Global Marketing Management William A. Kotas Florida International University

Chapter 3 Financial Environment

Chapter Overview 1. Historical Role of the U.S. Dollar 2. Development of the Current International Monetary System 3. Fixed Versus Floating Exchange Rates 4. Foreign Exchange and Foreign Exchange Rates 5. Balance of Payments 6. The Asian Financial Crisis 7. Marketing in Euro-Land

Introduction Foreign exchange is the monetary mechanism allowing the transfer of funds from one nation to another. The existing international monetary system always affects companies as well as individuals whenever they buy or sell products and services traded across national borders.

Introduction (contd.) Although international marketers have to operate in a currently existing international monetary system for international transactions and settlements, they should understand how the scope and nature of the system has changed and how it has worked over time. The 1990s – particularly, the second half of the decade – proved to be one of the most turbulent periods in recent history.

1. Historical Role of the U.S. Dollar Each country has its own currency through which it expresses the value of its products. In the post-World War II period, the United States agreed to to exchange the dollar at $35 per ounce of gold. The dollar became the common denominator in world trade. In the early seventies, the U.S. dollar standard was dropped.

2. Development of Today’s International Monetary System Post-World War II developments had long-range effects on international financial arrangements. The negotiations to establish the postwar international monetary system took place at the resort of Bretton Woods in New Hampshire in 1944 which established the International Monetary Fund (IMF). President Richard Nixon suspended the convertibility of the dollar to gold on August 15, 1971.

2. Development of Today’s International Monetary System (contd.) The IMF oversees the international monetary system and its functions are as follows: – –To promote international monetary cooperation – –To facilitate the expansion and balanced growth of international trade – –To promote exchange stability and to maintain orderly exchange arrangements – –To assist in the establishment of a multilateral system of payments in respect to current transactions between member nations; to eliminate foreign exchange restrictions

2. Development of Today’s International Monetary System (contd.) – –To make available the general resources of the fund temporarily available to members under adequate safeguards; help members to correct maladjustments in the balance of payments – –To shorten the duration and lessen the degree of disequilibrium in the international balance of payments to members – –The IMF created special drawing rights (SDRs) in 1969.

2. Development of Today’s International Monetary System (contd.) The value of SDRs is determined by a weighted average of a basket of four currencies: the U.S. dollar, the Japanese yen, the European Union’s euro, and the British pound. During the Asian financial crisis, the IMF provided more than $110 billion in bailout packages to Thailand, Indonesia, and South Korea. Another creation of of the Bretton Woods Agreement was the International Bank for Reconstruction and Development, known as the World Bank.

3. Fixed Versus Floating Exchange Rates Two kinds of currency floats encompass free/clean float (allows no government intervention) and managed float (allows limited government intervention). In March 1973, the major currencies began to float in the foreign exchange markets. Today, the global economy is dominated by three major currency blocs: The U.S. dollar, the Japanese yen, and the EU’s euro.

4. Foreign Exchange and Foreign Exchange Rates One of the most fundamental determinants of the exchange rate is Purchasing Power Parity (PPP). The Economist publishes a PPP study (Big Mac Index) every year based on McDonald’s Big Mac hamburger. Factors influencing Foreign Exchange Rates (see Exhibit 3-3): – –Macroeconomic Factors: Relative inflation, balance of payments, foreign exchange reserves, economic growth,

4. Foreign Exchange and Foreign Exchange Rates (contd.) government spending, money supply growth, and interest rate policy. – –Political Factors: Exchange rate control, election year or leadership change. – –Random Factors: Unexpected and/or unpredicted events, fear of uncertainty, etc. Many countries attempt to maintain a lower value for their currency in order to encourage exports.

4. Foreign Exchange and Foreign Exchange Rates (contd.) Spot versus forward exchange rates Hard currencies are the world’s strongest and represent the world’s leading economies. To avoid the risk of currency fluctuations, companies use hedging. Target exchange rate Exchange rate pass through

5. Balance of Payments The balance of payment (BOP) of a nation summarizes all the transactions that take place between its residents and and the residents of other countries over a specified time period, usually a month, quarter or year. The BOP transactions contain three categories (see Exhibit 3-5): – –Current account – –Capital account – –Official reserves

5. Balance of Payments (contd.) The BOP on capital account summarizes financial transactions and is divided into short -and long-term capital accounts. Direct investments are controlled by residents of other nations. Portfolio investment includes long-term investments that do not give the investors effective control over the investment. There are three balances to identify on the BOP statement of a country:

5. Balance of Payments (contd.) – –Balance of merchandise trade account – –The current account (including merchandise trade, trade in services, and unilateral transfers) – –The basic balance (the current account and the long-term capital) The internal market adjustment refers to movement of prices and income in a country. The external market adjustment concerns exchange rates or a nation’s currency and its value with respect to the currencies of other nations.

6. The Asian Financial Crisis The Asian financial crisis in the latter half of the 1990s escalated into the biggest threat to global prosperity. China’s devaluation of its currency (yuan) triggered the Asian financial crisis in Because of this financial crisis, Thailand lost almost 60 percent of its baht’s purchasing power in dollar terms in The Malaysian ringgit lost some 40 percent of its value during the same period.

6. The Asian Financial Crisis (contd.) The Korean won depreciated 50 percent against the U.S. dollar. For Asian economies, four likely scenarios and changes in perspectives in marketing practices and strategy development include (see Exhibit 3-7): – –The Southeast Asian Countries Scenario –The Japan Scenario –The Korea Scenario –The China Scenario

6. The Asian Financial Crisis (contd.) In the coming years, for the Asian economies, necessary conditions to sustain their strong economic performance include: – –Strong financial institutions – –More corporate transparency – –Reliable and improved financial reporting systems that are consistent with free markets – –Supply of managerial pool – –Future economic reforms

6. The Asian Financial Crisis (contd.) Short-term and long-term corporate responses to the Asian financial crisis may include: – –Pull-out – –Emphasize a product’s value – –Change the product mix – –Repackage the goods – –Maintain stricter inventory – –Look outside the region for expansion opportunities

6. The Asian Financial Crisis (contd.) – –Increase advertising in the region – –Increase local procurement

7. Marketing in Euro-Land The European Union (EU) consists of fifteen countries. Of those fifteen, eleven countries form the “euro-zone” (see Exhibit 3-10). Their economies represent a combined 28 percent of the world’s gross domestic product. The Maastricht Treaty spelled out the guidelines toward European Monetary Union (EMU). The European Central Bank is headquartered in Frankfurt, Germany. The Big Bang in the euro-zone will occur in the year 2002.

7. Marketing in Euro-Land (contd.) After July 1, 2002, the euro will replace local currencies. Ramifications of the Euro for Marketers: – –Price transparency – –Intensified competitive pressure – –Streamlined supply chains – –New opportunities for small and medium-sized companies – –Adaptation of internal organizational structures