2000 chp 11 intl monetary system
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Chapter 11
The International
Monetary System
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What Is The International
Monetary System?A pegged exchange rate system exists when a
country fixes the value of its currency relative toa reference currency
many Gulf states peg their currencies to the U.S.dollar
A dirty floatexists when a country tries to holdthe value of its currency within some range of a
reference currency such as the U.S. dollarChina pegs the yuan to a basket of other currencies
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What Is The International
Monetary System?A fixed exchange rate system exists when
countries fix their currencies against eachother at some mutually agreed on
exchange rateEuropean Monetary System (EMS) prior to
1999
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What Was The Gold Standard?
The gold standard refers to a system inwhich countries peg currencies to gold andguarantee their convertibility
the gold standard dates back to ancient timeswhen gold coins were a medium of exchange,unit of account, and store of value
payment for imports was made in gold or silver
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What Was The Gold Standard?
later, payment was made in paper currencywhich was linked to gold at a fixed rate
in the 1880s, most nations followed the gold
standard$1 = 23.22 grains of fine (pure) gold
the gold par value refers to the amount of acurrency needed to purchase one ounce ofgold
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Why Did The
Gold Standard Make Sense?The great strength of the gold standard
was that it contained a powerfulmechanism for achieving balance-of-trade
equilibrium by all countrieswhen the income a countrys residents earn
from its exports is equal to the money its
residents pay for importsIt is this feature that continues to prompt
calls to return to a gold standard
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Why Did The
Gold Standard Make Sense?The gold standard worked well from the
1870s until 1914but, many governments financed their World
War I expenditures by printing money and so,created inflation
People lost confidence in the systemdemanded gold for their currency putting
pressure on countries' gold reserves, andforcing them to suspend gold convertibility
By 1939, the gold standard was dead
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What Was The
Bretton Woods System? In 1944, representatives from 44 countries met
at Bretton Woods, New Hampshire, to design anew international monetary system that wouldfacilitate postwar economic growth
Under the new agreementa fixed exchange rate system was establishedall currencies were fixed to gold, but only the U.S.
dollar was directly convertible to golddevaluations could not to be used for competitive
purposesa country could not devalue its currency by more than
10% without IMF approval
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What Institutions Were
Established At Bretton Woods? The Bretton Woods agreement also
established two multinational institutions
1. The International Monetary Fund (IMF) to
maintain order in the international monetarysystem through a combination ofdiscipline andflexibility
2. The World Bank to promote general economic
development also called the International Bank for Reconstruction
and Development (IBRD)
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What Institutions Were
Established At Bretton Woods?1. The International Monetary Fund(IMF) fixed exchange rates stopped competitive
devaluations and brought stability to the world tradeenvironment
fixed exchange rates imposed monetary disciplineon countries, limiting price inflation
in cases of fundamental disequilibrium,devaluations were permitted
the IMF lent foreign currencies to members duringshort periods of balance-of-payments deficit, whena rapid tightening of monetary or fiscal policy wouldhurt domestic employment
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What Institutions Were
Established At Bretton Woods?2. The World Bank
Countries can borrow from the World Bank in twoways
1. Under the IBRD scheme, money is raised throughbond sales in the international capital market
borrowers pay a market rate of interest - thebank's cost of funds plus a margin for expenses.
2. Through the International Development Agency, anarm of the bank created in 1960
IDA loans go only to the poorest countries
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Why Did The Fixed Exchange
Rate System Collapse? 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 U.S. dollar in response to speculationthe dollar would 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
the U.S. dollar came under speculative attack
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What Was The
Jamaica Agreement?A new exchange rate system was established in
1976 at a meeting in Jamaica
The rules that were agreed on then are still in
place todayUnder the Jamaican agreement
floating rates were declared acceptable
gold was abandoned as a reserve asset
total annual IMF quotas - the amount membercountries contribute to the IMF - were increased to$41 billion today they are about $300 billion
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What Has Happened To
Exchange Rates Since 1973?Since 1973, exchange rates have been
more volatile and less predictable thanthey were between 1945 and 1973because ofthe 1971 and 1979 oil crisesthe loss of confidence in the dollar after U.S.
inflation in 1977-78the rise in the dollar between 1980 and 1985the partial collapse of the EMS in 1992the 1997 Asian currency crisisthe decline in the dollar from 2001 to 2009
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What Has Happened To
Exchange Rates Since 1973?Major Currencies Dollar Index, 1973-2010
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Which Is Better Fixed
Rates Or Floating Rates? Floating exchange rates provide
1. Monetary policy autonomy
removing the obligation to maintain exchange rate
parity restores monetary control to a government2. Automatic trade balance adjustments
under Bretton Woods, if a country developed apermanent deficit in its balance of trade that could
not be corrected by domestic policy, the IMF wouldhave to agree to a currency devaluation
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Which Is Better Fixed Rates
Or Floating Rates? But, a fixed exchange rate system
1. Provides monetary discipline ensures that governments do not expand
their money supplies at inflationary rates2. Minimizes speculation causes uncertainty
3. Reduces uncertainty promotes growth of international trade and
investment
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Who Is Right?
There is no real agreement as to whichsystem is better
We know that a Bretton Woods-style fixed
exchange rate regime will not workBut a different kind of fixed exchange rate
system might be more enduring
could encourage stability that would facilitatemore rapid growth in international trade andinvestment
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What Type of Exchange Rate
System Is In Practice Today?Various exchange rate regimes are followed
today
14% of IMF members follow a free float policy
26% of IMF members follow a managed float system22% of IMF members have no legal tender of their
own
ex. Euro Zone countries
the remaining countries use less flexible systemssuch as pegged arrangements, or adjustable pegs
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What Type of Exchange Rate
System Is In Practice Today?Exchange Rate Policies of IMF Members
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What Is A Pegged Rate
System?A country following a pegged exchange
rate system pegs the value of its currencyto that of another major currency
popular among the worlds smaller nations
imposes monetary discipline and leads to lowinflation
adopting a pegged exchange rate regime canmoderate inflationary pressures in a country
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What Is A Currency Board?
Countries using a currency board committo converting their domestic currency ondemand into another currency at a fixed
exchange ratethe currency board holds reserves of foreign
currency equal at the fixed exchange rate toat least 100% of the domestic currency issued
the currency board can issue additionaldomestic notes and coins only when there areforeign exchange reserves to back them
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What Is The Role
Of The IMF Today? Today, the IMF focuses on lending
money to countries in financial crisis
There are three main types of financialcrises:
1. Currency crisis
2. Banking crisis
3. Foreign debt crisis
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What Is The Role
Of The IMF Today?A currency crisis
occurs when a speculative attack on theexchange value of a currency results in a
sharp depreciation in the value of thecurrency, or forces authorities to expend largevolumes of international currency reservesand sharply increase interest rates in order to
defend prevailing exchange ratesBrazil 2002
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What Is The Role
Of The IMF Today?A banking crisis refers to a situation in which a
loss of confidence in the banking system leadsto a run on the banks, as individuals and
companies withdraw their depositsA foreign debt crisis is a situation in which a
country cannot service its foreign debtobligations, whether private sector or
government debtGreece and Ireland 2010
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What Was The Mexican
Currency Crisis Of 1995?The Mexican currency crisis of 1995 was a
result ofhigh Mexican debts
a pegged exchange rate that did not allow fora natural adjustment of prices
To keep Mexico from defaulting on itsdebt, the IMF created a $50 billion aidpackagerequired tight monetary policy and cuts in
public spending
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What Was The
Asian Currency Crisis? The 1997 Southeast Asian financial crisis was
caused by events that took place in theprevious decade including
1. An investment boom - fueled by huge increases inexports
2. Excess capacity - investments were based onprojections of future demand conditions
3. High debt - investments were supported by dollar-based debts
4. Expanding imports caused current accountdeficits
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What Was The
Asian Currency Crisis?By mid-1997, several key Thai financial
institutions were on the verge of default
speculation against the baht
Thailand abandoned the baht peg and allowedthe currency to float
The IMF provided a $17 billion bailout loanpackage
required higher taxes, public spending cuts,privatization of state-owned businesses, and higherinterest rates
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What Was The
Asian Currency Crisis?Speculation caused other Asian currencies
including the Malaysian Ringgit, the IndonesianRupaih and the Singapore Dollar to fall
These devaluations were mainly driven byexcess investment and high borrowings, much of it in
dollar denominated debt
a deteriorating balance of payments position
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What Was The
Asian Currency Crisis?The IMF provided a $37 billion aid package for
Indonesia required public spending cuts, closure of troubled
banks, a balanced budget, and an end to crony
capitalismThe IMF provided a $55 billion aid package to
South Korea required a more open banking system and economy,
and restraint by chaebol
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How Has The IMF Done?
By 2010, the IMF was committing loans to 68countries in economic and currency crisis
All IMF loan packages require tightmacroeconomic and monetary policy
However, critics worry the one-size-fits-all approach to macroeconomic
policy is inappropriate for many countries
the IMF is exacerbating moral hazard - when peoplebehave recklessly because they know they will besaved if things go wrong
the IMF has become too powerful for an institutionwithout any real mechanism for accountability
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How Has The IMF Done?
But, as with many debates about internationaleconomics, it is not clear who is right
However, in recent years, the IMF has started tochange its policies and be more flexibleurged countries to adopt fiscal stimulus and monetary
easing policies in response to the 2008-2009 globalfinancial crisis
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What Does The Monetary
System Mean For Managers? Managers need to understand how the
international monetary system affects1. Currency management - the current system is
a managed float - government intervention can
influence exchange rates speculation can also create volatile movements in
exchange rates
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What Does The Monetary
System Mean For Managers?2. Business strategy - exchange rate movements
can have a major impact on the competitiveposition of businesses need strategic flexibility
3. Corporate-government relations - businessescan influence government policy towards theinternational monetary system companies should promote a system that facilitates
international growth and development
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