Global monetary

1. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

2. CHAPTER
99
The Global Monetary
System
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

3. Key Issues
• How does the Global Monetary System affect
exchange rates?
• How did the current system evolve?
• What are the differences between the fixed and
floating exchange system?
• What is the role of the International Monetary
Fund and the World Bank in the Global Monetary
System?
• What are the implications of the global monetary
system for currency management and business
strategy?
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

4. International Monetary System
• Currency exchange rates depend on the structure
of the international monetary system
• Generally they are not freely convertible and do
not float freely
– Only 51 were freely convertible in 1997
– Another 50 were pegged to the exchange rate of major
currencies such as the US Dollar and the French Franc
or to baskets of other currencies
– Another 45 currencies were allowed by their
governments to float within a range of another
currency
– This is 146 of 188 UN member nations in 1999
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5. Evolution of the International
Monetary System
• Gold Standard
– Currencies pegged to the value of gold;
convertibility guaranteed
– By 1880 most countries were on the gold standard
– Achieves balance of trade equilibrium for all
countries (value of exports equals value of imports);
flow of gold was used to make up differences
– Abandoned in 1914; attempt to resume after WWI
failed with Great Depression
• Bretton Woods (1944)
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6. Bretton Woods (1944 - 1973)
• 44 countries met to design a new system in 1944
• Established International Monetary Fund (IMF)
and World Bank
– IMF maintained order in monetary system
– World Bank promoted 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; government had to buy/sell their currency to
maintain level
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7. The Role of the IMF
per Bretton Woods
• Exchange rate discipline
– National governments had to manage inflation through
their money supply
• Exchange rate flexibility
– Provided loans to help members states with temporary
balance-of-payment deficit;
• Allowed time to bring down inflation
• Relieved pressures to devalue
– Excessive drawing from IMF funds came with IMF
supervision of monetary and fiscal policies
– Allowed up to 10% devaluations and more with IMF
approval
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8. The Role of the World Bank
• World Bank (IBRD-International Bank for
Reconstruction and Development) role
– Refinance post-WWII reconstruction and development
– Provide low-interest long term loans to developing
economies
• The International 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
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9. 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
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10. Jamaica Agreement 1976
• Floating rates declared acceptable
• Gold abandoned as reserve asset;
– IMF returned its gold reserves to its members at current
prices
– Proceeds were placed in a 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
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11. The 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?
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12. Recent Activities and the IMF
• Mexican crisis 1995
• Russian crisis1995
• Asian crisis 1997/1998
– The investment boom
– Excess capacity
– The debt bomb
– Expanding imports
– The crisis
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• How did the IMF do?
– Inappropriate policies?
– Moral hazard
• Reckless behavior
• No consequences
– Lack of accountability
• Record mixed

13. Implications for Business
• Currency management
– The monetary system is not perfect
– Both speculative activity and government intervention
affect the system
– Companies must use risk management instruments
• Business strategy
– Minimize risk by placing assets in different parts of the
world, e.g., production
– Contract manufacturing
– Manage company-government relations
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