7-1 chapter 7 The International Monetary System and the Balance of Payments International Business, 6th Edition Griffin & Pustay Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-2 Chapter Objectives Discuss the role of the international monetary system in promoting international trade and investment Explain the evolution and functioning of the gold standard Summarize the role of the World Bank Group and the International Monetary Fund in the post-World War II international monetary system established at Bretton Woods Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-3 Chapter Objectives (continued) Explain the evolution of the flexible exchange rate system Describe the function and structure of the balance of payments accounting system Differentiate among the various definitions of a balance of payments surplus and deficit Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-4 International Monetary System The international monetary system establishes the rules by which countries value and exchange their currencies and provides a mechanism for correcting imbalances between a country’s international payments and receipts. Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-5 Balance of Payments The Balance of Payments (BOP) Accounting System records international transactions and supplies vital information about the health of a national economy and likely changes in its fiscal and monetary policies. Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-6 History of the International Monetary System The Gold Standard The Sterling-Gold Standard The Collapse of the Gold Standard The Bretton Woods Era The End of the Bretton Woods Era Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-7 The Gold Standard Countries agree to buy or sell their paper currencies in exchange for gold on the request of any individual or firm and to allow the free export of gold bullion and coins. Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-8 Fixed Exchange Rate System Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-9 Sterling-Based Gold Standard British pound sterling was the most important currency from 1821 to Most firms would accept either gold or British pounds. Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-10 Map 7.1 The British Empire, 1913 Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-11 The Collapse of the Gold Standard Economic pressures of WWI Countries suspended pledges to buy or sell gold at currencies’ par values Gold standard readopted in 1920s Dropped during Great Depression British pound allowed to float in 1931 –Float: value determined by supply and demand Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-12 Figure 7.1 The Contraction of World Trade, Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-13 The Bretton Woods Era 44 countries met in Bretton Woods, New Hampshire, in 1944 Goal: to create a postwar economic environment to promote worldwide peace and prosperity Renewed gold standard on modified basis (dollar-based) Created International Bank for Reconstruction and Development and International Monetary Fund Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-14 International Bank for Reconstruction and Development (the World Bank) Goal 1: to help finance reconstruction of European economies –Accomplished in mid-1950s Goal 2: to build economies of the world’s developing countries Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-15 Figure 7.2 Organization of the World Bank Group Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-16 Objectives of the International Monetary Fund To promote international monetary cooperation To facilitate the expansion and balanced growth of international trade To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation To assist in the establishment of a multilateral system of payments Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-17 Objectives of the International Monetary Fund (continued) To give confidence to members by making the general resources of the IMF temporarily available to them and to correct maladjustments in their balances of payments To shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-18 Membership in the IMF Open to any country willing to agree to rules and regulations 185 member countries as of 2008 Membership requires payment of a quota Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-19 A Dollar-Based Gold Standard Countries agreed to peg the value of currencies to gold U.S. $ keystone of system Fixed exchange rate system Adjustable peg Functioned well in times of economic prosperity Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-20 The End of the Bretton Woods System Susceptible to speculative “runs on the bank” U.S. $ became only source of liquidity necessary to expand international trade People questioned the ability of U.S. to meet obligations (Triffin Paradox) IMF created special drawing rights (SDRs) – paper gold Bretton Woods system ended August 15, 1971 Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-21 Performance of the International Monetary System since 1971 Most currencies began to float Value of U.S. $ fell relative to most major currencies Group of Ten agreed to restore fixed exchange rate system with restructured rates of exchange Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-22 International Monetary System since 1971 Development of floating exchange rate system –Supply and demand for a currency determine its price in the world market –Managed float – central banks can affect supply and demand Legitimized in 1976 with the Jamaica Agreement Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-23 Table 7.1 The Groups of Five, Seven, and Ten Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-24 Table 7.2 Key Central Banks CountryBank CanadaBank of Canada European UnionEuropean Central Bank JapanBank of Japan United KingdomBank of England United StatesFederal Reserve Bank Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-25 European Union Believed flexible system would hinder ability to create integrated economy Created European Monetary System to manage currency relationships ERM participants maintained fixed exchange rates among their currencies Facilitated creation and adoption of euro Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-26 Map 7.2 Exchange Rate Arrangements as of 2007 Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-27 Figure 7.3 Exchange Rates of Dollar vs. Yen, the Euro, and the Deutsche Mark, Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-28 International Debt Crisis OPEC quadrupled world oil prices –Resulted in inflationary pressures in oil-importing countries –Exchange rates adjusted –Transfer of wealth Countries borrowed more than they could repay Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-29 Approaches to Resolve the International Debt Crisis The Baker PlanThe Brady Plan Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-30 The Balance of Payments Accounting System The BOP accounting system is a double-entry bookkeeping system designed to measure and record all economic transactions between residents of one country and residents of all other countries during a particular time period. Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-31 Figure 7.4 The Asian Contagion Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-32 Balance of Payments (BOP) Accounting System Measures and records all economic transactions between residents of one country and residents of all other countries during specified time period Provides understanding of performance of each country’s economy in international markets Signals fundamental changes in country competitiveness Assists policy makers in designing appropriate public policies Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-33 Four Important Aspects of the BOP Accounting System Records international transactions made in some time period Records only economic transactions Records transactions between residents of one country and all other countries –Residents include individuals, businesses, government agencies, nonprofit organizations Uses a double-entry system Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-34 Major Components of the BOP Accounting System Current Account Capital Account Official Reserves Errors and Omissions Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-35 Types of Current Account Transactions Exports and imports of goods Exports and imports of services Investment income Gifts Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-36 Capital Account Foreign Direct Investment Portfolio Investment Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-37 Table 7.4 Capital Account Transactions Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-38 Table 7.5 BOP Entries, Capital Account Debt (Outflow)Credit (Inflow) Portfolio (short-term)Receiving a payment from a foreigner Making a payment to a foreigner Buying a short-term foreign asset Selling a domestic short- term asset to a foreigner Portfolio (long-term)Buying back a short-term domestic asset from its foreign owner Selling a short-term foreign asset acquired previously Buying back a long-term domestic asset from its foreign owner Selling a domestic long- term asset to a foreigner Foreign direct investment Buying a foreign asset for purposes of control Selling a long-term foreign asset previously acquired Buying back from its foreign owner a domestic asset Selling a domestic asset to a foreigner Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-39 Official Reserves Account Records level of official reserves Four types of assets –Gold –Convertible currencies –SDRs –Reserve positions at the IMF Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-40 Official Reserves Account Assets Gold Convertible securities SDRs Reserve positions Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-41 Errors and Omissions BOP must balance Current Account + Capital Account + Official Reserves Account = 0 Current Account + Capital Account + Official Reserves Account + Errors and Omissions = 0 Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-42 Table 7.6. U.S. Balance of Payments in 2007 Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-43 Figure 7.5a. Leading U.S. Merchandise Exports, 2007 Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-44 Figure 7.5b. Leading U.S. Merchandise Imports, 2007 Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-45 Figure 7.6. Trade Between the U.S. and its Major Trading Partners, 2007 Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-46 Defining BOPs Surpluses and Deficits Official Settlements Balance reflects changes in a country’s official reserves; essentially, it records the net impact of the Central Bank’s intervention in the foreign-exchange market in support of the local currency Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

7-47 Figure 7.7 The U.S. BOP According to Various Reporting Measures Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

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