International Monetary System And Financial Mkts

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International Monetary System And Financial Mkts

  1. 1. INTERNATIONAL MONETARY SYSTEM AND FINANCIAL MARKETS<br />-AN OVERVIEW<br />
  2. 2. INTRODUCTION<br />TRADE AND EXCHANGE OF GOODS/SERVICES OR FACTORS OF PRODUCTION HAS BEEN FACILITATED BY THE EVOLUTION OF MONEY<br />A SOVEREIGN NATION EXERCISES ITS AUTHORITY TO ISSUE LEGAL TENDER MONEY. THIS HAS ACCEPTABILITY WITHIN THE GEOGRAPHICAL BOUNDARIES OF THE NATION<br />
  3. 3. INTRODUCTION<br />SPECIALIZATION AND DIVISION OF LABOUR GENERATE GAINS FOR EVERYONE. THIS IS MADE POSSIBLE ONLY WHEN THERE IS A RELIABLE MONETARY MECHANISM(MAINTENANCE OF ORDER IN THE FUNCTIONING OF A CURRENCY)<br />THE SAME IS TRUE FOR TRADE AND FINANCE ACROSS THE BORDERS.<br />
  4. 4. THE INTERNATIONAL MONETARY SYSTEM<br />IN INTERNATIONAL TRADE AND FINANCE, WE REQUIRE AN INTERNATIONAL ARRANGEMENT BETWEEN TRADING NATIONS ABOUT EXCHANGE RATES AND THE POSSIBLE CONVERSION OF CURRENCIES.<br />SUCH AN ARRANGEMENT IS CALLED THE INTERNATIONAL MONETARY SYSTEM<br />IT IS A PART OF THE INTERNATIONAL FINANCIAL SYSTEM.<br />
  5. 5. INTERNATIONAL FINANCIAL SYSTEM<br />THIS IS A BROAD TERM ENCOMPASSING <br />TRANSFER OF FUNDS BETWEEN PARTIES ACROSS BORDERS<br />CONVERSION OF NATIONAL CURRENCIES<br />ACQUISITION/LIQUIDATION OF FINANCIAL ASSETS ACROSS BORDERS, AND<br />INTERNATIONAL CREDIT CREATION<br />IT IS MULTILATERAL IN NATURE<br />
  6. 6. STUDY OF THE INTERNATIONAL MONETARY SYSTEM<br />IT SHOULD ENCOMPASS:-<br />EXCHANGE RATE REGIMES<br />LIQUIDITY-AVAILABILITY OF RESERVES<br />THE INTERNATIONAL MONETARY FUND<br />THE ADJUSTMENT PROCESS-TO COPE WITH SPECIFIC IRREGULARITIES/PROBLEMS<br />CURRENCY BLOCKS AND UNIONS OF REGIONS LIKE ECU AND EMU<br />
  7. 7. EXCHANGE RATE REGIMES-AN INTRODUCTION<br />WHAT IS AN EXCHANGE-RATE REGIME?<br />IT MEANS AN UNDERSTANDING/AGREEMENT BETWEEN ACTIVELY TRADING NATIONS ABOUT THE VALUES OF THEIR RESPECTIVE DOMESTIC CURRENCIES<br />THE OBJECTIVE BEING TO ENSURE STABILITY AND PREDICTABILITY OF MARKET-DETERMINED RATES OF EXCHANGE<br />
  8. 8. EXCHANGE RATE REGIMES-AN INTRODUCTION<br />THE EMPHASIS IS ON EACH GOVERNMENT TO MAINTAIN ADEQUATE GOLD (OR DOLLAR*) RESERVES, AND TO<br />EXERCISE DISCRETION SO AS NOT TO ALLOW THE DOMESTIC CURRENCY TO EITHER DRASTICALLY APPRECIATE OR DEPRECIATE.<br />SHARP CHANGES CREATE UNCERTAINTY-THEY BENEFIT SOME AT THE EXPENSE OF OTHERS.<br />* under gold-exchange standard followed in the Bretton Woods system<br />
  9. 9. EXCHANGE RATE REGIMES-THE 3 PRINCIPAL REGIMES<br />GOLD-SPECIE STANDARD: THIS IS THE OLDEST MONETARY STANDARD. UNDER THIS REGIME COINS MUST CARRY A KNOWN QUANTITY OF GOLD SO THAT DIFFERENT CURRENCIES COULD BE EXCHANGED FOR TRADE<br />GOLD-BULLION STANDARD: HERE, A CURRENCY NOTE/COIN IN CIRCULATION HAS TO BE BACKED BY A KNOWN QUANTITY OF GOLD RESERVE OF THE ISSUING AUTHORITY.<br />THESE ARE THE 2 VARIANTS OF THE GOLD STANDARD-ALSO REFERRED TO AS THE MINT-PARITY STANDARD.<br />
  10. 10. EXCHANGE RATE REGIMES-THE BRETTON WOODS SYSTEM<br />THIS IS AN AGREEMENT UNDER WHICH THE DOMESTIC CURRENCY IS OFFERED TO BE EXCHANGED AT A FIXED RATE WITH THE DOLLAR.<br />THE DOLLAR IS ITSELF ON A GOLD BULLION STANDARD<br />THIS IS ALSO CALLED THE GOLD-EXCHANGE STANDARD. IT EVOLVED AFTER WORLD-WARII<br />
  11. 11. EXCHANGE RATE REGIMES-THE BRETTON WOODS SYSTEM<br />IT GAVE AN IMPORTANT STATUS TO THE DOLLAR<br />THE USA GAVE A COMMITMENT TO MAINTAIN THE GOLD RESERVES I.E. THE GOLD BULLION STANDARD.<br />THIS COMMITMENT LASTED TILL ABOUT 1970 WHEN USA RENEGED ITS COMMITMENT TO CONVERT DOLLARS AT A FIXED RATE OF $35/OUNCE<br />
  12. 12. BRETTON WOODS SYSTEM-SOME NOTEWORTHY FEATURES<br />DOLLAR VALUE IN TERMS OF GOLD FIXED<br />EACH OTHER CURRENCY HAD A KNOWN EXCHANGE VALUE OF THE DOLLAR WITH THE LOCAL CURRENCY-THE ‘CENTRAL PARITY ‘.<br />NATIONS WERE OBLIGED TO SELL/BUY DOLLARS IN ORDER TO MAINTAIN THE MARKET DETERMINED EXCHANGE RATES WITHIN A +/- RANGE OF 1% ON EACH SIDE.<br />
  13. 13. BRETTON WOODS SYSTEM-SOME NOTEWORTHY FEATURES<br />SO, MEMBER NATIONS WERE OBLIGED TO SELL DOLLARS IF DOLLAR APPRECIATED BEYOND 1% ABOVE THE CENTRAL PARITY. THEY HAD TO MAINTAIN SUFFFICIENT DOLLAR RESERVES IN ORDER TO DO IT.<br />THEY HAD TO BUY DOLLARS WITH LOCAL CURRENCY IN CASE DOLLAR DEPRECIATED LOWER THAN 1%BELOW THE CENTRAL PARITY(RUNNING THE PRINTING PRESS)<br />
  14. 14. BRETTON WOODS SYSTEM-SOME NOTEWORTHY FEATURES<br />THESE UPPER AND LOWER LEVELS OF THE MARKET-DETERMINED DOLLAR VALUE WERE CALLED THE ‘SUPPORT POINTS’. GOVERNMENTS OF MEMBER NATIONS WERE TO ENSURE THAT THE MARKET VALUE OF THE DOLLAR WAS WITHIN THE BAND.<br />IF IT WAS PERSISTENTLY RISING BEYOND IT, THE GOVERNMENT COULD GET THE CENTRAL PARITY RAISED I.E. GET THE DOMESTIC CURRENCY DEVALUED.<br />
  15. 15. BRETTON WOODS SYSTEM-SOME NOTEWORTHY FEATURES<br />DOMESTIC PRESSURES AND CERTAIN INTERNATIONAL CONDITIONS ENSURED THAT THE USA ABOLISHED THE GOLD BULLION STANDARD.<br />BY 1971, THE WORLD MOVED TO ‘FLOATING EXCHANGE RATES’.<br />THIS PHASE ALSO CREATED REGIONAL BLOCKS LIKE EUROPEAN MONETARY SYSTEM.<br />
  16. 16. THE RANGE OF VARIATIONS <br />SINCE 15TH AUGUST 1971, AFTER USA GAVE UP THE BRETTON WOODS COMMITMENT OF MAINTAINING A CONSTANT DOLLAR VALUE IN TERMS OF GOLD OF $35/OUNCE, THERE HAVE BEEN VARIATIONS OF THE EXCHANGE RATE SYSTEM ADOPTED BY MEMBER NATIONS.<br />SPECTRUM OF FLOATING EXCHANGE RATES-THERE ARE 8 PRINCIPAL VARIATIONS WITH FEATURES OF FIXED AND FLOATING RATES<br />
  17. 17. THE 8 PRINCIPAL TYPES OF EXCHANGE-RATES AND THEIR FEATURES<br />ECUADOR, PANAMA ACCEPT THE DOLLAR AS LEGAL TENDER. THIS IS CALLED DOLLARIZATION/EUROISATION<br />CURRENCY BOARD-THERE IS A LEGAL COMMITMENT TO EXCHANGE LOCAL CURRENCY WITH A FOREIGN CURRENCY AT A SPECIFIED RATE.LOCAL CURRENCY IS FULLY BACKED BY FOREIGN EXCHANGE RESERVES-ARGENTINA, HONG KONG<br />FIXED PEG: SIMILAR TO BRETTON WOODS, BUT THE PEG IS AGAINST EITHER A CURRENCY OR TO A BASKET(WEIGHTED AVERAGES). +/-1% ABOUT THE CENTRAL PARITY IS ALLOWED. CHINA TILL RECENTLY.<br />
  18. 18. THE 3 LIMITED FLEXIBILITY REGIMES<br />PEGGED WITHIN HORIZONTAL BANDS: HERE, THE BANDS ARE ALLOWED TO BE WIDER THAN +/- 1%. <br />CRAWLING PEG: THE PEG-RATE IS PERIODICALLY ADJUSTED AT DISCRETION OF THE GOVERNMENTS OR ACCORDING TO PRE-DETERMINED CRITERIA.<br />CRAWLING BANDS: LIKE ABOVE, CENTRAL PARITY IS ADJUSTED PLUS CERTAIN MARGINS ABOUT IT ARE ALLOWED.<br />ABOUT 30 NATIONS COMPRISE THESE TYPES<br />
  19. 19. MANAGED FLOATS AND INDEPENDENT FLOATS<br />MANAGED FLOAT: ACTIVE INTERVENTION BY CENTRAL BANKS IN THE FOREIGN EXCHANGE MARKETS TO INFLUENCE PREVAILING EXCHANGE RATES-BUT NO COMMITMENT TO SET ANY PRE-DETERMINED PATTERN.<br />INDEPENDENT FLOAT: MINIMAL INTERVENTION BY THE CENTRAL BANK AND THE RATES ARE ALMOST ENTIRELY MARKET-DETERMINED.<br />ABOUT 75 NATIONS INCLUDING BHARAT ARE UNDER THESE CATEGORIES. <br />
  20. 20. IDEAL EXCHANGE RATE?<br />THE WORLD HAS SEEN 3 PHASES OF EXCHANGE RATE REGIMES:-<br />GOLD STANDARD(FIXED RATES) TILL WORLD WAR I, ADJUSTABLE PEG(BRETTON WOODS) 1944-1973, FLOATING RATES 1973 ONWARDS<br />IMPOSSIBLE TO ACHIEVE AT A TIME THE THREE MAIN OBJECTIVES: STABILITY; INTEGRATION WITH GLOBAL FINANCIAL SYSTEM; MONETARY POLICY FREEDOM<br />
  21. 21. THE IMPOSSIBLE TRINITY<br />RATE STABILITY; INTEGRATION WITH ROW; MONETARY FREEDOM CAN BE ATTEMPTED USING THE THREE POLICY TOOLS OF:-<br />CURRENCY UNION/BOARD: IMPOSSIBLE TO RETAIN MONETARY FREEDOM<br />FLOAT: CAN’T GUARANTEE STABILITY<br />CAPITAL CONTROLS(RESTRICTIONS ON FLOW OF FUNDS): INTEGRATION WITH ROW DENIED<br />

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