International monetary system


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International monetary system

  1. 1. International MonetarySystemPRESENTED BY:Gaurav Sharma
  2. 2. Preface Increased Volatility of currency affects the earnings of MNC’s, Banks and Cross Border investor’s There are large and unexpected fluctuations in the value of currency hence a setup called Bretton Woods was formed in 1944 to reduce this riskiness of international business The main feature of Bretton Woods was the relatively fixed exchange rate of individual currency in the terms of USD $ and convertibility of $ into gold In 1971 Bretton Woods fell prey to international financial turmoil and was replaced by the present regime of rapidly fluctuating exchange rates which resulted in both problems and opportunities for MNC’s
  3. 3. INTERNATIONAL MONETARYSYSTEM The International Monetary System refers to set of policies, institutions, practices, regulations & mechanism that determine the rate at which one currency would be exchange for another. There are primarily 5 market mechanisms to establish exchange rate with each having its share of merits & demerits – Free float Managed float Target zone arrangement Fixed rate system Hybrid system
  4. 4.  All countries like to have economic stability & prefer a stable exchange rate, however fixing exchange rate often leads to currency crises if the monetary policy is inconsistent with it Countries are less vulnerable to economic shocks if they allow their currency to float freely but that may exhibit excessive volatility which hurts trade & economic growth The trade off between different mechanism depend upon the importance of the underlying benefits & trade offs associated with them
  5. 5. Free Float Free market exchange rates are determined by interaction of currency supply & demand which is in turn influenced by price level changes interest differential & economic growth The exchange rate fluctuates randomly as market participants arises & react to new information, for example – Government policies or acts of God & nature This is also called clean float as the exchange rates are free flowing without any manipulation
  6. 6. Managed float Intervention by Government’s in the foreign change market in order to reduce economic uncertainty associated with free/ clean float This is triggered by the fear that a sudden change in the currency appreciates or inflation of it depreciates Central banks of countries intervene to smooth as out exchange rate fluctuations & determine the rate that is why it is called Managed/ dirty float Crawling peg – unofficial pegging
  7. 7. Target zone arrangement Underthis system, countries adjust their national economic policies to maintain there exchange rates within a specific margin Members of the arrangement adjust their national economic policies to maintain the target range
  8. 8. Fixed rate Bretton wood was also a fixed rate mechanism, in this type of regime, Governments are committed to maintain a target exchange rate Central banks buy/ sell currency actively if the exchange rate is threatened For this system to work, all member nations must accept the groups joint inflation rate as its own. These controls are major source of imperfection for MNC’s which provide both risk & opportunities to them
  9. 9. The current hybrid system Thecurrency system is the one where major currencies float on a managed basis, some currencies are freely floating while other currencies follow various types of pegged exchange rates Examples – another currency as legal tender – Equador, el Salvador (US dollar) – pegged against a single currency, Malaysia, Maldives, Nepal, Iraq, Jordan
  10. 10. Brief history of Internationalmonetary system Why Gold – Gold has a certain desirable properties like durability, ease of storage, easy recognition, standardization Short term changes in its stock are limited by high production cost, making it expensive to manipulate It ensures price stability in long run This is the reason why most currencies fairly recent recently followed gold standard which defined their exchange rates
  11. 11. The Gold standard The gold standard essentially involved a commitment by the participating countries to fix the price of their currencies in terms of a specific amount of gold The price was maintained by buying/ selling gold at that price The value of gold relative to other goods does not change much over long period of time, that helps in maintaining monetary discipline & ensures long run price stability Concept of fat money – gold standard
  12. 12. The gold standard from 1925 -1944 The gold standard broke down during World War I, and was briefly re-instated between 1925-31 as gold exchange standard Under this system, only US & Britain were allowed to hold gold reserves while other could hold both gold, dollars &/ or pound reserves 1931 – Britain departed from Gold standard due to high influx of gold & capital, this led to devaluation of many currencies which in turn led to trade wars, some economists even blame the protectionist regimes of triggering the great depression
  13. 13. Bretton woods (1946 – 1971 ) To avoid destructive monetary economic policies to be formulated allied nations agreed to form a new postwar system The conference held in New hampshire also created institutions, IMF & World Bank to promote international financial stability World bank had the primary function of lending to nations devastated by the world war The IMF had agenda to foster global growth and economic stability
  14. 14. Bretton woods – The fine print USD became the key currency & each Government pledged to maintain a fixed, or pegged exchange rate vis-à-vis the dollar or gold 1 ounce of gold = $ 35 1 ounce of gold = 140 mark (German) so 4 mark = $ 1 Exchange rates were allowed to fluctuate by 1% above or below initial base price. The fixed exchange rates were maintained by official intervention by central banks in the form of sale & purchase of dollars with the IMF providing the foreign exchange
  15. 15. Bretton woods (continued) Technical aspects of the system had practical implications on the participating countries Stabilityof exchange rates removed a great deal of uncertainty from international trade & investment transactions Italso imposed a great deal of discipline on the participating nations economic policies
  16. 16. Fall of Bretton woods The Bretton wood system was fixed rate, only in name, out of 21 major industrialized countries Only the US & Japan held to their par value during 1946-71. Out of 21, 12 devalued their currencies more than 30% against the dollar The death blow for the system came from President Nixon, who was alarmed at high inflation rate & he devalued the dollar to deal with the emerging trade deficit
  17. 17. Post Bretton woods Smithsonian agreement of 1971 – US devalued to 38 $ / Oz of gold & other countries were revalued on agreed amounts vis-à-vis the dollar By 1973 – The world officially turned to floating exchange rates
  18. 18. Role of International Monetary Fund The IMF works to foster global growth and economic stability. It provides policy advice and financing to members in economic difficulties and also works with developing nations to help them achieve macroeconomic stability and reduce poverty. Its main works are – policy advice to governments and central banks based on analysis of economic trends and cross-country experiences research, statistics, forecasts, and analysis based on tracking of global, regional, and individual economies and markets loans to help countries overcome economic difficulties concessional loans to help fight poverty in developing countries It is having 188 member countries till date
  19. 19. Special Drawing Right (SDR) The IMF supplemented its foreign exchange by creating a new reserve asset, (named SDR). It serves as the IMF’s unit of account It is a weighted average of the currencies of five nations (US, Germany, France, Japan & Great Britain) The weights, which are based on the relative importance of each country in international trade are updated periodically
  20. 20. Role of World bankThe world bank is an internationally supported bank that provides financial and technical assistance to developing countries for development programs (e.g. bridges, roads, schools)with the stated goal of reducing poverty.Role of Bank of International Settlements Acts as the “Central Bank“ for Industrial Countries’ Central Bank Helps in managing FOREIGN EXCHANGE RESERVES BIS also holds deposits of Central Banks
  21. 21. Floating Rate system - 1973 Proponents of the new system said that this system would reduce economic volatility & facilitate free trade, floating exchange rates would offset the differences in inflation rate High inflation countries would have their currencies depreciate, allowing their firms to stay competitive without having to act wages & unemployment
  22. 22. Assessment of Floating Ratesystem Currency volatility has increased – The experience till date from the system has been disappointing. The dollars ups & down has little to do with inflation & a lot to do with expectations of future government policies & economic conditions Theinstability reflects the non monetary shocks to the world economy, such as changing oil prices & competitiveness amongst countries
  23. 23. Jamaica Agreement 1976 Floating rates declared acceptable  Gold abandoned as reserve asset;1. IMF returned gold reserves to members at current prices2. Proceeds placed in trust fund to help poor nations3. IMF quotas – member country contributions – increased; membership now 188 countries4. Less-develop, non-oil exporting countries given more access to IMF  IMF continued its role of helping countries cope with macroeconomic and exchange rate problems
  24. 24. Major events after 1973 OPEC and the Oil Crisis (1973-74)1. OPEC raised oil prices four fold2. Exchange rate turmoil resulted3. Caused OPEC nations to earn large surplus B-O-P. Surpluses recycled to debtor nations which set up debt crisis of 1980’s. Dollar Crisis (1977-78)1. U.S. B-O-P difficulties2. Result of inconsistent monetary policy in U.S.3. Dollar value falls as confidence shrinks.
  25. 25.  The Rising Dollar (1980-85) 1. U.S. inflation subsides as the Fed raises interest rates 2. Rising rates attracts global capital to U.S. 3. Result: Dollar value rises. The Sinking Dollar:(1985-87) 1. Dollar revaluated slowly downward; 2. Plaza Agreement (1985) G-5 agree to depress US $ further. 3. Louvre Agreement (1987) G-7 agree to support the falling US $ Recent History (1988-2005) 1988 US$ stabilized Post-1991 Confidence resulted in stronger dollar 1993-1995 Dollar value falls
  26. 26. Financial Crisis 2007-12 Global Financial crisis: Worst Financial Crisis since the Great Depression (1930)EVENTS Subprime lending Growth of the housing bubble Easy credit conditions Weak and fraudulent underwriting practices Deregulation Increased debt burden or over-leveraging Incorrect pricing of risk Boom and collapse of the shadow banking system EURO Zone crisis Commodities boom Currency volatility
  27. 27. THANK YOU