Intl monetary system ch. 10


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  • Intl monetary system ch. 10

    2. 2. Monetary System Relationship between monetary system and foreign exchange rates Historical development Fixed vs floating exchange rates Role of the IMF and World Bank Implications for managers
    3. 3. International Monetary System Currency exchange rates depend on the structure of the international monetary system In 2003 of all IMF members currencies ◦ Only 19% were free floating ◦ 25% were managed float ◦ 8% were adjustable peg ◦ 22% were fixed peg ◦ 4% were fixed by a currency board ◦ 22% were not currency of their own (use Euro, US Dollar)
    4. 4. Evolution of the InternationalMonetary System GoldStandard: currencies pegged to gold value ◦ Convertibility guaranteed ◦ By 1880 most on gold standard ◦ Balance of trade equilibrium for all countries  Value of exports should equal value of imports  Flow of gold used to make up differences ◦ Abandoned in 1914  Failed resumption after WWI  Great Depression
    5. 5. Bretton Woods (1944 - 1973) 44 countries met to design a new system in 1944 Established: International Monetary Fund (IMF) and World Bank ◦ IMF: maintain order in monetary system ◦ World Bank: promote general economic development ◦ Fixed exchange rates pegged to the US Dollar ◦ US Dollar pegged to gold at $35 per ounce ◦ Countries maintained their currencies ± 1% of the fixed rate; buy/sell own currency to maintain level
    6. 6. The Role of the IMF IMF maintained exchange rate ◦ discipline  National governments had to manage inflation through their money supply ◦ flexibility  Provides loans to help members states with temporary balance-of-payment deficit; ◦ Allows time to bring down inflation ◦ Relieves pressures to devalue  Excessive drawing from IMF funds came with IMF supervision of monetary and fiscal policies ◦ Allowed to 10% devaluations and more with IMF approval 187 members by 2003
    7. 7. The Role of the World Bank WorldBank (IBRD) role (International Bank for Reconstruction & Development) ◦ Refinanced post-WWII reconstruction and development ◦ Provides low-interest long term loans to developing economies TheInternational Development Agency (IDA), an arm of the bank created in 1960 ◦ Raises funds from member states ◦ Loans only to poorest countries ◦ 50 year repayment at 1% per year interest
    8. 8. Collapse of Bretton Woods Devaluation pressures on US dollar after 20 years ◦ Lyndon Johnson policies  Vietnam war financing  Welfare program financing ◦ Nixon ended gold convertibility of US dollar in 1971 ◦ US dollar was devalued and dealers started speculating against it for further devaluation ◦ Bretton Woods fixed exchange rates abandoned in January 1972
    9. 9. Jamaica Agreement 1976 Floating rates declared acceptable Gold abandoned as reserve asset; ◦ IMF returned gold reserves to members at current prices ◦ Proceeds placed in trust fund to help poor nations ◦ IMF quotas – member country contributions – increased; membership now 182 countries ◦ 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
    10. 10. Case for Floating Exchange Rates ◦ Monetary policy autonomy ◦ Trade balance adjustments helped The Case for Fixed Exchange Rates ◦ Monetary discipline ◦ Speculation limited ◦ Uncertainty reduced ◦ Trade balance adjustment effects on inflation controlled Who is right?
    11. 11. Recent Activities and the IMF  Mexican Crisis 1995  Russian Ruble crisis1995  Asian crisis 1997/1998 ◦ Events  The investment boom  Excess capacity  The debt bomb  Expanding imports  The crisis  How does the IMF achieve results? ◦ Inappropriate policies? ◦ Moral Hazard? ◦ Lack of accountability?
    12. 12. Managerial Implications Currency management ◦ Currency market does not always work as expected ◦ Government intervention ◦ Speculative activity Business strategy ◦ Movements in exchange rates are difficult to predict ◦ Forward market is imperfect predictor of exchange rate movements ◦ Forward exchange rate market covers risk for months not years ◦ Maintenance of strategic flexibility required  Disperse manufacturing  Outsource ◦ Corporate-government relations