2Monetary SystemRelationship between monetary system and foreign exchange ratesHistorical developmentFixed vs floating exchange ratesRole of the IMF and World BankImplications for managers
3International Monetary System Currency exchange rates depend on the structure of the international monetary systemIn 2003 of all IMF members currenciesOnly 19% were free floating25% were managed float8% were adjustable peg22% were fixed peg4% were fixed by a currency board22% were not currency of their own (use Euro, US Dollar)
5Evolution of the International Monetary System Gold Standard: currencies pegged to gold valueConvertibility guaranteedBy 1880 most on gold standardBalance of trade equilibrium for all countriesValue of exports should equal value of importsFlow of gold used to make up differencesAbandoned in 1914Failed resumption after WWIGreat Depression
6Bretton Woods ( )44 countries met to design a new system in 1944Established: International Monetary Fund (IMF) and World BankIMF: maintain order in monetary systemWorld Bank: promote general economic developmentFixed exchange rates pegged to the US DollarUS Dollar pegged to gold at $35 per ounceCountries maintained their currencies ± 1% of the fixed rate; buy/sell own currency to maintain level
7The Role of the IMF IMF maintained exchange rate 187 members by 2003 disciplineNational governments had to manage inflation through their money supplyflexibilityProvides loans to help members states with temporary balance-of-payment deficit;Allows time to bring down inflationRelieves pressures to devalueExcessive drawing from IMF funds came with IMF supervision of monetary and fiscal policiesAllowed to 10% devaluations and more with IMF approval187 members by 2003
8The Role of the World Bank World Bank (IBRD) role (International Bank for Reconstruction & Development)Refinanced post-WWII reconstruction and developmentProvides low-interest long term loans to developing economiesThe International Development Agency (IDA), an arm of the bank created in 1960Raises funds from member statesLoans only to poorest countries50 year repayment at 1% per year interest
9Collapse of Bretton Woods Devaluation pressures on US dollar after 20 yearsLyndon Johnson policiesVietnam war financingWelfare program financingNixon ended gold convertibility of US dollar in 1971US dollar was devalued and dealers started speculating against it for further devaluationBretton Woods fixed exchange rates abandoned in January 1972
10Jamaica Agreement 1976 Floating rates declared acceptable Gold abandoned as reserve asset;IMF returned gold reserves to members at current pricesProceeds placed in trust fund to help poor nationsIMF quotas – member country contributions – increased; membership now 182 countriesLess-develop, non-oil exporting countries given more access to IMFIMF continued its role of helping countries cope with macroeconomic and exchange rate problems
11Case for Floating Exchange Rates The Case for Fixed Exchange Rates Monetary policy autonomyTrade balance adjustments helpedThe Case for Fixed Exchange RatesMonetary disciplineSpeculation limitedUncertainty reducedTrade balance adjustment effects on inflation controlledWho is right?
12Recent Activities and the IMF Mexican Crisis 1995Russian Ruble crisis1995Asian crisis 1997/1998EventsThe investment boomExcess capacityThe debt bombExpanding importsThe crisisHow does the IMF achieve results?Inappropriate policies?Moral Hazard?Lack of accountability?
13Managerial Implications Currency managementCurrency market does not always work as expectedGovernment interventionSpeculative activityBusiness strategyMovements in exchange rates are difficult to predictForward market is imperfect predictor of exchange rate movementsForward exchange rate market covers risk for months not yearsMaintenance of strategic flexibility requiredDisperse manufacturingOutsourceCorporate-government relations