Money Makes the World Go 'Round

Demystifying the Rise and Fall of Monetary Exchange Rates by Anne Siegel

Not long ago, a prominent New York Times article pondered the effect of a strong U.S. dollar on American business. "Rising Dollar Has U.S. Executives Concerned," the headline proclaimed. Indeed, the article bristled with quotes from worried economists, manufacturers, Wall Street forecasters and others, all expressing uncertainty about a situation that at first glance seemed ideal. After all, what could be better than a strong dollar? Isn't that what American business and government wants?

Well, yes and no. Any fluctuation in the U.S. dollar has a potentially major impact on competitiveness, sales and profits. A stronger dollar helps U.S. consumers purchase more foreign goods, which become relatively cheaper. But a strong dollar also hurts U.S. exports because American-made goods become more expensive for overseas consumers.

A similar situation exists for U.S. vs. foreign investment. American companies that have invested heavily in foreign markets are going to see profits drop as the dollar rises. Conversely, foreign-based companies that produce goods in the U.S. will see a rise in profits stemming from this same phenomenon.

In the seesaw environment of world economics, it seems what's good for the goose is often bad for the gander.

Striking the proper balance is the name of the game, and Mohsen Bahmani-Oskooee knows how to play this game well. For the past 16 years, he has been steadily building a reputation as a noted researcher on a number of economic-related topics. These include international reserves, open economy macroeconomics and the economics of exchange rates.

In 1993, a distinguished colleague at the University of Illinois-Chicago remarked that Bahmani-Oskooee demonstrated "high potential in the general field of empirical economics. In the (narrower) field of international reserves, he already achieved world-class status." Bahmani-Oskooee's breakthrough work in international reserves sought to answer the question, "What amount of international reserves does a country's central bank need to hold?"

The question is a crucial one for the financiers who oversee their country's money supply. Each country that is a member of the International Monetary Fund (IMF) is required to retain a certain amount of internationally accepted "stable" currencies - including the U.S. dollar, German deutsche mark, Japanese yen, Swiss and French francs, British pound, etc. - and the required amount of gold.

Bahmani-Oskooee's research focused on the value of gold. Should it be valued at current market rates, or at the lower official rate? Bahmani-Oskooee found evidence that the higher market rate was acceptable for maintaining sufficient reserves. The decision was a popular one among world governments, since it meant that less of a country's wealth needed to be held in reserve.

Bahmani-Oskooee's work with international reserves launched a distinguished and prolific career that currently includes some 80 papers published in textbooks and professional journals. He has studied numerous factors affecting international exchange rates, including the balance of trade, black market rates, inflation, and federal deficits. In addition to his in-depth analysis of the U.S. economy, Bahmani-Oskooee has done extensive work on the Turkish and Iranian economies and, to a lesser extent, the Japanese and Korean economies.

Bahmani-Oskooee has returned to his native Iran on several occasions in conjunction with his research, which has been supported by the Iranian Central Bank. He also has received a UWM Foundation/Graduate School Research Award and a Social Science Research Council Grant. Currently, he is a designated research fellow for the Economic Research Forum (sponsored by World Bank of the International Monetary Fund).

Making the Subject 'Come Alive'

Bahmani-Oskooee, 45, balances his research and publishing activities with a demanding teaching schedule and many administrative duties at UWM. Now entering his sixth year as chairman of the university's economics department, Bahmani-Oskooee has held the position longer than anyone else in the department's history.

And yet, despite these pressing demands on Bahmani-Oskooee's time, he appears focused and calm during an interview. He obviously enjoys his work and sharing his knowledge with others. He painstakingly discusses each step in a particular research study, giving the listener enough information to reach the study's logical conclusion. He demonstrates how the results of one study raise questions that lead to the next study and, in the process, gives a brief glimpse into the methodology of research.

And that's precisely what Bahmani-Oskooee hopes to achieve in his teaching and research. "You have to make the subject come alive," the economics professor repeats often during an interview. "Otherwise, economic theory becomes dry and boring. You have to apply that theory to real-world examples. That's when someone says, 'a-ha!' and it starts to develop real meaning."

Bahmani-Oskooee's work is a prime example of the complexity of modern international economics, which goes far beyond a simple understanding of supply and demand. His work has shown that international exchange rates are affected by such diverse influences as the federal budget deficit and productivity. In turn, exchange rates exert their own influence on the stock market, inflation, world trade and even consumer travel.

Millions of U.S. travelers, for example, have flocked to Mexico since the 1994 devaluation of the peso. Bargain-hunting travelers like New York Times writer Susan Spano have found a haven where the dollar stretches like a limitless expanse of sandy beach. In Oaxaca City, Spano recalls, "I was like someone who suddenly discovers a Filene's Basement in Mexico. Take hotel rates. My third-floor double (room) cost $42." She goes on to recount the thrill of $1.50 taxi rides and discount-priced dinners. "The most I could spend at ... one of the city's fanciest restaurants was $12,"

A similarly rosy picture exists for U.S. travelers heading to other destinations around the world. But, cautions Bahmani-Oskooee, travelers should be aware that inflation gains could easily offset the effects of a strong dollar. He mentions that rising prices in Japan and parts of Europe have made them expensive places to visit.

Devalued Currencies Produce Strikingly Different Results

Although far fewer travelers are putting countries such as Turkey and Iran on their travel itinerary, those countries have experienced dramatic currency devaluation in recent years. Bahmani-Oskooee points out that prior to the Iranian revolution in 1979, about 70 Iranian rials was equal to $1 U.S. By 1993, when Bahmani-Oskooee was invited to make a presentation at an Iranian conference, the official value of the rial had dropped to 1,160 and its black market rate was far higher.

Bahmani-Oskooee continued to study the Iranian economy as its government took action to control its currency devaluation and stem the tide of spiraling inflation. "The Iranian government took a chance by consolidating its many exchange rates into a single rate, and at the same time liberalizing trade," Bahmani-Oskooee says.

The effects on Iran's economy were dramatic. Over a two-year period, demand for the dollar skyrocketed and reached the rate of 7,000 rials per dollar. Iran's Central Bank panicked and the government immediately reversed the policy, setting an artificial exchange rate and limiting imports. That situation exists today, as the rial has stabilized at about 3,000/ $1. "Interestingly, the black market rate has gradually dropped, too," Bahmani-Oskooee says. "That has given me a new area to study: black market economics."

While a depreciating currency spelled trouble for Iran, the same situation had a far different effect in Turkey, Bahmani-Oskooee discovered. He selected Turkey as a case study because a substantial amount of statistical data was available. "This often isn't the case in developing countries," Bahmani-Oskooee comments.

In 1973, 9 Turkish lira was the equivalent of $1 U.S. Today, it takes a remarkable 80,000 lira to buy one dollar. Yet, this dramatic depreciation of Turkey's currency didn't have the devastating effect experienced in Iran. In fact, by 1995 Turkish stock prices had risen to become the fourth highest in the world. The country achieved this distinction by following the same economic prescription as seen in Iran: lift restrictions on the exchange rate and trade. In this case, the effect caused investors to pour money into Turkey's economy, confident that they would be able to control the amount of goods (and money) flowing into and out of the country. "It gave investors and developers more optimism, because they perceived that the risk was lower," Bahmani- Oskooee comments.

These two examples illustrate that economic influences may produce dramatically different results in different countries. Bahmani-Oskooee's work has led him to some conclusions on this subject. "In developing countries, a depreciating currency may lead to an increase in exports, which is good, but also an increase in inflation. If inflation rises higher than wages, average citizens can't afford to purchase goods. Local production eventually will drop."

Although much of Bahmani-Oskooee's work takes a historical perspective, he's actively monitoring current economic trends as well. So what's in store for the U.S. economy? "The U.S. economy is now in good shape," he comments. "We're close to full employment, inflation is low, interest rates are reasonable, the dollar seems to be gaining. Since the economy is strong, a strong dollar will work to our advantage. And the stock market should react favorably to this situation, since good economic news is usually good for the stock market. And a strong dollar is also good news for world travelers, too."

Economics Wasn't His First Choice

Bahmani-Oskooee's enthusiasm for his subject is contagious, but it took many years to emerge. In Iran, high school students must pass a rigorous entrance exam to be among the 10% accepted for college. At the time Bahmani-Oskooee's math-related skills weren't sufficient for him to be accepted into his first choice of subjects, mechanical and electrical engineering. So he had to settle for his third choice, economics.

"I wasn't happy during that first year of college," Bahmani-Oskooee admits. He even re-took the entrance exam, hoping to gain acceptance to the engineering program. But his score still wasn't high enough to switch courses. Bahmani-Oskooee returned to his economic studies with a new determination that attracted favorable attention from his professors. They encouraged him to consider graduate studies in the U.S. Bahmani-Oskooee took their advice and was accepted to Michigan State University. He completed a master's degree in 1979 and a Ph.D. in 1981. (His dissertation was on international reserves.) He joined the UWM faculty later that year.

Bahmani-Oskooee learned a valuable lesson from his educational training that heavily influences his teaching style today. "The reason I wasn't excited about economics in the beginning is that it was all theory and statistics," he says. "When I started taking Ph.D. courses in international economics, it finally became interesting. Why? It suddenly became real for me. Whatever I learned, I was experiencing in the real world."

That revelation has made Bahmani-Oskooee a popular professor with undergraduates and graduates alike. He says he especially enjoys the challenge of "keeping several hundred kids quiet in a large lecture hall" during his introductory macroeconomics course. His ability to make students pay attention - and learn - was officially recognized with a 1984-85 AMOCO Foundation Teaching Excellence Award.

Graduate Students Become Proficient Researchers

Bahmani-Oskooee also has several graduate students studying under his supervision. During a recent interview, Bahmani-Oskooee pointed with pride to a book by a former graduate student that made numerous references to Bahmani-Oskooee's work. These references were earmarked by the former student via a series of Post-It notes, since the book itself was written in Korean. (Bahmani-Oskooee speaks several languages, but Korean is not one of them.) Notable among Bahmani-Oskooee's current students is Aghdas Mirzaie (International Economics Fascinates Student Researcher), whose work examines relationships between productivity, exports and exchange rates.

Another graduate student's interests led to a work-study program in Russia. Mike Barry received a fellowship from the UWM Graduate School's international studies department to spend a year studying the Russian economy. "Imagine," Bahmani-Oskooee remarks, "one of our students has learned enough to advise the Russian treasury department!" Barry plans to return to UWM this summer and will teach an undergraduate course on international finance in Fall 1997 while continuing his Ph.D. studies.

Bahmani-Oskooee encourages his graduate students to find a balance between teaching and research. To his mind, they are a necessary combination. "There's no question research makes us better teachers," Bahmani-Oskooee says. "When students ask questions about current developments in a certain subject, the professor must know what's going on. To do that one must constantly review the literature to understand what others are doing. Beyond that, the professor must detect flaws in others' research; what questions weren't answered? That's how knowledge is advanced."

Bahmani-Oskooee practices this approach, but not only to set a good example for students. It keeps him interested in economics, he says, so that he can instill that spark in others.