is stated there and proved here, and sterilized intervention, the RBI's reserve management, and the Fed's swap lines all reappear with their full mechanics. From M7.01, S = I and the current account as S − I is the accounting spine of §4.5, and the credit cycle is what floods across borders in §4.7. From M7.03, real versus nominal rates and the real (TIPS) yield: the real yield drives both currencies and, decisively, gold (§4.10), and relative inflation is what drives the INR's structural depreciation (§4.11). From M7.04, fiscal deficits and sovereign crises: the twin-deficits identity (§4.5) is the bridge from the fiscal balance to the external balance, and a sudden stop (§4.7) is the external face of the sovereign crises you studied. From M7.05, cycles and crises: Asia 1997 was the archetypal sudden stop, and the global financial cycle (§4.7) is the cross-border version of the credit cycle. From M3.01–M3.03, discounting, the country-risk premium, and Damodaran's currency-matched risk-free rate: valuing a company in rupees versus dollars is a currency choice, and §4.11 is where cost-of-capital work meets FX. From M0.03, real versus nominal (Fisher): relative PPP is Fisher applied across two countries. And from M5.06, IT services: an Indian exporter's dollar revenue is the single most important company-level FX exposure in the Indian market, and it runs through everything below.