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 92

CHAPTER 7
The International Monetary
System and the Balance of Payments
Chapter Objectives

After studying this chapter, students should be able to:

1. Discuss the role of the international monetary system in promoting

international trade and investment.
2. Explain the evolution and functioning of the gold standard.
3. Summarize the role of the World Bank Group and the International
Monetary Fund in the post-World War II international monetary system
established at Bretton Woods.
4. Explain the evolution of the flexible exchange rate system.
5. Describe the function and structure of the balance of payments
accounting system.
6. Differentiate among the various definitions of a balance of payments
surplus and deficit.

LECTURE OUTLINE

OPENING CASE: Will the Stars Shine on Astra Again?A Global Currency War

PT Astra is one of the oldest and largest conglomerates in Asia, at one point having
employed 125,000 people. After borrowing in dollars from foreign banks, Astra's fortunes
plummeted with the collapse of the Indonesian rupiah. A new president installed in
1998, Rini Soewandi, did much to turn the company around until her ouster in 2000.
Now, with deals struck with the Indonesian Bank Restructuring Agency (IBRA) and the
International Monetary Fund (IMF), Indonesia and Astra may again have reason to be
optimistic.This section explores the issue of the global utilization of exchange rates to
create international currency wars in an attempt to gain a domestic competitive
advantage.

Key Points

• Astra was a domestically oriented firmThe currency wars erupted in the aftermath of
the Global Recession of 2008-09.

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• Even so, it was not impervious to international competitive issues, such as changes
in the value of the Indonesian rupiahExchange rates have become the weapon of
choice.

• As global competition increases, domestically protected companies face greater and

greater challenges internally and outside of their countryPoliticians have long been
concerned that foreign nations may manipulate currencies to make goods more
attractive to consumers.
Formatted: Colorful List - Accent 1, Left, No bullets or
• The section provides specific examples of currency manipulations. numbering

Formatted: Colorful List - Accent 1, Left, No bullets or

• Easy money policies promote growth, but may also trigger currency wars numbering

CHAPTER SUMMARY

Chapter Seven explores the international monetary system and the balance of
payments. The chapter traces the history of the international monetary system
beginning with the gold standard and ending with the current system of a managed float.
It then goes on to examine the different accounts and balances in the balance of
payments.

HISTORY OF THE INTERNATIONAL MONETARY SYSTEM

• The international monetary system establishes the rules by which countries value
and exchange their currencies. It also provides a mechanism for correcting
imbalances between a country’s international payments and its receipts.
• The accounting system that governs the international monetary system is the
balance of payments (BOP). The BOP records international transactions and
supplies vital information about the health of a national economy and likely changes
in its fiscal and monetary policies.

Teaching Note:
Students may find it helpful to use a timeline when discussing the
different exchange-rate systems that have taken place over the last
century.

The Gold Standard

• The gold standard, under which countries agreed to buy and sell their paper
currencies in exchange for gold on the request of any individual or firm, was the
international monetary system in place in the nineteenth century.
• The gold standard had the effect of creating a fixed exchange rate system because
each country tied or pegged the value of its currency to gold. An exchange rate is
the price of one currency in terms of a second currency. The par value of a
currency is its official price in terms of gold.
• For nearly a century (from 1821 until 1918), the most important currency in
international business was the British pound sterling; thus, the international monetary
system was frequently referred to as the sterling-based gold standard during this
time.

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94

The Collapse of the Gold Standard

• As countries suffered through the economic chaos of World War I, the sterling-based
gold standard came unraveled; however, it was readopted in the 1920s.
• In spite of its resuscitation, the gold standard ended in 1931 when Britain, under
pressure to honor guarantees made under the system, allowed its currency to float
(the pound’s value was determined by the forces of supply and demand).
• While some countries, primarily those in the British Commonwealth, pegged their
currencies to the pound after the gold standard was abandoned, others linked their
currencies to the U.S. dollar or the French franc. In addition, many countries
engaged in a beggar-thy-neighbor policy, in which nations deliberately devalued
their currencies in the hope of making their goods cheaper in the world marketplace.
Figure 7.1 should be discussed here.

The Bretton Woods Era

• In 1944, representatives of 44 countries met to construct a postwar international

monetary system that would create an environment of worldwide peace and
prosperity. The representatives agreed to renew the gold standard on a modified
basis, and they created two new international organizations, the International Bank
for Reconstruction and Development and the International Monetary Fund, to assist
the rebuilding of the world economy and monetary system.
• The International Bank for Reconstruction and Development, also known as the
World Bank, was established in 1945 to finance reconstruction of war-torn European
economies, and when this was completed, focused on building the economies of
lesser-developed nations.
• The World Bank has created three affiliated organizations: the International
Development Association, the International Finance Corporation, and the Multilateral
Guarantee Agency, which together comprise the World Bank Group. See Figure
7.2 here.
• The World Bank lends only for “productive purposes” and follows a hard loan policy
(it makes loans only if there is a reasonable expectation that they will be repaid).
• The International Development Association (IDA) was established in response to
criticism from poorer countries that World Bank policies favored countries well along
the path to economic development. The IDA offers soft loans (those that bear
significant risk of not being repaid).
• The International Finance Corporation (IFC) is charged with promoting the
development of the private sector in developing countries, while the Multilateral
Investment Guarantee Agency (MIGA) encourages direct investment in developing
countries by offering private investors insurance against noncommercial risk.
• Regional development banks parallel the efforts of the World Bank as they
promote the economic development of poorer countries within their regions. The text
provides an example of how the Asian Development Bank and the World Bank
coordinated their efforts to finance a hydroelectric power plant in Nepal.

EMERGING OPPORTUNITIES
Frog Ranching in Peru
This section describes the World Bank Group’s attempt to help poor Peruvian
campesinos (subsistence farmers) improve their livelihood. It financed a new
Peruvian company, Forests and Frogs, which will raise and export poison-dart frogs.

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Poor peasants are being trained to gather and nurture the amphibians’ eggs.
Forests and Frogs believes it can double the peasants’ income once the project is
underway.

• The International Monetary Fund. The International Monetary Fund’s (IMF) primary
responsibility is to oversee the functioning of the international monetary system.
• To join the IMF, countries must pay a deposit, called a quota. Quotas are important
because they determine a country’s voting power within the organization, serve as
part of a nation’s official reserves, and determine a country’s borrowing power from
the IMF.
• A country is allowed to borrow up to 25 percent of its quota from the IMF. Additional
borrowings require that countries agree to IMF conditionality.
• A Dollar-Based Gold Standard. Under the international monetary system
established at Bretton Woods, all countries agreed to peg the value of their
currencies to gold (the dollar was pegged to gold at a value of $35 per ounce).
Thus, the agreement was a fixed exchange rate system. In addition, the United
States agreed to redeem the dollar for gold at the request of foreign central banks.
In this way, the dollar played a key role in the Bretton Woods system.
• The Bretton Woods system provided a generally stable environment for international
business because under the agreement, each country agreed to maintain the value
of its currency within ±1 percent of its par value.
• An additional feature of the Bretton Woods agreement was an adjustable peg
mechanism that allowed a country to alter the value of its currency in extraordinary
circumstances. The text provides an example of the circumstances that prompted
Great Britain to readjust the pound’s peg value in 1967.

The End of the Bretton Woods System

• The reliance on the U.S. dollar eventually led to the downfall of the Bretton Woods
system. Since the supply of gold did not expand in the short term, the dollar became
the source of additional liquidity to finance expanding international trade. However,
as foreign dollar holdings began to increase, doubt about the ability of the United
States to live up to its Bretton Woods obligation began to rise.
• The Tiffin paradox arose because foreign banks needed to increase their holdings
of dollars to finance expansion of international trade, but the more dollars they
owned, the less faith they had in the ability of the United States to redeem the dollars
for gold.
• The IMF attempted to alleviate the situation by creating an additional source of
international liquidity, the special drawing right (SDR). The SDR, a weighted
average of the market value of five major currencies, is used by IMF members to
settle official transactions at the IMF.
• The SDR did not have the desired effect of reducing the glut of dollars held by
foreigners, and by 1971, it became clear that the United States did not have enough
gold to meet the demand of those who wanted to exchange dollars for gold. Nixon
officially ended the system, and currencies began to float against each other.
• The fixed exchange rate system was restored at the Smithsonian Conference (see
Table 7.1) in late 1971. Under the new agreement, the dollar was devalued to $38
per ounce of gold, and the par value of strong currencies was revalued upward. In
addition, the band of fluctuation within which currencies were allowed to fluctuate
was widened to ± 2.25 percent.

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Performance of the International Monetary System since 1971

• The Smithsonian Conference agreement proved to be short-lived as central banks

conceded they could not successfully resist free-market forces. Since 1973, many
currencies have operated under a flexible (or floating) exchange rate system,
within which currency values are determined primarily by supply and demand.
Occasionally, a central bank will intervene and affect exchange rates leading to the
term “managed float” or dirty float. See Table 7.2 for a list of today’s most
important central banks.

BRINGING THE WORLD INTO FOCUS

Fixed Versus Flexible Exchange Rates
This box discusses how the fixed and flexible exchange rate systems each reach
equilibrium – the fixed system through the purchase and sale of gold, the flexible
system through changes in supply and demand (and therefore value) for a country's
currency.

• Under the Jamaica Agreement, established in 1976, each country was free to adopt Formatted: Font: Bold
whatever exchange rate system best met its requirements. Some countries (i.e., the
United States) chose a floating exchange rate, while others opted for a fixed
exchange rate system by pegging their currencies to another. Crawling pegs allow
the peg to change gradually over time.
• The European Monetary System (EMS) was established by EU members in 1979
to manage currency relationships among themselves. Most EMS members
participate in the exchange rate mechanism, in which participants maintain fixed
exchange rates among their currencies (within a ±2.25 percent band) and a floating
rate against the U.S. dollar and other currencies.
• The EMS members also created a new index currency, the European Currency
Unit, which is a weighted “basket” of the currencies of the EU members that is used
for accounting purposes within the EU.
• While the EMS has been helpful in curbing inflation and in promoting intra-EU
investment, it has also been adjusted 39at times because of differences in the
monetary policies of EU members.
• The current international monetary system is based on flexible exchange rates,
although some countries (i.e., the EU) have chosen to maintain fixed exchange-rate
systems.
• Other Postwar Conferences. The world’s central banks meet periodically to iron out
policy conflicts among themselves. One such meeting, the Plaza Accord (held in
1985), resulted in an agreement to let the dollar’s value fall. Table 7.1 can again be
used here.
• A second meeting, the Louvre Accord, was called in 1987 to stabilize the dollar.
Discuss Figure 7.3 here, showing the changing value of the dollar against the
Japanese yen, Euro and the Deutsche Mark, 1960-2010.
• Because a depreciation in a firm’s home currency makes it easier for the firm to
export and defends it from the threat of imports, exchange rates are very important to
firms.

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BRINGING THE WORLD INTO FOCUS

Should Bretton Woods Be Restored?
This box is basically a discussion of the trade-offs between a fixed exchange rate
system (such as Bretton Woods) and the floating exchange rate system prevalent
today. A fixed system eliminates uncertainty for business, but a floating system
allows more flexibility to governments in managing their economies.

• The International Debt Crisis. The international debt crisis grew out of events that
occurred shortly after the flexible exchange rate system of 1973 began, when Arab
nations quadrupled the price of oil. Banks recycled the petrodollar in the form of
loans to countries that were damaged by the rise in oil prices. However, many
countries borrowed more than they could repay.
• Various efforts were made to resolve the crisis. The 1985 Baker Plan stressed the
importance of debt rescheduling, tight IMF-imposed controls over domestic fiscal and
monetary policies, and continued lending to debtor countries in hope that economic
growth would allow them to repay their creditors. The plan had limited success.
• The 1989 Brady Plan focused on the need to reduce the debts of the troubled
countries by writing off parts of debt or providing countries with funds to buy back
their loan notes at below face value.
• The international monetary system suffered a crisis in July 1997, when investors
began to distrust the abilities of Thai borrowers to repay their debts. Thailand was
forced to unpeg its currency from a dollar-denominated basket of currencies,
resulting in a rapid deterioration in the currency’s value. The crisis quickly spread to
neighboring countries, setting off a major international currency crisis.

THE BALANCE OF PAYMENTSOP ACCOUNTING SYSTEM

• The balance of payments (BOP) accounting system is a double-entry bookkeeping

system designed to measure and record all economic transactions between
residents of one country and residents of all other countries during a particular time
period.
• There are several reasons why international business people should pay attention to
the BOP. First, BOP statistics help identify emerging markets for goods and services.
Second, they can warn of possible new policies that may alter a country’s business
climate, thereby affecting the profitability of a firm’s operations in that country. Third,
they can indicate reductions in a country’s foreign reserves, which may mean that a
country’s currency will depreciate in the future. Fourth, they can signal increased
riskiness of lending to particular countries.

The Major Components of the BOP Accounting System

The BOP accounting system can be divided into four major accounts: the current
account; the capital account; the official reserves account; and the errors and
omissions account.

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Current Account

• The current account records exports and imports of merchandise and services,
investment income, and gifts. Table 7.3 summarizes the debit and credit entries
for transactions involving the current account.
• To Germany, a sale of a Mercedes-Benz automobile to a doctor in Marseilles is a
merchandise export, and the purchase by a German resident of Dom Perignon
champagne from France is a merchandise import. The difference between a
country’s exports and imports of goods is called the balance on merchandise
trade. The United States has a merchandise trade deficit because it has been
importing more than it exports, while Japan has a merchandise trade surplus
because it has been exporting more than it imports.
• The sale of a service (i.e., consulting services) to a resident of another country is
a service export, while the purchase of a service by a resident of another
country is a service import. The term trade in invisibles is also used to
describe trade in services. The difference between a country’s export of services
and its import of services is called the balance on services trade.
• Income (i.e., interest and dividends) German residents earn from their foreign
investment is viewed as an export of the services of capital by Germany.
Income earned by foreigners from their investments in Germany is known as an
import of the services of capital by Germany.
• Unilateral transfers are gifts between residents of one country and another
country.
• Current account balance measures the net outflow or inflow resulting from
merchandise trade, service trade, investment income, and unilateral transfers.

Capital Account

• The capital account records capital transactions – purchases and sales of

assets – between residents of one country and those of other countries. Capital
account transactions can be divided into foreign direct investment (FDI) and
portfolio investment. The former is any investment made for the purpose of
controlling the organization in which the investment is made, while the latter is
any investment made for purposes other than control. Both types of investment
are discussed in Chapter One. Discuss Table 7.4 here.
• Short-term portfolio investments are financial instruments with maturities of
one year or less. Long-term portfolio investments are stocks, bonds, and
other financial instruments issued by private and public organizations that have
maturities greater than one year and that are held for purposes other than
control.
• Current account transactions affect the short-term components of the capital
account because the first entry in the double-entry BOP accounting system
involves the purchase or sale of something, and the second entry typically
records the payment or receipt of payment for the thing bought or sold. (See
Building Global Skills at the end of the chapter for an example of the process.)
• Capital inflows are credits in the BOP accounting system and occur either when
foreign ownership of assets in a country increases or when ownership of foreign

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assets by a country’s residents declines. The text provides examples of both

situations.
• Capital outflows are debits in the BOP accounting system and occur either when
ownership of foreign assets by a country’s residents increases or when foreign
ownership of assets in a country declines. The text provides examples of both
situations. Table 7.5 summarizes the impact of various capital account
transactions on the BOP.

Official Reserves Account

• The official reserves account records holdings of the official reserves held by a
national government including gold, convertible currencies (currencies that are
freely exchangeable in world currency markets), SDRs, and reserve positions at
the IMF.

Errors and Omissions

• The errors and omissions account is used to make the BOP balance in
accordance with the following equation: Current Account + Capital Account +
Errors and Omissions + Official Reserves = 0.
• A large portion of the errors and omissions account is probably due to
underreporting of capital account transactions. It is becoming more and more
difficult to keep track of legal capital transactions as they become increasingly
sophisticated and grow in volume. Other errors and omissions are deliberate
actions and are frequently illegal. Flight capital, for example, is money sent
abroad by foreign residents seeking a safe haven for their assets, hidden from
the sticky fingers of their home governments.

BRINGING THE WORLD INTO FOCUS

Ben Franklin, World Traveler
This box examines the process of determining how much U.S. currency is held
by foreigners. The box notes that current estimates are that 49 percent of U.S.
currency in circulation is held by foreigners. These foreign holdings act as
interest-free loans to the United States.

• Other errors and omissions are related to the current account, particularly
merchandise exports and trade in services.

The U.S. Balance of Payments in 20102

• U.S. merchandise exports were $1,288561.72 billion in 20102 (see Figure 7.4 for a
detailed breakdown). Automobiles and auto parts were the largest component of
U.S. merchandise exports. Table 7.6 and Figure 7.4 give a more detailed
breakdown of imports and exports by industry. Discuss the tables here.
• U.S. merchandise imports totaled $1,934.62,302.7 billion in 20102. The leading
import was automobiles and auto parts. See Figure 7.4b here.
• U.S. exports of services were $548.9649.3 billion in 20102, with travel and tourism
being the largest portion ($134.418.4 billion).

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• The U.S. tends to import more goods from its major trading partners than it exports
to them; however, it tends to export more services to them than it imports from them.
Discuss Figure 7.5 here.
• The capital account (use Table 7.6 here) shows that in 20102, U.S. FDI outflows
were $351.488.3 billion, while FDI inflows were $236.2166.4 billion. New U.S. long-
term international portfolio investments were $147.270.5 billion in 20102, while new
foreign long-term portfolio investments in the United States were $813.5707.7 billion.
The capital account balance was $255.9450.8 billion in 20102, as foreigners bought
more U.S. assets than U.S. residents bought foreign assets.
• The official reserves account transactions were 1.84.5 billion, and the errors and
omissions account was 216.8had a discrepancy of $5.9 billion.

Defining Balance of Payments Surpluses and Deficits PP 7-46

• When people talk about a balance of payments surplus or deficit, they are talking
about a subset of BOP accounts. For example, a merchandise trade surplus occurs
when a country exports more than it imports. Other balances that are often
mentioned include the balance on services, the balance on goods and services, the
current account balance, and the basic balance (the sum of the current account and
net long-term capital investment).
• The official settlements balance reflects changes in a country’s official reserves; it
essentially records the net impact of the central bank’s interventions in the foreign
exchange market in support of the local currency.
• Which BOP concept to use depends on the issue confronting the international
businessperson or policy maker. There is no single measure of a country’s global
economic performance. The balance on goods and services reflects the combined
international competitiveness of a country’s manufacturing and service sectors. The
current account balance shows the combined performance of the manufacturing and
service sectors and also reflects the generosity of the country’s residents, as well as
income generated by past investments. The basic balance combines current
account transactions with long-term capital investments. The official settlements
balance is a record of supply and demand for a country’s currency.
• Figure 7.6 shows the U.S. Balance of Payments for the past decade using figures
for various sub-accounts.

CHAPTER REVIEW

1. 7-1 What is the function of the international monetary system? Formatted: No bullets or numbering

The international monetary system establishes the rules by which countries value and
exchange their currencies. In addition, the system provides a mechanism to correct
imbalances that may exist between a country’s international payments and its receipts. (LO
7.1; AACSB: Communication Skills; Learning Outcome: Summarize the roles of the
international monetary system and global capital market)

2. 7-2 Why is the gold standard a type of fixed exchange rate system? Formatted: No bullets or numbering

The gold standard is a type of fixed exchange rate system because under the system, each
country pegged the value of its currency to gold. Currencies are then exchanged using the

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 101

stated amount of gold. The text provides an example of the process using the U.S. dollar
and the British pound. (LO 7.2; AACSB: Analytical Skills; Learning Outcome: Summarize the
roles of the international monetary system and global capital market)

3. 7-3 What were the key accomplishments of the Bretton Woods conferencewas the initial Formatted: No bullets or numbering
goal of the World Bank?

The key accomplishments of the Bretton Woods conference included an agreement to

renew the gold standard on a modified basis and an agreement to create two international
organizations – the International Bank for Reconstruction and Development and the
International Monetary Fund – to assist in the rebuilding of the world economy and the
international monetary system.The World Bank was established in 1945 to finance
reconstruction of war-torn European economies, and when that was completed, focused on
building the economies of lesser-developed nations. (LO 7.3; AACSB: Communication
Skills; Learning Outcome: Summarize the roles of the international monetary system and
global capital market)

4. 7-4 Why was the IFC established by the World Bank? Formatted: No bullets or numbering

The International Finance Corporation was created in 1956 to promote the development of
the private sector in developing countries. To that end, the IFC (in collaboration with private
investors) serves as an investment banker as it provides debt and equity capital for
commercial activities that show promise. (LO 7.3; AACSB: Analytical Skills; Learning
Outcome: Summarize the roles of the international monetary system and global capital
market)

5. 7-5 Why are quotas important to IMF members? Formatted: No bullets or numbering

Quotas (the deposits countries pay to join the organization) are important to IMF members
for several reasons. First, a country’s quota determines its voting power within the IMF.
Second, a country’s quota serves as part of its official reserves. Third, quotas determine a
country’s borrowing power from the IMF. (LO 7.3; AACSB: Analytical Skills; Learning
Outcome: Summarize the roles of the international monetary system and global capital
market)

6. 7-6 Why did the Bretton Woods system collapse in 1971? Formatted: No bullets or numbering

A key part of the Bretton Woods system was the agreement by the United States to
exchange its currency for gold. During the 1950s and 1960s, foreigners happily held onto
dollars. However, as their holdings increased, they began to question the ability of the
United States to redeem their dollars for gold. After an attempt by the IMF to increase
liquidity in the system using special drawing rights, the Bretton Woods system collapsed in
1971 amid fears that the United States did not have enough gold on hand to meet the
demands of those who wanted to exchange their dollars for gold. (LO 7.3 and 7.4; AACSB:
Dynamics of the global economy; Learning Outcome: Summarize the roles of the
international monetary system and global capital market)

7. 7-7 Describe the differences between a fixed exchange rate system and a flexible Formatted: No bullets or numbering
exchange rate system.

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102

Under a fixed exchange rate system, the price of a given currency does not change relative
to other currencies. Under a flexible exchange rate system, currencies fluctuate according
to supply and demand. (LO 7.4; AACSB: Communication Skills; Learning Outcome:
Summarize the roles of the international monetary system and global capital market)

8. 7-8 List the four major accounts of the BOP accounting system and their components. Formatted: No bullets or numbering

The four major accounts of the BOP accounting system are the current account, the capital
account, the official reserves account, and the errors and omissions account. The capital
account summarizes merchandise exports and imports, service exports and imports,
investment income, and gifts for a given country. The capital account provides a record of a
country’s capital transactions including purchases and sales of assets. The official reserves
account provides a summary of a country’s official reserves including gold, convertible
currencies, SDRs, and reserve positions at the IMF. Finally, the errors and reserves
account provides a mechanism for ensuring that the BOP balances. (LO 7.5; AACSB:
Communication Skills; Learning Outcome: Summarize the roles of the international
monetary system and global capital market)

9. 7-9 What factors cause measurement errors in the BOP accounts? Formatted: No bullets or numbering

Various factors contribute to measurement errors in the BOP accounts. It is believed that a
large portion of the account is a result of the underreporting of capital account transactions.
A portion of this underreporting is due in part to the growing volume of legal short-term
money flowing between countries. Another portion of the account is due to the illegal
activities of drug smuggling, money laundering, and the evasion of government-imposed
currency and investment controls. Errors in the current account also affect the errors
and omissions account. The main problems reducing the accuracy of current account
transactions typically involve merchandise exports and trade in services. (LO 7.5 and 7.6;
AACSB: Communication Skills; Learning Outcome: Summarize the roles of the international
monetary system and global capital market)

10. 7-10 Identify the different types of balance of payments surpluses and deficits. Formatted: No bullets or numbering

The merchandise trade balance, which summarizes a country’s trade position in goods, is
the most commonly referred to balance. Other balances include the balance on services,
which records a country’s trade in services, the balance on goods and services which
combines the balance on services and the merchandise trade balance, the current account
balance which summarizes the activities in the current account (see Review Question 8), the
basic balance which sums the current account balance and net long-term capital, and the
official settlements balance which reflects changes in a country’s official reserves. (LO 7.6;
AACSB: Communication Skills; Learning Outcome: Summarize the roles of the international
monetary system and global capital market)

QUESTIONS FOR DISCUSSION

1. 7-11 What parallels exist between the role of the British pound in the nineteenth-century Formatted: No bullets or numbering
international monetary system and that of the U.S.US dollar since 1945?

In the nineteenth century, the British pound was the most important currency in international
business. The pound gained this status because the United Kingdom emerged at the end of

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the Napoleonic Wars as the dominant economic and military power in Europe. The British
pound (or gold) was accepted by most companies in the settlement of transactions.
However, after World War I, when the Great Depression affected economies worldwide,
Britain was unable to meet its pledges under the gold standard, and the monetary system
ended shortly thereafter. The U.S. dollar, like the British pound, emerged as the dominant
currency at the conclusion of World War II, when the United States held the position of a
military and economic superpower. Individuals and companies were happy to settle their
transactions with dollars, much as they were with the pound in earlier times. Under the new
international monetary system established at Bretton Woods, the U.S. pledged to exchange
its currency for gold at the rate of $35 per ounce. However, when the country found itself
unable to meet its pledge, it ended the system in 1971. (LO 7.1; AACSB: Communication
Skills; Learning Outcome: Summarize the roles of the international monetary system and
global capital market)

2. 7-12 Did the key role that the dollar played in the Bretton Woods system benefit or hurt Formatted: No bullets or numbering
the United States?

It can be argued that the key role the dollar played in the Bretton Woods system benefited
the United States because it helped the country to gain the status of a force to be reckoned
with. Moreover, the system gave the United States veto power on important decisions, and
a portion of each country’s deposits with the IMF were kept in the United States. On the
other hand, it could be argued that the large depreciation in the value of the dollar that
began at the conclusion of the system and continued into the 1980s helped to create an
unstable domestic environment (although U.S. exporters benefited from the decline in the
dollar’s value). (LO 7.3; AACSB: Analytical Skills; Learning Outcome: Summarize the roles
of the international monetary system and global capital market)

3. 7-13 Under what conditions might a country devalue its currency today? Formatted: No bullets or numbering

A country might devalue its currency in an effort to help the international competitiveness of
its exporters. A devalued dollar, for example, has the effect of making U.S. exports cheaper
in foreign markets and foreign imports more expensive to U.S. consumers. U.S. automakers
enjoyed a less competitive domestic environment, for example, in the early 1990s when the
U.S. dollar was very weak compared to the Japanese yen. This created a situation in which
Japanese auto exports were not price competitive with domestically produced vehicles and
eventually allowed U.S. producers to recapture a share of the U.S. market. (LO 7.4; AACSB:
Dynamics of the global economy; Learning Outcome: Summarize the roles of the
international monetary system and global capital market)

4. 7-14 Are there any circumstances under which a country might want to increase its Formatted: No bullets or numbering
currency’s value?

Countries may try to increase the value of their currencies in certain circumstances. For
example, major trading partners met at the Louvre Accord in an effort to halt the decline of
the dollar, which had plummeted almost 46 percent against the Deutsche mark and 41
percent against the yen in just two years. Countries were worried that any further
devaluation in the dollar would disrupt world trade. However, for the most part, countries
will be reluctant to revalue their currencies because a stronger currency makes exports less
competitive and imports less expensive. The combination of these effects creates a trade
deficit. (LO 7.4; AACSB: Dynamics of the global economy; Learning Outcome: Summarize
the roles of the international monetary system and global capital market)

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5. 7-15 Can international businesses operate more easily in a fixed exchange rate system Formatted: No bullets or numbering
or in a flexible exchange rate system?

Under a fixed exchange rate system, countries peg the value of their currencies to gold.
Under a flexible exchange rate system, supply and demand determine the value of a
country’s currency. Many people would argue that because of the stability and predictability
of exchange rates under a fixed system, such a system would be preferred by international
businesses. However, others would argue that a flexible exchange rate system would be
preferable to international businesses because their competitiveness would not be affected
by inflation, as it would be offset by a depreciation in exchange rates. (LO 7.4; AACSB:
Analytical Skills; Learning Outcome: Summarize the roles of the international monetary
system and global capital market)

6. 7-16 What connections exist between the current account and the capital account? Formatted: No bullets or numbering

The current account and the capital account have an inverse relationship as a result of the
BOP double-entry accounting system. Thus, if the current account is running a deficit, the
capital account must run a surplus to offset the deficit and bring the BOP into balance. In
the 1990s, the United States had experienced a current account deficit and a capital
account surplus, while Japan had experienced just the opposite situation. (LO 7.5; AACSB:
Communication Skills; Learning Outcome: Summarize the roles of the international
monetary system and global capital market)

BUILDING GLOBAL SKILLS

Essence of the exercise

This exercise is designed to allow students to better understand the BOP concept by actually
accounting for various “transactions.” The exercise provides three examples of how the BOP
double-entry system works, and then asks students to record another set of transactions.

Answers to the follow-up questions:

How will the following transactions be recorded in the U.S. BOP accounts?

1. 7-17 A n AmericanUS entrepreneur seeking to sell souvenirs at the 2012 summer Formatted: No bullets or numbering
Olympics in LondoLondonn pays British Airways, a U.K. carrier, $1,500 for a Los Angeles –
London round-trip ticket.

The credit entry in this transaction affects the short-term portfolio account in the amount of
$1,500. The debit entry in this transaction is a service import of $1,500. (LO 7.5 and 7.6;
AACSB: Analytical Skills; Learning Outcome: Summarize the roles of the international
monetary system and global capital market)

2. 7-18 The AmericanA US entrepreneur instead pays United Airlines (an American airline) Formatted: No bullets or numbering
$1,500 for a Los Angeles – London round-trip ticket.

This transaction will not affect the U.S. BOP because the airline is an American carrier being
used by an American national. (LO 7.5 and 7.6; AACSB: Analytical Skills; Learning

Copyright © 20135 Pearson Education, Inc. publishing as Prentice Hall

 105

Outcome: Summarize the roles of the international monetary system and global capital
market)

3. 7-19 Ford Motor Company (U.S.) pays $2.5 billion for all the common stock of the Formatted: No bullets or numbering
Jaguar Motor Co. (U.K.).

Ford is buying a long-term asset (the Jaguar Motor Co.) for purposes of control, and the
U.K. is buying a short-term asset called “an increase of claims on foreigners or a decrease
of foreign claims on the U.K." The U.S. BOP will reflect a debit of $2.5 billion in the foreign
direct investment account, and a credit of $2.5 billion in the short-term portfolio account.
(LO 7.5 and 7.6; AACSB: Analytical Skills; Learning Outcome: Summarize the roles of the
international monetary system and global capital market)

4. 7-20 The U.S. government gives Rwanda $500 million worth of food to feed starving Formatted: No bullets or numbering
refugees.

The U.S. BOP would reflect a debit in the unilateral transfer account for the amount of $500
million since the money is a gift, and the short-term portfolio account would show a credit for
$500 million. (LO 7.5 and 7.6; AACSB: Analytical Skills; Learning Outcome: Summarize the
roles of the international monetary system and global capital market)

Other Applications
Students can take this exercise to the next level by determining how each of the
transactions listed above affects the current account, the capital account, and the overall
balance of payments for each country in question.

CLOSING CASE

Recent U.S.US BOP Performance: Is the Sky Falling?

The closing case provides two divergent views as to how the U.S.US BOP should be
interpreted. One perspective looks at the last decade’s BOP favorably, while the other
perspective does not.

Key Points:

• Over the last decade, the U.S.US BOP has reflected a large annual deficit in the
current account, a large annual surplus in the capital account, and relatively small
changes in the official reserves account.

• This BOP can be interpreted in two ways. First, that U.S.US firms are uncompetitive
in foreign markets, and foreigners are taking over the country by buying up valuable
U.S. assets. Second, that the United States is attracting foreign investment through
foreign country current account surpluses.

• Both views are consistent with the data.

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106

• Those who favor the first argument believe that the United States must reduce its
BOP deficit by following policies to make U.S.US firms more competitive in foreign
markets and by following policies to keep imported goods out.

• People who believe the second argument is true feel that the country should strive to
do anything possible to become more attractive to foreign investors.

• It is important for companies to understand BOP statistics because they are the key
to the type of international trade policy the United States will pursue.

Case Questions

1. 7-21 What is more important to the U.S.US economy – exports or foreign capital Formatted: Indent: Left: 0.5", No bullets or numbering
inflows?

The answer to this question depends on whether one takes the view that the last
decade’s BOP indicates that the United States is becoming uncompetitive in foreign
markets, or the view that the BOP indicates that the United States is in a good
position relative to foreign rivals. Those who support the former viewpoint would
probably argue that exports are more important to the U.S.US economy, while those
who feel that the United States is attracting investment because its prospects are
very attractive are likely to believe that foreign capital inflows are more important.
(LO 7.5 and 7.6; AACSB: Dynamics of the global economy; Learning Outcome:
Summarize the roles of the international monetary system and global capital market)

2. 7-22 What is the connection between the U.S.US current account deficit and Formatted: Indent: Left: 0.5", No bullets or numbering
capital account surplus?

The connection between the current account deficit and the capital account surplus
is that one cannot exist without the other; the accounts have an inverse relationship.
In a sense then, the means by which the United States is able to run a deficit in its
current account (by importing more than it exports) is to finance the deficit with its
capital account. (LO 7.5 and 7.6; AACSB: Analytical Skills; Learning Outcome:
Summarize the roles of the international monetary system and global capital market)

3. 7-23 Which of the following groups is likely to endorse the “sky is falling” view of Formatted: Indent: Left: 0.5", No bullets or numbering
the U.S.US BOP?
• Import-threatened firms such as textile producers
• Textile workers
• A cash-starved California biotechnology company
• Merrill Lynch
• Boeing Aircraft, one of the country’s largest exporters
• Consumers

Import-threatened firms such as textile producers, and textile workers are likely to
endorse the “sky is falling” perspective of the United States. A cash-starved biotech
firm is likely to view foreign investment favorably, as is Merrill Lynch. Consumers
probably do not endorse the “sky is falling” perspective because all those cheap
imports help the consumer’s dollar go further. Finally, export-oriented Boeing Aircraft

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 107

is not likely to endorse a “sky is falling” perspective. (LO 7.5 and 7.6; AACSB:
Analytical Skills; Learning Outcome: Summarize the roles of the international
monetary system and global capital market)

Additional Case Application

Instructors may wish to raise the issue of whether the BOP should be considered
an accurate measure of economic performance for the United States or other
service-oriented economies. The class can be divided into two groups. One
group can be assigned responsibility for analyzing the position of the United
States when service trade is not included in the overall BOP. The second group
can analyze the economic well-being of the United States when trade in services
is incorporated into its economic measures. The two groups can then present
their findings to the rest of the class.

Copyright © 20135 Pearson Education, Inc. publishing as Prentice Hall

Another random document with
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 “What, at this hour!” he exclaimed, standing at the top of the steps,
gazing after two figures who were rapidly disappearing in the
direction of the garden. “Small chance of a tête-à-tête with Alice to-
night,” he said to himself as he pulled his moustache thoughtfully.
Five minutes later, Geoffrey came running back alone;
breathlessly he jerked out: “Such a trick as I’ve played her! She
offered to race me to the big pear-tree, each starting from the
garden-gate, and going one north the other south; I agreed, and
when I saw her well started south I just came home! What a state
she will be in when she finds herself alone at the end of the ghost-
walk! She says she is not, but I believe she is, horribly afraid of
ghosts and bogies; and if she meets the cavalier who is said to stalk
about the garden won’t it be fun? I only wish I had thought of it in
time, I’d have dressed up. It pays her off nicely for some of the pretty
little jokes she has practised on me. It’s not too late yet”—snatching
up a shawl and a garden-hat and commencing a toilet.
“I can’t say that I exactly see the humour of the situation,” said
Reginald, as, springing down the steps and vaulting lightly over an
iron railing, he set off by a short cut to the garden at a run.
“Active fellow, is he not?” observed Geoffrey, removing the shawl
in which he had already enveloped himself. “But this alacrity in
joining his wife, in the present overcharged state of the domestic
atmosphere, is something quite new. The sky is not going to fall, is
it?” he added, looking up interrogatively.
“No; but really, Geoffrey, you shouldn’t have left her,” remonstrated
Helen. “The garden is an awful eerie place by moonlight, I should not
care to take a solitary walk there myself.”

The pear-tree, which was to have been the goal, was the pear-tree
par excellence of the whole garden; it was trained along a wall
covered with fruit-trees, beneath which ran a broad gravel terrace,
approached by several flights of steps, one of which was exactly
opposite this particular tree.
 Alice, breathless and triumphant, had arrived first at the foot of the
steps. She looked up and down the broad walk; no sign of Geoffrey.
“How very odd,” she thought.
Presently she heard his rapidly-approaching footsteps, and,
mounting the terrace, began to gather pears with much deliberation.
Hearing him arrive, she never troubled to turn her head, merely
remarking as she reached up for a lovely, yellow, corpulent pear:
“Snail! You ought to be ashamed of yourself. I could trundle a
wheelbarrow faster than you can run.”
“Could you indeed?” replied her husband, putting his arm round
her slender waist.
“Geoffrey, how dare——Reginald!” she gasped, dropping all the
pears.
“I may dare, may I not?” said he, taking her in his arms and giving
her twenty kisses. “Look here,” said he, smiling at her indignant eyes
and crimson cheeks, “I’ve just had a letter from you, my darling,”
producing the letter and hurriedly telling her the story.
“And the other one I wrote to Afghanistan?” she asked
breathlessly.
“That I never heard of till now; the Afridis made short work of our
letters.”
“Then you have never had a line from me till to-day?” she cried,
backing towards the wall and looking at him with dilated eyes.
“Never, since I left Cannes.”
“Then oh, Regy, what must you have thought of me?”
“Just what I have been asking myself, what can you have thought
of me? No wonder you called me harsh, cruel, and tyrannical; such
names were too mild a term for me. What an unmanly, vindictive
wretch I must have appeared! And you, you richly deserve the name
of the ‘patient Grizzel.’ Don’t you think so?” drawing her towards him
by both hands. “Come, tell me what you thought of me for never
answering your letter.”
 Too overwhelmed to speak, she stood dumb before him, with both
her little trembling hands in his.
“You can’t think,” he went on, “how I hoped and hoped for even
one line, after that Cheetapore affair had been cleared up. Surely
then I learnt that ‘hope deferred maketh the heart sick.’”
Seeing the ready tears in Alice’s eyes he stopped.
“Why, you little goose, you are never going to cry now, are you? It
was not your fault I did not get your letter. I have it safe now, and I
am the happiest man in England this instant; that is to say,” lowering
his voice almost to a whisper, “if you will forgive me, Alice, and if you
love me still?”
“Forgive you!” she echoed, speaking with an effort, “it is for you to
forgive me. Do forgive me,” she pleaded, with lovely beseeching
eyes; “it cost me more than you. My punishment seemed at times
greater than I could bear.”
At the mere recollection of what she had endured, two large tears
that could no longer be suppressed escaped from her eyelashes,
and rolled down her pale cheeks.
“My Alice, my love, you were forgiven long, long ago; only it
seemed to me, till now, that you did not want my forgiveness. You
would not speak, and I could not; I tied my hands most effectually
that day on Southsea pier. And, after all, Alice, you would not have
respected me if I had not required some apology, or if I had tendered
you a forgiveness you had never asked for, after the way you broke
up our home and turned me adrift. No, my darling,” in answer to a
piteous look, “I am not scolding you. I never, never will be rough or
rude to you again, if you will promise to forgive me for the barbarous
way I have treated you lately. When I think of the thousand-and-one
rudenesses I’ve been guilty of—intentionally too—I feel that I am
asking a great deal. If I had only your capacity for blushing, you
would see how thoroughly ashamed I feel. Am I to be forgiven?”
leaning towards her.
“Of course you are.”
 “And,” speaking still more earnestly, “you like me a little in spite of
all?”
A deep blush was his only answer for some seconds; then, with an
effort, she raised her truthful eyes to his, and said:
“You know I do; you need not have asked. It is,” she pursued, with
emotion, “far more a question whether—whether you care for me. I
know you never will, never can, as you once did; but it has seemed
to me at times that you almost hated me.”
“Indeed?” with a beaming smile long foreign to his countenance; “I
see you are more easily imposed upon than ever. You know very
well, it is patent to even Geoffrey, that I have always loved you
exactly three times better than you love me. It is not in your nature to
love as I do, though I never make much fuss about my feelings; still
you may as well know that you are more to me, ten times over, than
anything in the world. Even at the worst of times it has always been
the same. What troubled me most, when I thought I was dying, was,
not my many sins and shortcomings, not the thought of a future
world, not what ought to come first with all of us, my soul; no, it was
you, that I might only see you once more, even for an instant, was
the prayer, the thought, that never left me night or day. I will not
conceal from you, Alice, that I did my very best to stifle recollection,
to forget you, to throw my whole heart into my profession. It was no
good; nothing, not a draught of the Egyptian nepenthe itself would
have banished you from my heart. When I first went to India I used to
take long headlong rides, half in hopes of galloping away from my
thoughts, half in hopes of killing myself. I sometimes think I was a
little mad then.”
“Reginald, you must have been,” she exclaimed with conviction.
“Yes; you don’t half know how miserable I’ve been without you.
Well, I quieted down in time, and when the fighting came off I took it
out of myself in that way. But wherever I was, you were seldom
absent from my mind; whether alone in my quarters, or sitting round
a noisy camp fire, or on a still starry night, on the line of march, your
face was ever before me. As to never caring for you as before, I
believe I love you better—yes, better than when we were first
married; though had anyone suggested such a possibility at the time,
I would have throttled him on the spot. But do not,” he continued with
a smile, “spread the fact among the young married ladies of your
acquaintance; they might try and follow your example, with scarcely
such happy results. Lovers’ quarrels are not always the renewing of
love.”
“How can you joke on such a subject, Regy?” she asked almost
inarticulately.
“Well, then, I’ll be serious once more. Never, as long as you live,
doubt my love for you, Alice. Do you believe in it now?”
“I do,” she whispered, “and you have made me very, very happy.”
“Then you can’t refuse to make me happy! You have not given me
one kiss yet, remember, and you have three years’ arrears to make
up. To begin with, I’ll take the one you offered me the other night
now.”
“I daresay you will,” she replied demurely, with a spice of her old
spirit. “Have you ever heard, ‘He that will not when he may,’ etc.?
And you took quite enough just now to last you for a long time,” she
added, with a deep blush.
“You are not going to put me on allowance, are you? I tell you
plainly I won’t stand it. After offering me a kiss you never can again
pretend you are shy. Now, candidly, can you? I’m afraid you are a
little impostor,” quietly insinuating his arm round her waist.
“I see you are as great a tease as ever, at any rate, Reginald,” she
exclaimed tragically. “If you ever dare to allude to my foolish, idiotical
offer, I won’t say what I shall do to you. I am not an impostor, and
you know very well I am shy; you often said it—it——”
“Well, go on, I would not commence a sentence I was afraid to
finish if I were you!”
“Well, that it was my only fault—there!”
“And so it was; and as you are cured now of course you are
perfect.”
 A silence. At length she said:
“Were you really going away to-morrow, Regy?”
“Yes, indeed I was. I have been lingering on here from day to day,
hoping for one little word, just one, and it did not come. I would have
gone back into the world a hard, embittered, cynical man. You smile,
you think I am that already?”
“Tell me, Regy, will you be the very same Regy I knew of old, and
will the rude, cold, stern guardian I have met lately, and—I tell you in
confidence that I am a little afraid of—will he go?”
“He will,” replied her husband, with quiet decision. “He will take his
departure along with the haughty young lady with whom he gets on
so well. Are you sorry? Are you sorry to lose your guardian and find
your husband?”
“Sorry!” she repeated, taking the flower out of his button-hole with
the calmest air of rightful appropriation. “Do I look sorry? By-the-way,
for the third time of asking, you may as well give me my wedding-
ring”—fastening the flower in the front of her dress, and holding out a
small white palm. “How glad I shall be to see it again,” she
exclaimed, as she eagerly watched him disengaging it from his
chain.
“Here it is,” handing it to her; “it is a travelled ring.”
“Let me see”—turning it to the moonlight and scrutinising it closely
—“if it is my own. Yes, there is the ‘R. A.’ entwined. Now please to
put it on.”
“Alice,” he said, taking her little ring-less hand in his and slipping it
on her finger, “remember, you are not to remove it again.”
“I never will, you may be very sure, as long as I live, and when I
die it shall be buried with me. See, it is quite too big for me now,”
holding up her hand.
“It is indeed,” he reluctantly owned to himself, as he looked at the
fragile, almost transparent fingers held up for his inspection. An
agonising thought flitted through his brain and turned his heart, as it
were, to ice. “Had he gained her but to lose her after all?”
 “Why do you shiver?” cried Alice gaily. “Why do you look so odd—
you are not ill, are you?”
“Ill? Not I!” recovering himself with an effort. “It is probably your
friend the goose walking over my grave.”
“Don’t talk of graves,” she said with a shudder, drawing nearer to
him involuntarily, and laying her hand on his shoulder. “You don’t
know,” she added in a low voice, “what a good wife I am going to be.
You have given me back my wedding-ring, and in return I promise
solemnly to be truthful, loving, and obedient as long as I live. Nothing
but death can ever come between us now,” she added tremulously,
as, stealing her arm round his neck, she gave him the tenderest and
shyest of kisses.
“You little witch!” he exclaimed, returning it with interest. “Do you
know that that is almost the first kiss you have ever given me of your
own accord, Lady Fairfax? What a change a few hours can make in
one’s life! This morning, mine seemed so empty, so cheerless; just
what it has been for the last three years. I had no one to look after, or
care about much, except myself, and I am not very fond of myself;
sometimes, I know all my faults quite as well, nay, far better than you
do.”
“What are they?” she asked with a smile. “Let us compare notes.”
“I am determined to the verge of obstinacy, and beyond it. Proud
to a degree little short of insanity. Overbearing, supercilious,
tenacious, I would die sooner than yield, once I have made up my
mind that I am in the right. If I had been less blinded by my pride, I
would have written to you when Maurice was born, and saved us
both two long miserable years. How can I ever make amends to you,
my darling? How can I ever overtake these years I have left you
alone?”
“Hush!” she said, “you must not abuse yourself. It has been all my
fault from first to last; it is only like you to take the blame, but you
know very well it all lies at my door. But, indeed, indeed I have been
punished, and justly punished! I ought to have trusted you, Reginald;
if I had followed my first impulse I would have spared myself many a
bitter tear. I seem to have been under some malign influence, and to
have had an absolute vocation for making you and myself miserable,
that awful winter that seems so many years ago. Since then, Time
has crawled by and brought no remedies for me—a blank empty
future, and nothing to look back on but hateful haunting recollections;
only for Maurice I must have gone melancholy mad. You will never
leave me again, will you?
“You won’t go to Looton now?” she added suddenly.
“Yes; in fact I must. I’ll run down there for a few days and see how
everything is getting on, look into the accounts, ride over the home
farm, etc., and tell them to be ready for us at Christmas.”
“At Christmas?” she echoed in amazement.
“Yes. I shall then come back here and take you off abroad for the
next three months. You were talking of Nice the other day: will you
accept me as a companion instead of your aunt? How would you like
to spend the autumn in Italy?”
“And Maurice?”
“Oh, Maurice will be made over to Helen; she will take excellent
care of him. He has had a very good time the last two years; it’s my
turn now. I must have you all to myself, no rivals, small or large,
which is one reason why I don’t want to settle down at home just at
present. We should have nothing but one scene of visiting, feasting,
and mutual entertainments. Whereas, roaming about abroad, we can
scorn all social claims, spend our time as we please, and, if the
worst comes to the worst, pretend we are bride and bridegroom. If
you are a good girl and get strong and well by Christmas I shall bring
you home again; if not, I shall take you on to Egypt.”
“Egypt!” she echoed. “Why Egypt? And why do you sigh, Regy,
and look at me so wistfully?” she asked, raising her gray eyes to his
fond dark ones, that seemed to brim over with a look of anguish she
could not understand.
“I did not sigh,” he replied mendaciously. “And why not go to
Egypt? You know you have always had a craving to out-travel Helen
and to see the old Nile. Come, it is getting late, I cannot let you stay
out any longer; the dew is falling, you must go in.”
“Ah! I see you have had enough of me already,” she replied with a
pretty little shrug. “Tell me, Regy, who have you got in this locket?—
you never used to wear one.”
“Who do you think—are you jealous? A Begum who took rather a
fancy to me,” he said, opening the case and revealing herself. “As
long as I had the original I never wore it of course. I believe this
locket is a kind of talisman; it has been twice into action, for I never
left it out of my possession night or day.”
They were slowly promenading up and down the centre garden-
walk, now stopping for an instant, now again going on, this time very,
very leisurely, as it was the very last turn they were to take. On this
point Reginald was resolute, although he grudged sorely to shorten
the happiest hour he had known for years. Oblivious of all the world,
and absorbed in each other, they were approaching the gate, which
suddenly burst open, and Geoffrey, singing, “Alice, where art thou?”
appeared.
“I’ve been sent,” he shouted, “to know if you mean to roost in the
pear-tree? Where are the pears?” he added imperiously. “Why,
what’s all this? I do believe,” looking from one to the other, “that you
two have buried the hatchet, come off the war-path, and smoked the
pipe of peace!”
“Yes, wise and observant Geoffrey, you are right for once. We
have been the victims of an unfortunate accident that has cost us
both very dearly,” replied Reginald gravely.
“Hip, hip, hurrah!” cried Geoffrey, dancing a war-dance round
them, concluding with three wild bounds into the air.
“I really must embrace you, my dear Regy. You know I’d twice as
soon have you as Alice.” So saying he flung himself on Reginald à la
Française.
“No no, my dear fellow, you really must excuse me,” pushing him
back. “If you must kiss somebody, you may kiss Alice; and for your
kind congratulations, conveyed, I presume, by those wild evolutions
just now, receive my warmest thanks. Also,” he added more
seriously, “for all your well-meant but unsuccessful endeavours to
reconcile us, all the tête-à-tête rides and walks you contrived. Only
you are not an old woman, you would make a superb chaperone.”
A less shrewd observer than Geoffrey could see that this assumed
gaiety covered a deeper emotion Reginald could hardly conceal.
“Well, here, Alice, is a kiss for you, by your lord and master’s kind
permission.”
“Imagine you have had it, it will do as well,” cried Alice, waving him
away with both hands.
“All right,” replied Geoffrey, rather huffed. “Imagination is no doubt
better than reality in this particular instance. I always knew if anyone
could manage you, or get you along at all in double harness, it was
our right honourable friend. But you must confess you jibbed
frightfully at starting. Plenty of the whip, that’s what you all want.

‘A woman, a dog, and a walnut-tree,

The more you beat them the better they be.’

Isn’t that so?”

“Geoffrey!” exclaimed Alice, “have you taken leave of your senses!
If people were to see you whooping and springing about they would
certainly think we kept a private lunatic asylum, and that you were
one of our most dangerous patients. Do be cautious, the moon is at
the full!”
Reginald having started off to fetch the pears, Geoffrey watched
him out of sight, and then said: “Alice, my good girl, seriously and
soberly, I never was so glad of anything in all my life. He is the best
fellow I ever knew, and ten times too good for you.”
“No one knows that better than myself,” she replied meekly, to
Geoffrey’s unbounded surprise.
 “Good-night, Geoff; I’m going. Tell him to tell them; I couldn’t,” she
added, vanishing through the gateway.
“Alice has gone, Rex,” said Geoffrey, “and you are to break it
gently to the family. No one could eat pears now: leave them on the
garden-seat and come along. You and Alice are the only pair they
will think of to-night.”
In a few minutes they had rejoined the party in the pleasure-
ground.
“Well, what has kept you? Have you brought the pears?” inquired
Helen, languidly.
“No; but I have brought you a piece of good news instead. You can
guess what it is, can you not?”
“I can, my dear Regy,” she replied, rising hastily—her active mind
having grasped the truth in one second—and kissing him with
effusion. “I know there is only one thing that could make you look so
happy. Where is Alice?”
“This,” said Geoffrey with mock gravity, taking Reginald’s unwilling
hand, “is Petruchio. Katharina has retired. In plain English, Alice was
too bashful to return here, and desired me to accept your
congratulations as her deputy. I’ve no doubt, Helen, that you and
Miss Ferrars will find her in her room.”
Helen and Miss Ferrars were not long in acting on this hint, and
found Alice sitting in the window-sill in the moonlight, leisurely
unplaiting her long, golden-brown plaits. She received them with
smiles and tears.
“I knew you would come,” she said, throwing herself into Helen’s
arms; “you have always been our good genius. You have heard it all
from him, have you not?” she whispered.
“Only a sketch—a mere outline,” Helen replied, seating herself. “I
have a vague idea that you are going abroad, that I am to have
charge of Maurice, and that we are all to meet at Looton at
Christmas. The moment I saw Regy’s face I knew what had
happened. Dear boy! it does one good to see him looking like
himself once more.”
The three ladies remained talking together till the small hours,
much to the detriment of Alice and Mary’s roses, and the tale of the
lost letter was told and re-told, deplored and discussed, at least ten
times over.
The next morning Reginald started for Looton, and within a week
Sir R. and Lady Fairfax were among the fashionable departures for
the Continent, and the party at Monkswood dispersed, to reunite at
Christmas.
 CHAPTER IX.
ALL’S WELL THAT ENDS WELL.

It is the end of the first week in January—bleak, black January!

Outside Looton the snow is falling lightly but persistently; already it is
a foot deep in the park. It is a bitterly cold, dreary, dark evening. Not
a single living creature is abroad that can possibly find shelter. What
a night for the homeless—what a night for the miserable starving
birds!
Inside Looton the prospect is much more cheerful. A huge log fire
is roaring up the chimney of the great hall, lighting up the frames of
dingy-looking portraits, reflecting itself in more than one dinted steel
cuirass and battered casque, and generally illuminating the arms and
armour of many a dead and gone Fairfax.
A large mastiff lies luxuriously at full length on a tiger-skin before
the fire; but of other living inmates the room is empty. The letter-box
stands on the table; no one is looking—let us have a peep. Here is
an epistle from Mrs. Mayhew to Miss Saville, which will doubtless tell
us all the family news.
“Looton, Jan. 5th.
“My dear Miss Saville,
“I am quite ashamed of myself for never having answered
your kind New Year’s letter. But you have no idea what a whirl
we have been living in since Christmas. I never seem to have
a moment to myself.
“Nearly all the party have gone out skating to-day—an
amusement not at all in my line—so at last I have an hour to
devote to my many indignant correspondents.
“You have heard from Alice frequently, of course, and I am
sure she has told you how much we have missed you, and
how disappointed she and Regy have been at your absence.
It is really too bad of your old enemy, rheumatism, to seize on
you just at this time.
“We have had such a Christmas! Reginald and Alice
determined that, as it was the first they had ever spent
together, they would celebrate the occasion properly. There
was a dinner to the tenantry, to whom Maurice was duly
presented in the character of the heir. Theatricals and a ball
entertained the grandees; nor were the poor forgotten—beef,
coals, warm clothes, and money were lavishly bestowed on
every side. The master and mistress of Looton are so happy
themselves, they do their very best to spread that rather
scarce commodity in all directions, and share it with rich and
poor, as far as money and kind words and deeds can go.
“You will like to hear all about Alice and Regy from a third
party, especially as I know how reticent Alice is about herself
—her letters are probably filled with Maurice and Reginald,
Reginald and Maurice.
“Four months in Italy have worked wonders for her. She has
completely recovered her blooming cheeks, her gay spirits,
and, above all, her health. She still looks a mere girl in her
teens, and as little of the matron as ever. I have done my best
to put a stop to her hunting, but it is of no use, especially as
she has Regy’s permission and countenance. He only takes
her when the distances are moderate and the country to
match, and as she is always superbly mounted, and well
looked after and piloted by her husband, I don’t think you
need be nervous; and I must say they both enjoy it so much,
and look so supremely happy when setting out together on a
hunting morning, that it seems almost a pity to make any
more protests.
“Reginald is a changed man—no longer silent, morose, and
cynical; he is my own dear light-hearted Regy once more, and
enters into everything with as much zest and spirit as Geoff
himself. A happier couple than he and Alice could not be
found. It is a pleasure to see them together. She runs a good
chance of being completely spoiled, only for her sweet,
unselfish disposition. She is allowed her own way in
everything. Fortunately it is Reginald’s way too, so there is no
harm done. Their opinions, wishes, and tastes seem to be
identical. Some day or other Alice’s individuality will be
completely lost and absorbed in Reginald’s stronger mind and
will. I tell him this sometimes, and make him extremely angry.
I am keeping our great piece of news to the last, as a bonne
bouche. I am sure you will be interested to know that Captain
Vaughan and Mary Ferrars are engaged. He has been here
since the first week in December, and their happiness is now
of a whole week’s standing. They seem to be very well suited
and mutually in love. He confided to me that it was the
extreme felicity of Reginald and Alice that had encouraged
him to follow their example. This time last year who would
have believed that they would be the couple—of all others—to
lure their friends into matrimony? At times I feared a very
different conclusion. However, they fully bear out the good old
saying, ‘All’s well that ends well.’
“With love and best wishes for the New Year, ever, dear
Miss Saville,
“Yours affectionately,
“Helen Mayhew.”

THE END.

CHARLES DICKENS AND EVANS, CRYSTAL PALACE PRESS.

 Now ready, at all Libraries and
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PALMS AND TEMPLES:

INCIDENTS OF A FOUR MONTHS’ VOYAGE ON

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With Notes upon the Antiquities, Scenery, People, and Sport of
Egypt.
By JULIAN B. ARNOLD.
Prefatory Notice by EDWIN ARNOLD, Author of “The Light of Asia,”
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 “We cannot but congratulate Mr. Arnold on his success as a clever
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“Mr. Arnold’s book is distinctly new, novel, and interesting.”—Land
and Water.

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