Chapter 10 Monetary System

McGraw-Hill/Irwin Global Business Today, 4/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. International Monetary System Currency exchange rates depend on the structure of the international monetary system In 2003 of all IMF members currencies -Only 19% were free floating -25% were managed float -8% were adjustable peg -22% were fixed peg -4% were fixed by a currency board -22% were not currency of their own (use Euro, US Dollar)

McGraw-Hill/Irwin Global Business Today, 4/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Major Currencies Dollar Index

McGraw-Hill/Irwin Global Business Today, 4/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Evolution of the International Monetary System Gold Standard: c urrencies pegged to gold value -Convertibility guaranteed -By 1880 most on gold standard -Balance of trade equilibrium for all countries Value of exports should equal value of imports Flow of gold used to make up differences -Abandoned in 1914 Failed resumption after WWI Great Depression

McGraw-Hill/Irwin Global Business Today, 4/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Bretton Woods ( ) 44 countries met to design a new system in 1944 Established: International Monetary Fund (IMF) and World Bank -IMF: maintain order in monetary system -World Bank: promote 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; buy/sell own currency to maintain level

McGraw-Hill/Irwin Global Business Today, 4/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. The Role of the IMF IMF maintained exchange rate -discipline National governments had to manage inflation through their money supply -flexibility Provides loans to help members states with temporary balance-of-payment deficit; -Allows time to bring down inflation -Relieves pressures to devalue Excessive drawing from IMF funds came with IMF supervision of monetary and fiscal policies -Allowed to 10% devaluations and more with IMF approval 187 members by 2003

McGraw-Hill/Irwin Global Business Today, 4/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. The Role of the World Bank World Bank (IBRD) role (International Bank for Reconstruction & Development) -Refinanced post-WWII reconstruction and development -Provides low-interest long term loans to developing economies The International Development Agency (IDA), an arm of the bank created in Raises funds from member states -Loans only to poorest countries -50 year repayment at 1% per year interest

McGraw-Hill/Irwin Global Business Today, 4/e © 2006 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 US dollar was devalued and dealers started speculating against it for further devaluation -Bretton Woods fixed exchange rates abandoned in January 1972

McGraw-Hill/Irwin Global Business Today, 4/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Jamaica Agreement 1976 Floating rates declared acceptable Gold abandoned as reserve asset; -IMF returned gold reserves to members at current prices -Proceeds placed in 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

McGraw-Hill/Irwin Global Business Today, 4/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. -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? The Case for Floating Exchange Rates

McGraw-Hill/Irwin Global Business Today, 4/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Managerial Implications Currency management -Currency market does not always work as expected -Government intervention -Speculative activity Business strategy -Movements in exchange rates are difficult to predict -Forward market is imperfect predictor of exchange rate movements -Forward exchange rate market covers risk for months not years -Maintenance of strategic flexibility required Disperse manufacturing Outsource -Corporate-government relations