The document provides an overview of the international monetary system, including different exchange rate regimes like floating rates, pegged rates, and currency boards. It discusses the history of international monetary systems from the gold standard to Bretton Woods to the current floating rate system. It also examines financial crises like those in Mexico and Asia and debates around fixed versus floating rates. For managers, understanding the monetary system is important for currency management, business strategy, and relations with government.

1. International B
usiness 7e
by Charles W.L. Hill
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter
10
The International Monetary System

3. Introduction
10-3
The institutional arrangements that countries adopt to
govern exchange rates are known as the international
monetary system
When a country allows the foreign exchange market to
determine the relative value of a currency, a floating
exchange rate system exists
When a country fixes the value of its currency relative to a
reference currency, a pegged exchange rate system exists

4. Introduction
10-4
When a country tried to hold the value of its currency
within some range of a reference currency, dirty float exists
Countries that adopt a fixed exchange rate system fix their
currencies against each other
Prior to the introduction of the euro, some European Union
countries operated with fixed exchange rates within the
context of the European Monetary System (EMS)

5. Classroom Performance System
10-5
A exchange rate system exists when the foreign
exchange market determines the relative value of a
currency.
a) Fixed
b) Floating
c) Pegged
d) Market

6. The Gold Standard
10-6
The gold standard dates back to ancient times when gold
coins were a medium of exchange, unit of account, and store
of value
Payment for imports was made in gold or silver
Later, as trade grew, payment was made in paper
currency which was linked to gold at a fixed rate

7. Mechanics Of The Gold Standard
10-7
Pegging currencies to gold and guaranteeing convertibility
is known as the gold standard
In the 1880s, most of the world’s trading nations followed
the gold standard
Under the gold standard one U.S. dollar was defined as
equivalent to 23.22 grains of "fine (pure) gold
The amount of a currency needed to purchase one ounce
of gold was called the gold par value

8. Strength Of The Gold Standard
10-8
The great strength of the gold standard was that it
contained a powerful mechanism for achieving balance-of-
trade equilibrium (when the income a country’s residents
earn from its exports is equal to the money its residents pay
for imports) by all countries

9. Classroom Performance System
10-9
What type of exchange rates system was the gold standard?
a) Fixed
b) Floating
c) Pegged
d) Market

10. The Period Between The Wars: 1918-1939
10-10
The gold standard worked fairly well from the 1870s until
the start of World War I in 1914
During the war, many governments financed their war
expenditures by printing money, and in doing so, created
inflation
People lost confidence in the system and started to
demand gold for their currency putting pressure on countries'
gold reserves, and forcing them to suspend gold
convertibility
By 1939, the gold standard was dead

11. The Bretton Woods System
10-11
In 1944, representatives from 44 countries met at Bretton
Woods, New Hampshire, to design a new international
monetary system that would facilitate postwar economic
growth
Under the new agreement:
a fixed exchange rate system was established
all currencies were fixed to gold, but only the U.S. dollar
was directly convertible to gold
devaluations could not to be used for competitive purposes
a country could not devalue its currency by more than 10%
without IMF approval

12. The Bretton Woods System
10-12
The Bretton Woods agreement also established two
multinational institutions:
 the International Monetary Fund (IMF) to maintain order in
the international monetary system
 the World Bank to promote general economic
development

13. The Role Of The IMF
10-13
The IMF was charged with executing the main goal of the
Bretton Woods agreement - avoiding a repetition of the
chaos that occurred between the wars through a
combination of discipline and flexibility
Discipline mean that:
the need to maintain a fixed exchange rate put a brake on
competitive devaluations and brought stability to the world
trade environment
a fixed exchange rate regime imposed monetary discipline
on countries, thereby curtailing price inflation

14. The Role Of The IMF
10-14
Flexibility meant that:
while monetary discipline was a central objective of the
agreement, a rigid policy of fixed exchange rates would be
too inflexible
the IMF was ready to lend foreign currencies to members
to tide them over during short periods of balance-of-
payments deficit, when a rapid tightening of monetary or
fiscal policy would hurt domestic employment

15. The Role Of The World Bank
10-15
The World Bank is also called the International Bank for
Reconstruction and Development (IBRD)
There are two ways to borrow from the World Bank:
1. under the IBRD scheme, money is raised through bond
sales in the international capital market
borrowers pay what the bank calls a market rate of
interest - the bank's cost of funds plus a margin for
expenses.
2. through the International Development Agency, an arm of
the bank created in 1960
 IDA loans go only to the poorest countries

16. The Collapse Of The Fixed
Exchange Rate System
10-16
Bretton Woods worked well until the late 1960s
It collapsed when huge increases in welfare programs and
the Vietnam War were financed by increasing the money
supply and causing significant inflation
Other countries increased the value of their currencies
relative to the dollar in response to speculation the dollar
would be devalued
However, because the system relied on an economically
well managed U.S., when the U.S. began to print money, run
high trade deficits, and experience high inflation, the system
was strained to the breaking point

17. The Floating Exchange Rate Regime
10-17
In 1976, following the collapse of Bretton Woods, IMF
members formalized a new exchange rate system at a
meeting in Jamaica
The rules that were agreed on then, are still in place today

18. The Jamaica Agreement
10-18
Under the Jamaican agreement:
floating rates were declared acceptable
gold was abandoned as a reserve asset
total annual IMF quotas - the amount member countries
contribute to the IMF - were increased to $41 billion

19. Exchange Rates Since 1973
10-19
Since 1973, exchange rates have become more volatile and less
predictable 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. Exchange Rates Since 1973
Figure 10.1: Major Currencies Dollar Index, 1973-2006
10-20

21. Classroom Performance System
10-21
Which agreement deemed floating exchange rates to be
acceptable?
a) The Bretton Woods Agreement
b) The Gold Standard
c) The Jamaica Agreement
d) The Louvre Accord

22. Fixed Versus Floating Exchange Rates
10-22
The merit of a fixed exchange rate versus a floating
exchange rate system continues to be debated
Many countries today are disappointed with the floating
exchange rate system

23. The Case For Floating Exchange Rates
10-23
The case for floating exchange rates has two main
elements:
1. monetary policy autonomy
2. automatic trade balance adjustments

24. The Case For Floating Exchange Rates
10-24
Supporters of floating exchange rates argue that removing
the obligation to maintain exchange rate parity restores
monetary control to a government
Under a fixed system, a country's ability to expand or
contract its money supply as it sees fit is limited by the need
to maintain exchange rate parity
So, under the Bretton Woods system, if a country
developed a permanent deficit in its balance of trade that
could not be corrected by domestic policy, the IMF would
have to agree to a currency devaluation

25. The Case For Fixed Exchange Rates
10-25
Supporters of fixed exchange rates focus on monetary
discipline, uncertainty, and the lack of connection between
the trade balance and exchange rates
Having to maintain a fixed exchange rate parity ensures
that governments do not expand their money supplies at
inflationary rates
They also claim that speculation that is associated with
floating exchange rates can cause uncertainty
Advocates of floating exchange rates also argue that
floating rates help adjust trade imbalances

26. Who Is Right?
10-26
There is no real agreement as to which system is better
We know that a fixed exchange rate regime modeled along
the lines of the Bretton Woods system will not work
A different kind of fixed exchange rate system might be
more enduring and might foster the kind of stability that
would facilitate more rapid growth in international trade and
investment

27. Exchange Rate Regimes In Practice
10-27
Various exchange rate regimes are followed today
Currently:
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 as
pegged arrangements, or adjustable pegs

28. Exchange Rate Regimes In Practice
Figure 10.2: Exchange Rate Policies, IMF Members, 2006
10-28

29. Classroom Performance System
10-29
Which type of exchange rate system do most IMF countries
follow today?
a) Free float
b) Managed float
c) Fixed peg
d) Adjustable peg

30. Pegged Exchange Rates
10-30
A country following a pegged exchange rate system, pegs
the value of its currency to that of another major currency
Pegged exchange rates are popular among the world’s
smaller nations
There is some evidence that adopting a pegged exchange
rate regime does moderate inflationary pressures in a
country

31. Currency Boards
10-31
Countries using a currency board commit to converting
their domestic currency on demand into another currency at
a fixed exchange rate
To make this commitment credible, the currency board
holds reserves of foreign currency equal at the fixed
exchange rate to at least 100% of the domestic currency
issued

32. Crisis Management By The IMF
10-32
Since many of the original reasons for the IMF no longer
exist, the organization has redefined its mission
The IMF now focuses on lending money to countries
experiencing financial crises
However, critics claim that IMF policies in these countries
have actually made the situation worse

33. Financial Crises In The
Post-Bretton Woods Era
10-33
A currency crisis occurs when a speculative attack on the
exchange value of a currency results in a sharp depreciation
in the value of the currency, or forces authorities to expend
large volumes of international currency reserves and sharply
increase interest rates in order to defend prevailing
exchange rates
A banking crisis refers to a situation in which a loss of
confidence in the banking system leads to a run on the
banks, as individuals and companies withdraw their deposits
A foreign debt crisis is a situation in which a country
cannot service its foreign debt obligations, whether private
sector or government debt

34. Classroom Performance System
10-34
A is a situation in which a country cannot service
its foreign debt obligations, whether private sector or
government debt.
a) currency crisis
b) banking crisis
c) foreign debt crisis
d) foreign exchange crisis

35. Mexican Currency Crisis Of 1995
10-35
The Mexican currency crisis of 1995 was a result of:
high Mexican debts
a pegged exchange rate that did not allow for a natural
adjustment of prices
To keep Mexico from defaulting on its debt, a $50 billion
aid package was created

36. The Asian Crisis
10-36
The 1997 Southeast Asian financial crisis was caused by a
series of events that took place in the previous decade:
huge increases in exports that helped fuel a boom in
commercial and residential property, industrial assets, and
infrastructure
investments that were made on the basis of projections
about future demand conditions that were unrealistic and
created significant excess capacity Investments made on the
basis of unrealistic projections about future demand
conditions created significant excess capacity
investments were often supported by dollar-based debts

37. The Asian Crisis
10-37
when inflation and increasing imports put pressure on the
currencies, the resulting devaluations led to default on dollar
denominated debts
by the mid 1990s, imports were expanding across the
region
by mid-1997, it became clear that several key Thai
financial institutions were on the verge of default
foreign exchange dealers and hedge funds started to
speculate against the Baht, selling it short
after struggling to defend the peg, the Thai government
abandoned its defense and announced that the Baht would
float freely against the dollar

38. The Asian Crisis
10-38
With its foreign exchange rates depleted, Thailand lacked
the foreign currency needed to finance its international trade
and service debt commitments, and was in desperate need
of the capital the IMF could provide
Following the devaluation of the Baht, speculation caused
other Asian currencies including the Malaysian Ringgit, the
Indonesian Rupaih and the Singapore Dollar to fall
These devaluations were mainly driven by similar factors
to those that led to the earlier devaluation of the Baht--
excess investment, high borrowings, much of it in dollar
denominated debt, and a deteriorating balance of payments
position

39. Evaluating The IMF’s Policy Prescriptions
10-39
By 2006, the IMF was committing loans to some 59 countries in
economic and currency crisis
All IMF loan packages require a combination of tight macroeconomic
policy and tight monetary policy
However, critics worry:
the “one-size-fits-all” approach to macroeconomic policy is
inappropriate for many countries
the IMF is worsening moral hazard (when people behave
recklessly because they know they will be saved if things go wrong)
The IMF has become too powerful for an institution without any real
mechanism for accountability
As with many debates about international economics, it is not clear
who is right

40. Implications For Managers
10-40
For managers, understanding the international monetary
system is important for:
currency management
business strategy
corporate-government relations

41. Currency Management
10-41
Managers must recognize that the current international
monetary system is a managed float system in which
government intervention can help drive the foreign exchange
market
Under the present system, speculative buying and selling
of currencies can create volatile movements in exchange
rates

42. Business Strategy
10-42
Managers need to recognize that while exchange rate
movements are difficult to predict, their movement can have
a major impact on the competitive position of businesses
To contend with this situation, managers need strategic
flexibility

43. Corporate-Government Relations
10-43
Managers need to recognize that businesses can influence
government policy towards the international monetary
system
So, companies should promote an international monetary
system that facilitates international growth and development

44. Classroom Performance System
10-44
Managers need to understand the implications of changing
exchange rates from all of the following perspectives except
A) corporate-governance relations
B) business strategy
C) foreign relations
D) currency management