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IBL IIChapter 6. Money & Banking
I. Money
Money is anything customarily used as a medium of exchange and measure of value. There are 3
characteristics to money; 1) it acts as a means of exchange, 2) as a unit measure of value and 3) as
a medium for storing value over time.
Money ben both be private and official. Private money can only be used for making payments
between private parties who agree in advance to its use. Most official money can be used to pay
debts of any kind. Some types of official money, however, can only be used by governments to pay
other governments (reserve currencies).
The value of money
The value of money is nominally consistent; if one agrees to purchase something for 100 units of a
specified currency, the obligation can be discharged only by paying those particular 100 units. The
obligation does not change because the purchasing power or conversion value of the currency has
fluctuated; nominalism. Application of this principle can be avoided in the special case where
currency is to be delivered not as money, but as a commodity.
The choice of money
In domestic transactions, obligations are paid in local currency. In international transactions, the
parties must designate the money that the buyer has to deliver. 2 monies have to be accepted.
First the money of account; the money that expresses the amount of obligation owed. Second
the money of payment; the money that the buyer must use to pay for the items purchased. In
most situations, the money chosen for both will be the same. In addition, contracting parties need
to select the place of payment. If there is no selection made, the courts will determine the place of
payment and that determination can vary from country to country.
By making these decisions, the parties to contract are also authorizing the courts in the states that
issues these monies or the court in the state where the payment takes place to take place in
resolve disputes related to the interpretation or performance of the contract.
Maintaining monetary value
The maintenance of value clause in the contract is a contractual provision that says that the
price will be adjusted according to the inflation rate. A seller of commodities can also avoid the
problem of inflation by designating a money of account that traditionally maintains is value.
A third way of avoiding this is to use the currency basket. This is a selected group of currencies
whose weighted average is used to define the amount of an obligation. The basket (or group) may
be created ad hoc for a particular agreement.
II. National Monetary Systems
There are 3 types of organizations that operate on the national plane to implement national
monetary policies. At the highest level is a political agency of the national government that sets
national fiscal policy and carries on the financial functions of the government. For most countries
this is a cabinet-level agency.
At the next level there is a central bank. In most countries, it is owned by the national
government, but through a variety of mechanisms, the bank is given some degree of independence
from the government and from the day-to-day pressures of politics. Its most important functions
are;
1. To issue bank notes and coins
2. To regulate the quantity of money in circulation
3. To maintain and invest currency reserves
4. To act as a lender of last resort
At the third level are the commercial banks that accept and manage deposits, make loans and
offer trust services. Commercial banks can be owned privately or by the government.
Bank deposits
Bank deposits are monies placed with a bank for its use. “Deposit” suggests the notion of a
bailment which implies that a bank has an obligation to keep the funds it receives in a vault for
safekeeping. This is not the case. Except for monies delivered for a designated purpose, deposits
become a bank’s funds. A bank can commingle them and use them as it sees fit. Most commonly
banks use these funds to make short- and medium-term loans. The depositor receives a claim
against the bank as a general, unsecured creditor. For some accounts, a depositor acquires the
authority to write checks, payment orders, or drafts for the benefit of third parties, with the value of
checks, orders, or drafts being deducted from his/her claim.
,IBL II
Commonly, banks pay interest on the monies they hold in deposit; however, not always.
Eurocurrency deposits
Eurocurrency deposits are foreign currency on deposit in a bank, on which the bank pays
interest in the same foreign currency. These are often free of the monetary control restrictions
imposed by their issuing country.
Interbank deposit market
A variety of short-term liquid instruments are traded in the interbank market, but most commonly is
the certificate of deposit (CD). This is a form of commercial paper, defined as an instrument
containing an acknowledged by a bank that a sum of money has been received by the bank and a
promise by the bank to repay that sum of money.
The foreign exchange market
Foreign exchange is the conversion of the money of one state into that of another state. The
foreign exchange market is an informal network of banks, foreign exchange brokers, and foreign
exchange dealers who facilitate the exchange of currencies. Despite the name, the foreign
exchange market does not exist in any place.
Hard currencies, the currencies of the major free-market nations, are freely exchangeable. The
currencies of developing countries are commonly called soft currencies because they are not freely
exchangeable.
A correspondent bank is a bank that acts as an agent of another bank, especially in carrying a
deposit balance for the latter.
Normally there are 2 major actors in the foreign exchange market; the commercial and central
banks. In addition, arbitrageurs, importers, exporters, multinational firms, tourists, governments
and intergovernmental organizations may become involved. The transaction itself is generally
unregulated, although governments in developing countries sometimes impose licensing
requirements on banks and traders and often require that all exchanges be made through their
central banks.
Commercial banks participate in the foreign exchange market both as intermediaries for importers,
exporters, multinational corporations and as correspondent banks in the interbank marketplace.
They play 3 roles;
1. They operate the payment mechanism
2. They extend credit
3. They help reduce the risk of international transactions
Central banks participate as lenders of last resort and as regulators of currency exchange rates. In
addition to providing funds for local transactions when no other funds are readily available, central
banks may independently intervene in the foreign currency market to maintain orderly trading
conditions. This sometimes involves the purchase of weaker currencies.
In making currency exchanges, traders typically use a widely traded intermediary currency. The
most commonly used currency is the American dollar.
Foreign exchange contracts
Foreign exchange contracts may be made as spot, future, forward or option contracts.
A spot contract is a transaction involving the immediate sale and delivery of a commodity, such
as a currency.
A future contract is a promise to buy or sell a commodity for a specified price, with both delivery
and payment to be made at a specified future date. Such contracts are both standardized and
transferable. Trading in futures, seldom results in the physical delivery of the commodity. More
often, the obligations of the parties are extinguished by offsetting transactions that produced a net
profit or less. Futures are primarily used as a way to transfer price risks from suppliers, processors,
and distributors (called hedgers when they become parties to these hedging contracts) to those
who are more willing to take the risk (speculators).
A forward contract is a transaction in which a commodity is presently sold, and the price
presently paid but the delivery is, by agreement, delayed to a later date. A forward contract is
generally negotiated individually by the parties who will actually make and receive physical delivery
of the goods involved.
An option contract creates the right to buy or sell a specific amount of a commodity at a fixed
price within an agreed-upon period of time. If the right is to buy a commodity, the option is known
as a call; if the right is to make a sale, the option is known as a straddle or spread eagle. The holder
of an option is not required to go through with the transaction. The holder must pay a fee or some
other consideration to acquire the option, but the total risk assumed in purchasing it is the loss of
that fee.
,IBL II
Arbitrage
Arbitrage is the nearly simultaneous purchase of currencies in one market and their resale in
another in order to profit from the price differential. Offers have to be accepted immediately, and
then performed regardless of a later dispute. If there is a dispute, traders commonly split the
difference.
The transfer of money
A bank transfers money internationally by setting up a correspondent bank relationship with foreign
bank and depositing funds to its own account in that bank. When a customer goes to his bank and
asks to transfer money overseas, the bank accepts the customer’s money at its domestic office,
then arranges for the correspondent bank to disburse funds in the foreign country to whomever the
customer has designated. This may be done by instruction; order to a bank to disburse funds to a
particular person. In this case the domestic bank directs its correspondent to pay funds directly to a
particular payee. It may also be done by the use of a bill of exchange. This is a three-party
instrument on which the drawer makes an unconditional order to a drawee to pay a named payee.
Here the bill is given to the customer, who in turn sends it to the payee. The payee then cashes it at
the correspondent bank.
Branch banking
International banks prefer to operate in host countries through branches rather than subsidiaries.
On the one hand, host countries impose few regulations limiting the operations of foreign banks. On
the other hand, they assume few supervisory responsibilities. Foreign banks do not have to
maintain reserves to cover potential losses. Foreign banks, however, cannot turn to the host
country’s central bank as a lender of last resort.
Although host states generally impose minimal regulations on foreign branches, the presence of a
foreign branch has sometimes been used as a means to obtain information from a foreign parent
bank.
From the perspective of a parent bank, the foreign branch is often treated as a separate business
unit, with its own profit-and-loss statement, its own foreign tax liabilities, and its own separate
account with the parent bank.
In terms of home state law, the treatment of foreign branches is not so easy. There is often
inconsistency, both between and within states. Sometimes foreign branches are treated as peculiar
separate entities; for example; statues commonly require a parent bank to get permission from its
home state banking authority before it may establish a foreign branch. Sometimes, however, home
country statues and courts treat foreign branches are mere extensions of their parents. Courts have
held that a parent bank can be ordered to freeze the account of a foreign corporation in the bank’s
foreign branches. And courts commonly hold that a parent bank liable for the debts incurred by its
foreign branches because the branch is subject to the supervision and control of the parent.
Chapter 7. Trade in goods
I. The world trade organization
The world trade organization (WTO) is an intergovernmental organization responsible for;
1. Implementing, administering and carrying out the WTO agreements and its annexes
2. Acting as a forum for ongoing MTNs
3. Serving as a tribunal for resolving disputes
4. Reviewing the trade policies and practices of WTO member states
Additionally, the WTO is to cooperate with the IMF and the World Bank in order to achieve greater
coherence in global economic policymaking.
The WTO agreement
the provisions of the WTO Agreement are exclusively institutional and procedural. it in essence
establishes a legal framework to bring together the various trade pacts that were negotiated under
GATT 1947. Thus, the WTO was created as a unified administrative organ to oversee all of the
Uruguay round agreements. This unification solves 2 problems that hampered the old GATT. First,
because GATT 1947 dealt with trade in goods, there was no obvious mechanism for handling
agreements relating to trade in services and the protection of intellectual property rights. The WTO
Agreement which separates the institutional concepts from the substantive rules, eliminates this
difficulty. Second, because the ITO never came into existence, the old GATT had no formal
institutional structure. The establishment of the WTO rectifies this.
The WTO is not substantially different than the old GATT. The WTO is to be guided by the
procedures, customary practices and decisions of the old GATT.
, IBL II
Membership of the WTO
In order to join the WTO, a nation must complete an accession agreement, which must be approved
by all WTO members. The negotiations with the many nations and various groupings within the
WTO are lengthy and complex.
States that were member of GATT 1947, along with the EU, were eligible to become original
members. These members agreed to adhere to all the Uruguay round multilateral agreements and
to submit their schedules of concessions and commitments concerning services within a year after
joining. Original member states that are recognized by the UN as being the least developed states
were required to undertake only commitments and concessions consistent with their individual
development, financial and trade needs and within their administrative and institutional
capabilities. They also were given an additional year in which to submit their schedules.
A state that did not qualify for admission as an original member must negotiate entry into the WTO
on terms to be agreed on between it and the WTO and approved by the WTO ministerial Conference
by 2/3 majority of the member states of the WTO. These negotiations are very complex.
At the time a state becomes a member, it may take advantage of article XIII. This provision allows
one member state to ignore another member state’s participation in the WTO agreement or in the
multilateral trade agreements.
A member may withdraw from the WTO six months after notifying the director-general of its
intention to do so.
Structure of the WTO
The WTO has 5 main organs;
1. A ministerial conference
2. A general council; also functions as the WTO’s dispute settlement body and trade policy
review body
3. A council for trade in goods
4. A council for trade in services
5. A council for trade-related aspects of intellectual property rights
The ministerial conference and the general council are made up of representatives from all the
member states. The general council names the members of the other main organs.
In addition to the main organs of the WTO, there is also a secretariat headed by a director general
who is appointed by the ministerial conference.
The director-general of the WTO is responsible for supervising the administrative functions of the
WTO. Because WTO decisions are made by member states (through either a ministerial conference
or the general council) the director-general has little power over matters of policy, other than his or
her ability to negotiate, mediate and persuade. The role is largely managerial. The director-general
is appointed by WTO members for a term of 4 years and supervises the WTO secretariat.
Ministerial conference
Meets at least every other year to oversee the operation of the WTO. Five standing committees
deal with 1) trade and development, 2) balance-of-payments restrictions, 3) budget, finance and
administration, 4) trade and the environment and 5) regional agreements.
General council
Carries on the functions of the ministerial conference in the intervals between the meetings of the
conference. It also functions as the WTO dispute settlement body and the WTO trade policy review
body. Each of these bodies has its own chairman. In addition, the three subordinate councils (trade
in goods, trade in services and trade-related aspects of intellectual property rights) function under
the guidance of the council to oversee the implementation and administration of the three main
WTO agreements.
The council is responsible for making agreements for effective cooperation with other
intergovernmental organizations whose responsibilities are related to the WTO and for consultation
and cooperations with NGOs involved in matters of interest to the WTO.
Decision-making
The WTO Agreement says that the WTO will continue the practice of decision making by consensus
followed under the GATT 1947. Consensus is the making of a decision by general agreement and
in the absence of any voiced objection. The WTO, however, can make a decision by a vote if a
consensus cannot be reached. At meetings of the ministerial conference and the general council,
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