INTERNATIONAL MONETARY SYSTEM AND FACTORS RESPONSIBLE FOR THE GROWTH OF

MULTINATIONAL FIRMS

INTERNATIONAL MONETARY SYSTEM

DEFINITION

‘‘ International Monetary System is part of the institutional framework

that binds national economies, such a system permits producers to

specialize in those goods for which they have a comparative advantage,

and serves to seek profitable investment opportunities on a global

basis’’

EVOLUTION OF INTERNATIONAL MONETARY SYSTEM

• Bimetallism (Before 1875)

• Classic Gold Standard (1875 – 1914)

• Interwar Period (1915 – 1944)

• Bretton Woods Agreement (1945 – 1972)

• Smithsonian Agreement (1971)

• International Monetary System (1973 to present)

CLASSIC GOLD STANDARDS (1875 – 1914)• Countries had to establish the rate at which its currency could be

converted to the weight of the gold.• Participants – Germany , France , UK, USA. • Example : $ 20.67/ounce , Pounds 4.247 / ounce.• Exchange rate between any two currencies was determined by their

gold content.• Gold was used as a storage of wealth and as a medium of exchange.• Central banks were restricted not to issue more currency than gold

reserves.

ADVANTAGES OF GOLD STANDARD• Price Stability

• Facilitates adjustment automatically

• Reduced the risk in exchange rate

• Strict monetary policies followed by countries

• Handle trade imbalance

DISADVANTAGES OF GOLD STANDARD• Growth of output ≠ Growth of gold supplies

• Volatility in the supply of gold

• Limiting the creation of money

• Countries cannot use monetary policy to fight domestic trade

TradeJapan USA

Gold

DECLINE OF GOLD STANDARD

• Money supply for financing the war activities was not easy.

• Exchange rate parity was greatly disturbed.

• Gold volume could not grow fast enough.

• It was not practical for a country to subordinate their national

currencies to gold.

INTERWAR PERIOD (1915 – 1944)

• Described as a period of de-globalization.

• Countries had abandoned the gold standard, the international trade and

capital flows shrank and started printing money to pay for war related

expenses.

• After the war, with high rates of inflation and a large amount of

outstanding money.

• A return to the old gold standard was attempted.

• The Great depression of 1930s diminished,

Commercial trade

International exchange of currencies

Cross border lending and borrowing

CONDITIONS PRIOR TO BRETTON WOODS

• Prior to WW I , national currencies had fixed exchange rates under the

international gold standards which abandoned after WW I.

• End of the War II to 1925- fluctuating exchange rates that collapsed in

the Great Depression.

• Many countries resorted to protectionism and competitive devaluation.

BRETTON WOODS AGREEMENT (1945-1972)• Named after the year 1944 meeting of 44 nations at Bretton Woods, New Hampshire initiated

by John Maynard Keynes and Harry Dexter White.

• The goal was exchange rate stability without the gold standard.

• The result was the creation of the IMF and the World Bank.

OBJECTIVE

• Freedom for governments to pursue domestic polices

• Promoting employment

• Stabilize exchange rates

• Provide capital for reconstruction from the war

FEATURES OF BRETTON WOODS SYSTEM• Key difference was that the dollar was the only currency that was

convertible into gold.

• Exchangeable rates could be readjusted at certain times under certain

conditions.

• Each country was allowed to have a 1% band around which their

currency was allowed to fluctuate around the fixed rate.

• The IMF was created with the specific goal of being the multilateral body

that monitored the implementation of the Bretton Woods agreement.

• Central banks had to exchange domestic currency for dollars upon

request.

• Changes in monetary policy can affect both the output in its country as

well as output in other countries.

• A procedure for mutual international credits.

• The Bretton Woods system was a dollar-based gold exchange standard

and not gold based currency exchange.

• Longest formal mechanism.

DEMISE OF THE BRETTON WOODS SYSTEM• Lead to problem of lack of international liquidity.• Countries began holding less in dollars and more keen on holding

gold.• Any pressure to devalue the dollar would cause problems

throughout the world.• The trade balance of the USA became highly negative.• Large amount of US dollars was held outside the USA that it was

more than the total gold holdings of the USA.• On 15th Aug 1971, President Nixon suspended the system of

convertibility of gold and dollar and decided for floating exchange rate system.

SMITHSONIAN AGREEMENT (1971) • Attempt to save Bretton Woods system , 10 major countries met at the

Smithsonian Institute , Washington in December 1971.

• Conditions

- Price of gold was raised to $38 per ounce

- Countries revalued its currency against US dollars up to 10%

- Exchange rate band was expanded to 2.25 %

• Devaluation of dollar did not stabilize the situation.

• Existed less than 2 years.

EXCHANGE RATE SYSTEM AFTER 1973• The Board of Governors of the IMF appointed committee initiated an

exchange rate system that could be acceptable to the member

countries.

• Systems are classified based on flexibility in the exchange rates

1. Fixed exchange rate

2. Flexible exchange rate

FIXED EXCHANGE RATE SYSTEM

• A currency is pegged to a foreign currency, with fixed parity. The rates are maintained

constant.

• When a currency trends towards crossing over the limits, government intervene to keep

it within the band.

FLEXIBLE EXCHANGE RATE SYSTEM

• Involves market forces determining the exchange rate without intervention of

government.

• Advantages

- Adjusted to changes in macro- economic variables.

- Stable around the equilibrium in the long run.

THE FLEXIBLE EXCHANGE RATE REGIME

•Flexible exchange rates were acceptable to the IMF members.•Central banks were allowed to intervene in the exchange rate markets to iron out unwarranted volatilities.•Gold was abandoned as an international reserve asset.•Less-developed countries were given greater access to IMF funds.

TYPES OF EXCHANGE RATE REGIME Within the flexible exchange rate regime there are 3 categories,

1.Floating

Independent floating system

Managed floating systems

2.Pegging

3.Target Zone Arrangements

1. FLOATING

INDEPENDENT FLOATING SYSTEM

• Independent floating system does not involve intervention and

so termed as ‘clean floating’.

• The purpose of intervention is simply to moderate the exchange

rate and to prevent any undue fluctuation.

• But no attempt is undertaken to achieve/maintain a particular

rate.

MANAGED FLOATING SYSTEMS

• Involves direct or indirect intervention by the monetary authorities of

the country to stabilize the exchange rate.

• Indirect intervention - The monetary authorities stabilize the exchange

rate through changing the interest rates.

• Direct intervention - The monetary authorities purchase and sell

foreign currency in the domestic market.

• Managed floating is also known as ‘dirty floating’.

• No Predetermined Path for the Exchange Rate.

PEGGING • Periodic adjustment of fixed exchange rate to catch up with market

determined rates.

•Combine the advantages of fixed exchange rate with flexibility of

floating exchange rate.

• It fixes the exchange rate at a given level which is responsive to

changes in market conditions (ie) it is allowed to crawl pegging.

• A Crawling Band allows a periodic adjustment of the exchange rate

band itself.

• The upper and lower limits are decided for exchange rate depending

demand and supply of foreign exchange.

•When exchange rate crosses limits, the monetary policies push the

exchange rate within the target zone.

• If economic indicators are being disturbed, the monetary authorities let

the exchange rate depreciate or appreciate as the case may be.

TARGET – ZONE ARRANGEMENTS

• Target zone arrangement involves member countries having fixed

exchange rate among their currencies. Alternatively, they may use a

common currency.

FIXED VERSUS FLEXIBLE EXCHANGE RATE REGIMES

• Arguments in favor of flexible exchange rates

Easier external adjustments

National policy autonomy

• Arguments against flexible exchange rates

Exchange rate uncertainty may hamper international trade

No safeguards to prevent crises

INTERNATIONAL MONETARY SYSTEM • Set of internationally agreed rules, conventions and supporting institutions.

• Facilitate - International trade 

- Cross border investment

- Financing capital movement globally

- Determination on exchange rates

• Solves problems relating to

- Liquidity

- Adjustment

- Stability

FEATURES OF IMS Flow of international trade Investment according to comparative advantage Stability in foreign exchange Promoting Balance of Payments Providing countries with sufficient liquidity Plan for avoiding uncertainty Allowing member countries to pursue independent monetary and

fiscal policies

IMPLICATIONS FOR MANAGERS

For managers , understanding of International monetary

system is important for

- Currency management

- Business strategy

- Corporate – government relations

CURRENCY MANAGEMENT

• To recognize , the current IMS is a managed float system in

which the government intervention can drive the foreign

exchange market .

• To understand the speculative buying and selling of

currencies can create volatile movements in exchange rates.

BUSINESS STRATEGY

• To recognize that while exchange rate movements are difficult to

predict , it can have a major impact on the competitive position of the

business.

• To contend with this impact , managers need strategic flexibility .

Example : dispersing production to different locations.

CORPORATE GOVERNMENT RELATIONS

• To recognize that businesses can influence government

policy towards the IMS.

• Companies should promote an IMS that facilitates

international growth and development .

REFERENCESP K Jain, Josette Peyrard, Surendra S Yadav, “International Financial

Management”, Macmillan India Ltd, New Delhi, 2005.

Madhu Vij, “ International Financial Management”, Excel books

publications, New Delhi, 2001.

Vyuptakesh Sharan, “ International Financial Management”, Prentice Hall of

India Pvt Ltd, New Delhi, 2006.

THANK YOU