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The currency arrangement negotiated at Bretton Woods and monitored by the IMF worked fairly well during the post-WWII era of reconstruction and growth in world trade
However, widely diverging monetary and fiscal policies, differential rates of inflation and various currency shocks resulted in the system’s demise
The US dollar became the main reserve currency held by central banks, resulting in a consistent and growing balance of payments deficit which required a heavy capital outflow of dollars to finance these deficits and meet the growing demand for dollars from investors and businesses
All exchange rate regimes must deal with the tradeoff between rules and discretion (vertical), as well as between cooperation and independence (horizontal) (see exhibit 2.8)
The pre WWI Gold Standard required adherence to rules and allowed independence
The Bretton Woods agreement (and to a certain extent the EMS) also required adherence to rules in addition to cooperation
The present system is characterized by no rules, with varying degrees of cooperation
Many believe that a new international monetary system could succeed only if it combined cooperation among nations with individual discretion to pursue domestic social, economic, and financial goals
Exhibit 3.8 The Trade-offs between Exchange Rate Regimes
Mini-Case Questions: The Revaluation of the Chinese Yuan
Many Chinese critics had urged China to revalue the yuan by 20% or more. What would the Chinese yuan’s value be in US dollars if it had indeed been devalued by 20%?
Do you believe that the revaluation of the Chinese yean was politically or economically motivated?
Mini-Case Questions: The Revaluation of the Chinese Yuan (cont’d)
If the Chinese yuan were to change by the maximum allowed per day, 0.3% against the US dollar, consistently over a 30 or 60 day period, what extreme values might it reach?
Chinese multinationals would now be facing the same exchange rate-related risks borne by US, Japanese, and European multinationals. What impact do you believe this rising risk will have on the strategy and operations of Chinese companies in the near-future?