Chapter

10

The International Monetary system

10-2

International monetary system (IMF)

The institutional arrangements that countries adopt to govern exchange rates Dollar, Euro, Yen and Pound float against each other Floating exchange rate: Foreign exchange market determines the relative value of a currency
2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin International Business, 5/e

10-3

International monetary system (IMF)

Some countries use other institutional arrangements to fix their currencys value Pegged exchange rate

Value fixed relative to a reference currency Hold value within range of a reference currency

Dirty float

Fixed exchange rate

Set of currencies are fixed against each other at some mutually agreed upon exchange rate Precursor to the EU

McGraw-Hill/Irwin International Business, 5/e

2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

10-4

The gold standard

Roots in old mercantile trade. Inconvenient to ship gold, changed to paperredeemable for gold. Want to achieve balance-of-trade equilibrium

Japan

USA

McGraw-Hill/Irwin International Business, 5/e

2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

10-5

Between the wars

Post WWI, war heavy expenditures affected the value of dollars against gold US raised dollar price of gold from $20.67 to $35 per ounce

Dollar worth less? - But can buy more US tatctic to increase exports and prop up economy

Other countries followed suit and devalued their currencies People lost confidence the in stability of the system countries reduce their values - major devaluation occurred Have currency, change into gold imedietly Put pressure on gold reserves.
2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin International Business, 5/e

10-6

Bretton Woods

In 1944, 44 countries met in New Hampshire Countries agreed to peg their currencies to US$ which was convertible to gold at $35/oz. Agreed not to engage in competitive devaluations for trade purposes and defend their currencies Weak currencies could be devalued up to 10% w/o approval IMF and World Bank created
2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin International Business, 5/e

10-7

Role of the IMF

McGraw-Hill/Irwin International Business, 5/e

Created to police monetary system by ensuring maintenance of the fixed-exchange rate Promote intl monetary cooperation and facilitate growth of intl trade Wanted to avoid problems following WW1, through A) Discipline Maintaining a fixed exchange rate imposes monetary discipline, curtails inflation , Brake on competitive devaluations and stability to the world trade environment
2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

10-8

Role of the IMF

B) Flexibility Lending facility:

foreign currencies to countries having balance-of-payments problems Adjustable parities: Allow countries to devalue currencies more than 10% if balance of payments was in fundamental disequilibrium

Lend

Persistent borrowings leads to IMF control of a countrys economic policy

2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin International Business, 5/e

10-9

Collapse of the fixed exchange system

Pressure to devalue dollar led to collapse President Johnson financed both the Great Society and Vietnam by printing money

High inflation, ($ in pockets) and high spending on imports

August 8, 1971, Nixon announces dollar no longer convertible into gold.

Countries agreed to revalue their currencies against the dollar March 19, 1972, Japan and most of Europe floated their currencies In 1973. Bretton Woods fails when key currency (dollar) is under speculative attack

McGraw-Hill/Irwin International Business, 5/e

Now have a managed-float system 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

10-10

The floating exchange rate

Jamaica Agreement - 1976

Floating rates acceptable Gold abandoned as reserve asset

IMF continues role of helping countries cope with macroeconomic and exchange rate problems

McGraw-Hill/Irwin International Business, 5/e

2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

10-11

Fixed versus floating exchange rates

Floating:

Monetary policy autonomy Restores control to government

Fixed: Monetary discipline Limits speculators Uncertainty Predictable rate movements

McGraw-Hill/Irwin International Business, 5/e

2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

10-12

Crisis management by the IMF

Role has expanded to meet crisis

Currency crisis

when a speculative attack on a currencys exchange value results in a sharp depreciation of the currencys value or forces authorities to defend the currency Loss of confidence in the banking system leading to a run on the banks When a country cannot service its foreign debt obligations
2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

Banking crisis

Foreign debt crisis

McGraw-Hill/Irwin International Business, 5/e

10-13

Russian Ruble crisis

Financial markets loss of confidence in Russias ability to meet national and international payments

Led to loss of international reserves and roll over of treasury bills reaching maturity

Financial markets unable to determine whos in charge

McGraw-Hill/Irwin International Business, 5/e

2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

10-14

Russian Ruble crisis

Persistent decline in value of ruble:

High inflation
Artificial low prices in Communist era Shortage of goods Liberalized price controls Too many rubles chasing too few goods

Growing public-sector debt

Refusal to raise taxes to pay for government

McGraw-Hill/Irwin International Business, 5/e

2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

10-15

Decline of the Ruble

0 -1000 -2000 -3000 -4000 -5000 -6000 1992 1993 1994 1995

McGraw-Hill/Irwin International Business, 5/e

2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

10-16

The Asian crisis

Mid 1997 several key Thai financial institutions were on the verge of default

Result of speculative overbuilding Excess investment

Thailand asks IMF for help

17.2 billion in loans, given with restrictive conditions

Following devaluation of Thai baht speculation hit other Asian currencies

Malaysia Singapore Indonesia Korea

2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin International Business, 5/e

10-17

Problems in Asian Market Economies

Cronyism. Too much money, dependence on speculative capital inflows. Lack of transparency in the financial sector.

McGraw-Hill/Irwin International Business, 5/e

2005 The McGraw-Hill Companies, Inc., All Rights Reserved.