InternationalBusiness 7eby Charles W.L. HillMcGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All righ...
Chapter 10The International Monetary System
10-3IntroductionThe institutional arrangements that countries adopt togovern exchange rates are known as the internationa...
10-4IntroductionWhen a country tried to hold the value of its currencywithin some range of a reference currency, dirty fl...
10-5Classroom Performance SystemA ________ exchange rate system exists when the foreignexchange market determines the rela...
10-6The Gold StandardThe gold standard dates back to ancient times when goldcoins were a medium of exchange, unit of acco...
10-7Mechanics Of The Gold StandardPegging currencies to gold and guaranteeingconvertibility is known as the gold standard...
10-8Strength Of The Gold StandardThe great strength of the gold standard was that itcontained a powerful mechanism for ac...
10-9Classroom Performance SystemWhat type of exchange rates system was the goldstandard?a) Fixedb) Floatingc) Peggedd) Mar...
10-10The Period Between The Wars: 1918-1939The gold standard worked fairly well from the 1870s untilthe start of World Wa...
10-11The Bretton Woods SystemIn 1944, representatives from 44 countries met at BrettonWoods, New Hampshire, to design a n...
10-12The Bretton Woods SystemThe Bretton Woods agreement also established twomultinational institutions: the Internationa...
10-13The Role Of The IMFThe IMF was charged with executing the main goal of theBretton Woods agreement - avoiding a repet...
10-14The Role Of The IMFFlexibility meant that:while monetary discipline was a central objective of theagreement, a rigid...
10-15The Role Of The World BankThe World Bank is also called the International Bank forReconstruction and Development (IBR...
10-16The Collapse Of The FixedExchange Rate SystemBretton Woods worked well until the late 1960sIt collapsed when huge i...
10-17The Floating Exchange Rate RegimeIn 1976, following the collapse of Bretton Woods, IMFmembers formalized a new excha...
10-18The Jamaica AgreementUnder the Jamaican agreement:floating rates were declared acceptablegold was abandoned as a re...
10-19Exchange Rates Since 1973Since 1973, exchange rates have become more volatile and lesspredictable than they were bet...
10-20Exchange Rates Since 1973Figure 10.1: Major Currencies Dollar Index, 1973-2006
10-21Classroom Performance SystemWhich agreement deemed floating exchange rates to beacceptable?a) The Bretton Woods Agree...
10-22Fixed Versus Floating Exchange RatesThe merit of a fixed exchange rate versus a floatingexchange rate system continu...
10-23The Case For Floating Exchange RatesThe case for floating exchange rates has two mainelements:1. monetary policy aut...
10-24The Case For Floating Exchange RatesSupporters of floating exchange rates argue thatremoving the obligation to maint...
10-25The Case For Fixed Exchange RatesSupporters of fixed exchange rates focus on monetarydiscipline, uncertainty, and th...
10-26Who Is Right?There is no real agreement as to which system is betterWe know that a fixed exchange rate regime model...
10-27Exchange Rate Regimes In PracticeVarious exchange rate regimes are followed todayCurrently:14% of IMF members follo...
10-28Exchange Rate Regimes In PracticeFigure 10.2: Exchange Rate Policies, IMF Members, 2006
10-29Classroom Performance SystemWhich type of exchange rate system do most IMF countriesfollow today?a) Free floatb) Mana...
10-30Pegged Exchange RatesA country following a pegged exchange rate system,pegs the value of its currency to that of ano...
10-31Currency BoardsCountries using a currency board commit to convertingtheir domestic currency on demand into another c...
10-32Crisis Management By The IMFSince many of the original reasons for the IMF no longerexist, the organization has rede...
10-33Financial Crises In ThePost-Bretton Woods EraA currency crisis occurs when a speculative attack on theexchange value...
10-34Classroom Performance SystemA _________ is a situation in which a country cannotservice its foreign debt obligations,...
10-35Mexican Currency Crisis Of 1995The Mexican currency crisis of 1995 was a result of:high Mexican debtsa pegged excha...
10-36The Asian CrisisThe 1997 Southeast Asian financial crisis was caused by aseries of events that took place in the prev...
10-37The Asian Crisiswhen inflation and increasing imports put pressure on thecurrencies, the resulting devaluations led ...
10-38The Asian CrisisWith its foreign exchange rates depleted, Thailand lackedthe foreign currency needed to finance its ...
10-39Evaluating The IMF’s Policy PrescriptionsBy 2006, the IMF was committing loans to some 59 countries ineconomic and c...
10-40Implications For ManagersFor managers, understanding the international monetarysystem is important for:currency mana...
10-41Currency ManagementManagers must recognize that the current internationalmonetary system is a managed float system i...
10-42Business StrategyManagers need to recognize that while exchange ratemovements are difficult to predict, their moveme...
10-43Corporate-Government RelationsManagers need to recognize that businesses caninfluence government policy towards the ...
10-44Classroom Performance SystemManagers need to understand the implications of changingexchange rates from all of the fo...
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  • The world’s four major currencies – dollar, euro, yen, and pound – are all free to float against each other. Pegged exchange rates, dirty floats and fixed exchange rates all require some degree of government intervention.
  • The answer is b.
  • The answer is a.
  • Post WWI, war heavy expenditures affected the value of dollars against gold. US raised dollars to gold from $20.67 to $35 per ounce. Other countries followed suit and devalued their currencies.
  • A key problem with the gold standard was that there was no multinational institution that could stop countries from engaging in competitive devaluations.
  • The International Monetary Fund (IMF) Articles of Agreement were heavily influenced by the worldwide financial collapse, competitive devaluations, trade wars, high unemployment, hyperinflation in Germany and elsewhere, and general economic disintegration that occurred between the two world wars. The aim of the IMF was to try to avoid a repetition of that chaos through a combination of discipline and flexibility.
  • The system of fixed exchange rates established at Bretton Woods worked well until the late 1960’s. The US dollar was the only currency that could be converted into gold The US dollar served as the reference point for all other currencies Any pressure to devalue the dollar would cause problems through out the world Factors that led to the collapse of the fixed exchange system include: President Johnson financed both the Great Society and Vietnam by printing money High inflation and high spending on imports On August 8, 1971, President Nixon announces dollar no longer convertible into gold Countries agreed to revalue their currencies against the dollar On March 19, 1972, Japan and most of Europe floated their currencies In 1973, Bretton Woods fails because the key currency (dollar) is under speculative attack
  • The answer is c.
  • Country Focus: The U.S. Dollar, Oil Prices, and Recycling Petrodollars Summary This feature e closing case explores what oil producing nations are likely to do with the dollars they have earned. Recently, oil prices have surged as a result of higher than expected demand, tight supplies, and perceived geopolitical risks. Since oil is priced in dollars, oil producers have seen their dollar reserves increase. Discussion of the feature can begin with the following questions. 1. What will happen to the value of the U.S. dollar if oil producers decide to invest most of their earnings from oil sales in domestic infrastructure projects? Discussion Points: If oil producers decide to invest their earnings in domestic infrastructure projects, it would be expected that the countries involved would see a boost in economic growth, and an increase in imports. This would put downward pressure on the dollar as the petrodollars are sold, or are invested in the local community, however the expected increase in imports that should result from greater economic growth would increase the demand for dollars. 2. What factors determine the relative attractiveness of dollar, euro, and yen denominated assets to oil producers flush with petrodollars? What might lead them to direct more funds towards non-dollar denominated assets? Discussion Point s: The relative attractiveness of an investment whether it is denominated in dollars, euro, or yen depends on expected returns and the degree of risk associated with the investment. When considering different currencies, it would be important to consider expected shifts in the exchange rate. So, for example, if the dollar was expected to depreciate relative to the euro or yen, non-dollar denominated assets might be more attractive all else being equal.
  • The answer is b.
  • The answer is c.
  • Country Focus: Turkey’s and the IMF Summary This feature explores Turkey’s 18th IMF program. In May 2001, the IMF agreed to lend $8 billion to Turkey to help stabilize its economy and halt a sharp slide in the value of its currency. While initially the Turkish government resisted IMF mandates on economic policy, in 2003, the government passed an austerity budget. By 2005, significant progress had been made and today, the country appears to be on track for recovery, with lower inflation rates, an increase in privatization, and a budget surplus. The following questions can be helpful in directing the discussion: Suggested Discussion Questions 1. What led to Turkey’s financial crisis? What goals did the IMF establish as part of the loan agreement? Discussion Points: Several factors led to Turkey’s financial crisis including a large and inefficient state sector and a subsidized agricultural sector, both of which were financed through debt. The IMF pushed for accelerated privatization of inefficient sectors, and a reduction in agricultural subsidies. In addition, the IMF called for pension reform and tax increases. 2. What are the challenges for a government to deal with a financial crisis like the one that Turkey experienced? Discussion Points: Students will probably suggest that one of the biggest challenges for governments facing a financial crisis is the domino effect it seems to have throughout the economy. In the case of Turkey, IMF assistance to stabilize the situation meant that the country had to follow what initially seemed to be unattractive policies. 3. Was the IMF successful in Turkey? Discussion Points: After several rocky attempts, most students will probably agree that the IMF’s programs in Turkey are finally beginning to show results. Inflation is down, economic growth is up, and the privatization program has continued to move along. In addition, government spending seems to be under control.
  • Management Focus: Airbus and the Euro Summary This feature describes how Airbus is protecting itself from exchange rate fluctuations. French aircraft maker Airbus prices its planes in dollars. However, because over half the company’s costs are in euros, the company has the potential to see significant fluctuations in its earnings if it does not hedge its foreign exchange exposure. The following questions can help in the discussion of the feature: Suggested Discussion Questions 1. What type of foreign exchange exposure does Airbus face? How can Airbus protect itself from its exposure to changing exchange rates? How does the company’s switch to more U.S. suppliers help the company? Discussion Points: Students should easily recognize the transaction exposure facing Airbus. Some students will point out that economic exposure is also a problem for the company. Airbus can hedge its transaction exposure in the foreign exchange markets using forward contracts, however to manage its economic exposure, the company is trying to reduce its costs by shifting to American suppliers, and asking European suppliers to price in dollars. 2. Airbus has asked its European based suppliers to start pricing in U.S. dollars. What does Airbus hope to gain by this request? What does it mean for suppliers? Discussion Points: Airbus’ decision to ask suppliers to price their components in dollars is an effort to control exchange rate risk. The company prices its planes in dollars, but was paying for components in a variety of currencies. By shifting to a strictly dollar run business, the company not only consolidates all of its transactions and so hedges its exposure more easily and cheaply, it also increases the proportion of its costs that are in dollars. For American suppliers, the shift to pricing in dollars is beneficial because it eliminates exchange rate risk. For other suppliers however, the shift may mean an introduction of exchange rate risk. Another Perspective: Students can learn more about Airbus by going to the company’s web site at { http:// www.airbus.com /en/ }.
  • The answer is c.
  • International business 7e chapter 10

    1. 1. InternationalBusiness 7eby Charles W.L. HillMcGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
    2. 2. Chapter 10The International Monetary System
    3. 3. 10-3IntroductionThe institutional arrangements that countries adopt togovern exchange rates are known as the internationalmonetary systemWhen a country allows the foreign exchange market todetermine the relative value of a currency, a floatingexchange rate system existsWhen a country fixes the value of its currency relative toa reference currency, a pegged exchange rate systemexists
    4. 4. 10-4IntroductionWhen a country tried to hold the value of its currencywithin some range of a reference currency, dirty float existsCountries that adopt a fixed exchange rate system fixtheir currencies against each otherPrior to the introduction of the euro, some EuropeanUnion countries operated with fixed exchange rates withinthe context of the European Monetary System (EMS)
    5. 5. 10-5Classroom Performance SystemA ________ exchange rate system exists when the foreignexchange market determines the relative value of acurrency.a) Fixedb) Floatingc) Peggedd) Market
    6. 6. 10-6The Gold StandardThe gold standard dates back to ancient times when goldcoins were a medium of exchange, unit of account, andstore of valuePayment for imports was made in gold or silverLater, as trade grew, payment was made in papercurrency which was linked to gold at a fixed rate
    7. 7. 10-7Mechanics Of The Gold StandardPegging currencies to gold and guaranteeingconvertibility is known as the gold standardIn the 1880s, most of the world’s trading nations followedthe gold standardUnder the gold standard one U.S. dollar was defined asequivalent to 23.22 grains of "fine (pure) goldThe amount of a currency needed to purchase one ounceof gold was called the gold par value
    8. 8. 10-8Strength Of The Gold StandardThe great strength of the gold standard was that itcontained a powerful mechanism for achieving balance-of-trade equilibrium (when the income a country’s residentsearn from its exports is equal to the money its residentspay for imports) by all countries
    9. 9. 10-9Classroom Performance SystemWhat type of exchange rates system was the goldstandard?a) Fixedb) Floatingc) Peggedd) Market
    10. 10. 10-10The Period Between The Wars: 1918-1939The gold standard worked fairly well from the 1870s untilthe start of World War I in 1914During the war, many governments financed their warexpenditures by printing money, and in doing so, createdinflationPeople lost confidence in the system and started todemand gold for their currency putting pressure oncountries gold reserves, and forcing them to suspend goldconvertibilityBy 1939, the gold standard was dead
    11. 11. 10-11The Bretton Woods SystemIn 1944, representatives from 44 countries met at BrettonWoods, New Hampshire, to design a new internationalmonetary system that would facilitate postwar economicgrowthUnder the new agreement:a fixed exchange rate system was establishedall currencies were fixed to gold, but only the U.S. dollarwas directly convertible to golddevaluations could not to be used for competitivepurposesa country could not devalue its currency by more than10% without IMF approval
    12. 12. 10-12The Bretton Woods SystemThe Bretton Woods agreement also established twomultinational institutions: the International Monetary Fund (IMF) to maintain orderin the international monetary system the World Bank to promote general economicdevelopment
    13. 13. 10-13The Role Of The IMFThe IMF was charged with executing the main goal of theBretton Woods agreement - avoiding a repetition of thechaos that occurred between the wars through acombination of discipline and flexibilityDiscipline mean that:the need to maintain a fixed exchange rate put a brakeon competitive devaluations and brought stability to theworld trade environmenta fixed exchange rate regime imposed monetarydiscipline on countries, thereby curtailing price inflation
    14. 14. 10-14The Role Of The IMFFlexibility meant that:while monetary discipline was a central objective of theagreement, a rigid policy of fixed exchange rates would betoo inflexiblethe IMF was ready to lend foreign currencies to membersto tide them over during short periods of balance-of-payments deficit, when a rapid tightening of monetary orfiscal policy would hurt domestic employment
    15. 15. 10-15The Role Of The World BankThe World Bank is also called the International Bank forReconstruction and Development (IBRD)There are two ways to borrow from the World Bank:1. under the IBRD scheme, money is raised through bondsales in the international capital market borrowers pay what the bank calls a market rate ofinterest - the banks cost of funds plus a margin forexpenses.2. through the International Development Agency, an armof the bank created in 1960 IDA loans go only to the poorest countries
    16. 16. 10-16The Collapse Of The FixedExchange Rate SystemBretton Woods worked well until the late 1960sIt collapsed when huge increases in welfare programsand the Vietnam War were financed by increasing themoney supply and causing significant inflationOther countries increased the value of their currenciesrelative to the dollar in response to speculation the dollarwould be devaluedHowever, because the system relied on an economicallywell managed U.S., when the U.S. began to print money,run high trade deficits, and experience high inflation, thesystem was strained to the breaking point
    17. 17. 10-17The Floating Exchange Rate RegimeIn 1976, following the collapse of Bretton Woods, IMFmembers formalized a new exchange rate system at ameeting in JamaicaThe rules that were agreed on then, are still in placetoday
    18. 18. 10-18The Jamaica AgreementUnder the Jamaican agreement:floating rates were declared acceptablegold was abandoned as a reserve assettotal annual IMF quotas - the amount member countriescontribute to the IMF - were increased to $41 billion
    19. 19. 10-19Exchange Rates Since 1973Since 1973, exchange rates have become more volatile and lesspredictable than they were between 1945 and 1973Volatility has increased because of:The 1971 oil crisisThe loss of confidence in the dollar that followed the rise of U.S.inflation in 1977 and 1978The 1979 oil crisisThe unexpected rise in the dollar between 1980 and 1985The partial collapse of the European Monetary System in 1992The 1997 Asian currency crisis
    20. 20. 10-20Exchange Rates Since 1973Figure 10.1: Major Currencies Dollar Index, 1973-2006
    21. 21. 10-21Classroom Performance SystemWhich agreement deemed floating exchange rates to beacceptable?a) The Bretton Woods Agreementb) The Gold Standardc) The Jamaica Agreementd) The Louvre Accord
    22. 22. 10-22Fixed Versus Floating Exchange RatesThe merit of a fixed exchange rate versus a floatingexchange rate system continues to be debatedMany countries today are disappointed with the floatingexchange rate system
    23. 23. 10-23The Case For Floating Exchange RatesThe case for floating exchange rates has two mainelements:1. monetary policy autonomy2. automatic trade balance adjustments
    24. 24. 10-24The Case For Floating Exchange RatesSupporters of floating exchange rates argue thatremoving the obligation to maintain exchange rate parityrestores monetary control to a governmentUnder a fixed system, a countrys ability to expand orcontract its money supply as it sees fit is limited by theneed to maintain exchange rate paritySo, under the Bretton Woods system, if a countrydeveloped a permanent deficit in its balance of trade thatcould not be corrected by domestic policy, the IMF wouldhave to agree to a currency devaluation
    25. 25. 10-25The Case For Fixed Exchange RatesSupporters of fixed exchange rates focus on monetarydiscipline, uncertainty, and the lack of connection betweenthe trade balance and exchange ratesHaving to maintain a fixed exchange rate parity ensuresthat governments do not expand their money supplies atinflationary ratesThey also claim that speculation that is associated withfloating exchange rates can cause uncertaintyAdvocates of floating exchange rates also argue thatfloating rates help adjust trade imbalances
    26. 26. 10-26Who Is Right?There is no real agreement as to which system is betterWe know that a fixed exchange rate regime modeledalong the lines of the Bretton Woods system will not workA different kind of fixed exchange rate system might bemore enduring and might foster the kind of stability thatwould facilitate more rapid growth in international trade andinvestment
    27. 27. 10-27Exchange Rate Regimes In PracticeVarious exchange rate regimes are followed todayCurrently:14% of IMF members follow a free float policy26% of IMF members follow a managed float system28% of IMF members have no legal tender of their ownthe remaining countries use less flexible systems such aspegged arrangements, or adjustable pegs
    28. 28. 10-28Exchange Rate Regimes In PracticeFigure 10.2: Exchange Rate Policies, IMF Members, 2006
    29. 29. 10-29Classroom Performance SystemWhich type of exchange rate system do most IMF countriesfollow today?a) Free floatb) Managed floatc) Fixed pegd) Adjustable peg
    30. 30. 10-30Pegged Exchange RatesA country following a pegged exchange rate system,pegs the value of its currency to that of another majorcurrencyPegged exchange rates are popular among the world’ssmaller nationsThere is some evidence that adopting a peggedexchange rate regime does moderate inflationarypressures in a country
    31. 31. 10-31Currency BoardsCountries using a currency board commit to convertingtheir domestic currency on demand into another currencyat a fixed exchange rateTo make this commitment credible, the currency boardholds reserves of foreign currency equal at the fixedexchange rate to at least 100% of the domestic currencyissued
    32. 32. 10-32Crisis Management By The IMFSince many of the original reasons for the IMF no longerexist, the organization has redefined its missionThe IMF now focuses on lending money to countriesexperiencing financial crisesHowever, critics claim that IMF policies in these countrieshave actually made the situation worse
    33. 33. 10-33Financial Crises In ThePost-Bretton Woods EraA currency crisis occurs when a speculative attack on theexchange value of a currency results in a sharpdepreciation in the value of the currency, or forcesauthorities to expend large volumes of internationalcurrency reserves and sharply increase interest rates inorder to defend prevailing exchange ratesA banking crisis refers to a situation in which a loss ofconfidence in the banking system leads to a run on thebanks, as individuals and companies withdraw theirdepositsA foreign debt crisis is a situation in which a countrycannot service its foreign debt obligations, whether privatesector or government debt
    34. 34. 10-34Classroom Performance SystemA _________ is a situation in which a country cannotservice its foreign debt obligations, whether private sectoror government debt.a) currency crisisb) banking crisisc) foreign debt crisisd) foreign exchange crisis
    35. 35. 10-35Mexican Currency Crisis Of 1995The Mexican currency crisis of 1995 was a result of:high Mexican debtsa pegged exchange rate that did not allow for a naturaladjustment of pricesTo keep Mexico from defaulting on its debt, a $50 billionaid package was created
    36. 36. 10-36The Asian CrisisThe 1997 Southeast Asian financial crisis was caused by aseries of events that took place in the previous decade:huge increases in exports that helped fuel a boom incommercial and residential property, industrial assets, andinfrastructureinvestments that were made on the basis of projectionsabout future demand conditions that were unrealistic andcreated significant excess capacity Investments made onthe basis of unrealistic projections about future demandconditions created significant excess capacityinvestments were often supported by dollar-based debts
    37. 37. 10-37The Asian Crisiswhen inflation and increasing imports put pressure on thecurrencies, the resulting devaluations led to default ondollar denominated debtsby the mid 1990s, imports were expanding across theregionby mid-1997, it became clear that several key Thaifinancial institutions were on the verge of defaultforeign exchange dealers and hedge funds started tospeculate against the Baht, selling it shortafter struggling to defend the peg, the Thai governmentabandoned its defense and announced that the Baht wouldfloat freely against the dollar
    38. 38. 10-38The Asian CrisisWith its foreign exchange rates depleted, Thailand lackedthe foreign currency needed to finance its internationaltrade and service debt commitments, and was in desperateneed of the capital the IMF could provideFollowing the devaluation of the Baht, speculation causedother Asian currencies including the Malaysian Ringgit, theIndonesian Rupaih and the Singapore Dollar to fallThese devaluations were mainly driven by similar factorsto those that led to the earlier devaluation of the Baht--excess investment, high borrowings, much of it in dollardenominated debt, and a deteriorating balance ofpayments position
    39. 39. 10-39Evaluating The IMF’s Policy PrescriptionsBy 2006, the IMF was committing loans to some 59 countries ineconomic and currency crisisAll IMF loan packages require a combination of tight macroeconomicpolicy and tight monetary policyHowever, critics worry: the “one-size-fits-all” approach to macroeconomic policy isinappropriate for many countriesthe IMF is exacerbating moral hazard (when people behaverecklessly because they know they will be saved if things go wrong)The IMF has become too powerful for an institution without any realmechanism for accountability As with many debates about international economics, it is not clearwho is right
    40. 40. 10-40Implications For ManagersFor managers, understanding the international monetarysystem is important for:currency managementbusiness strategycorporate-government relations
    41. 41. 10-41Currency ManagementManagers must recognize that the current internationalmonetary system is a managed float system in whichgovernment intervention can help drive the foreignexchange marketUnder the present system, speculative buying and sellingof currencies can create volatile movements in exchangerates
    42. 42. 10-42Business StrategyManagers need to recognize that while exchange ratemovements are difficult to predict, their movement canhave a major impact on the competitive position ofbusinessesTo contend with this situation, managers need strategicflexibility
    43. 43. 10-43Corporate-Government RelationsManagers need to recognize that businesses caninfluence government policy towards the internationalmonetary systemSo, companies should promote an international monetarysystem that facilitates international growth anddevelopment
    44. 44. 10-44Classroom Performance SystemManagers need to understand the implications of changingexchange rates from all of the following perspectivesexceptA) corporate-governance relationsB) business strategyC) foreign relationsD) currency management

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