International Monetary System

International Business 3e Chapter Preview List the benefits of stable and predictable exchange rates Discuss the law-of-one-price principle Describe purchasing power parity and the factors that affect exchange rates Explain how the gold standard functioned Discuss the experience with Bretton Woods Describe today’s international monetary system © Prentice Hall, 2006 International Business 3e

Currency Values and Business Exchange rates affect activities of both domestic and international firms Devaluation Lowers export prices Raises import prices Revaluation Raises export prices Lowers import prices © Prentice Hall, 2006 International Business 3e

Strong Currency: Curse or Cure? Export strategies in the face of a strong currency Get lean by shaving production costs Reward customers for paying a higher price Diversify into more currency-proof sectors Follow global demand to maintain sales Freezing prices can generate new sales © Prentice Hall, 2006 International Business 3e

Stability and Predictability Stable exchange rates Improve accuracy of financial planning Predictable exchange rates Reduce surprises of unexpected rate changes © Prentice Hall, 2006 International Business 3e

International Business 3e Law of One Price Identical item must have an identical price in all countries when expressed in a common currency Big MacCurrencies Undervalued or overvalued Fairly good rate predictor Limited use in business decisions © Prentice Hall, 2006 International Business 3e

Purchasing Power Parity Relative ability of two nations’ currencies to buy the same “basket” of goods in those two nations Considers price levels in adjusting relative currency values Purchasing power of a currency is eroded by inflation © Prentice Hall, 2006 International Business 3e

Inflation: Key Factors Money supply Monetary policy directly affects interest rates and money supply Fiscal policy indirectly affects taxes and spending Employment High employment raises wages, which are embodied in consumer prices Interest rates High rates lower borrowing and spending, which lowers inflation Adjustment Exchange rates adjust to maintain PPP © Prentice Hall, 2006 International Business 3e

International Business 3e Interest Rates Fisher Effect Nominal Interest rate = real interest rate + inflation rate International Fisher Effect Difference in nominal interest rates supported by two nations’ currencies will cause an equal but opposite change in their spot exchange rates © Prentice Hall, 2006 International Business 3e

International Business 3e Evaluating PPP Added costs Business confidence & psychology Trade barriers © Prentice Hall, 2006 International Business 3e

Forecasting Exchange Rates Efficient (inefficient) market views Prices reflect (don’t reflect) all public information Forecasting techniques Fundamental analysis Technical analysis © Prentice Hall, 2006 International Business 3e

International Business 3e Gold Standard International monetary system that linked nations’ currencies to specific values of gold In place from 1700s to 1939 Reduced exchange-rate risk Restricted monetary policies Corrected trade imbalances Ended by “competitive devaluation” © Prentice Hall, 2006 International Business 3e

Bretton Woods Agreement International monetary system based on value of US dollar (1944 to 1973) Fixed exchange rates Built-in flexibility World Bank and IMF Ended by weak US dollar © Prentice Hall, 2006 International Business 3e

International Business 3e Jamaica Agreement Formalized the system of floating exchange rates as the new international monetary system (1976) Managed float system Currencies float with government intervention Free float system Currencies float without government intervention © Prentice Hall, 2006 International Business 3e

International Business 3e The System Today Managed float system Pegged exchange rates Currency board European monetary system © Prentice Hall, 2006 International Business 3e

Recent Financial Crises Developing nations’ debt crisis Mexico Southeast Asia Russia Argentina © Prentice Hall, 2006 International Business 3e