1.

Did the intervention effort by the Thai government constitute direct or indirect
intervention? Explain.

The intervention effort by the Thai government constituted direct

intervention, since the government exchanged dollar reserves for baht in order
to strengthen the currency. This action would increase the demand for baht
and the supply of dollars for sale, which puts upward pressure on the baht. In
indirect intervention, a central bank attempts to influence the value of a
currency by influencing the factors that determine it. For example, if the Thai
government wanted to strengthen the baht, it could have increased interest
rates by decreasing the Thai money supply.

2. Did the intervention by the Thai government constitute sterilized or

nonsterilized intervention? What is the difference between the two types of
intervention? Which type do you think would be more effective in increasing
the value of the baht? Why?

The intervention by the Thai government constituted nonsterilized

intervention.

Using nonsterilized intervention, a central bank intervenes in the

foreign exchange market without adjusting for the change in money supply.
Using sterilized intervention, a central bank intervenes in the foreign exchange
market while retaining the money supply. Since the Thai government
exchanged dollar reserves for baht in the foreign exchange market, the dollar
money supply is increased.

An increase in the money supply may decrease U.S. interest rates,

which may additionally weaken the dollar with respect to the baht. Therefore,
nonsterilized intervention may compound the desired effects of the
intervention effort. If the Thai government’s objective is to increase the value
of the baht, nonsterilized intervention may be more effective.
3. If the Thai baht is virtually fixed with respect to the dollar, how could this
affect U.S. levels of inflation? Do you think these effects on the U.S. economy
will be more pronounced for companies such as Blades that operate under
trade arrangements involving commitments or for firms that do not? How are
companies such as Blades affected by a fixed exchange rate?

Under a fixed exchange rate system, inflation may be exported from

one country to another. For example, if Thailand experienced relatively high
levels of inflation during a fixed exchange rate system, Thai consumers may
have switched some of their purchases to U.S. products. Similarly, U.S.
consumers may have reduced their imports of Thai goods. This would send
Thai production down and unemployment up. Also, it could cause higher
inflation in the U.S. due to the excessive demand for U.S. products. Thus, the
high inflation in Thailand could cause high inflation in the U.S.

For companies such as Blades, this effect would probably be more

pronounced as their cost of production would rise, but they export at a fixed
price.

4. What are some of the potential disadvantages for Thai levels of inflation
associated with the floating exchange rate system that is now used in
Thailand? Do you think Blades contributes to these disadvantages to a great
extent? How are companies such as Blades affected by a freely floating
exchange rate?

A freely floating exchange rate may compound Thailand’s

inflationary problems. For example, if Thailand experiences high levels of
inflation, the baht may weaken. In turn, a weaker baht can cause import prices
to be higher, which can increase the prices of Thai materials and supplies and
thus increase the price of finished goods. Additionally, higher foreign prices
(from the Thai perspective) can force Thai consumers to purchase domestic
products.
 Blades does not contribute to these problems, as both its exports and
imports are denominated in baht. Consequently, a weaker baht would have no
direct impact on companies importing from Blades.

Blades could still be affected by a freely floating exchange rate

system, as it is now subject to exchange rate risk when converting the net baht
received to dollars.

5. What do you think will happen to the Thai baht’s value when the swap
arrangement is completed? How will this affect Blades?

Under the terms of the agreement, completion of the swap

arrangement requires Thailand to reverse the swap of its baht reserves for
dollars. Specifically, it will have to exchange dollars for baht at a future date.
Due to the decline in the value of the baht, however, Thailand’s central bank
will need more baht to be exchanged for the dollars needed to repay the other
central banks. The purchase of dollars by the Thai government in the foreign
exchange market will increase the demand for dollars and the supply of baht
for sale, which will put downward pressure on the value of the baht.

Since Blades has net inflows in baht, it will be negatively affected by

the completion of the swap agreement if the actions needed to complete the
agreement result in further weakening of the baht.