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world currency

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

2. McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
CHAPTER
The Global Monetary
System
9

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

4. McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
Slide
9-1

5. McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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)
Slide
9-2

6. McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
Slide
9-3

7. McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
Slide
9-4

8. McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
Slide
9-5

9. McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
Slide
9-6

10. McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
Slide
9-7

11. McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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?
Slide
9-8

12. McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
Slide
9-9
•How did the IMF do?
–Inappropriate policies?
–Moral hazard
•Reckless behavior
•No consequences
–Lack of accountability
•Record mixed

13. McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
Slide
9-11