McGraw-Hill/Irwin

2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

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