1. Global Business Today 10e
by Charles W.L. Hill
and G. Tomas M. Hult

2. The Global Monetary System
© Dmitry Kalinovsky/Shutterstock.com
Chapter 11: The International Monetary System

3. Learning Objectives
LO 11-1 Describe the historical development of the modern global monetary system. LO 11-2 Explain the role played by the World Bank and the IMF in the international monetary system. LO 11-3 Compare and contrast the differences between a fixed and a floating exchange rate system. LO 11-4 Identify exchange rate regimes used in the world today and why countries adopt different exchange rate regimes. LO 11-5 Understand the debate surrounding the role of the IMF in the management of financial crises. LO 11-6 Explain the implications of the global monetary system for management practice.

4. Opening Case: China’s Exchange Rate Regime
U.S. politicians claim China actively manipulates the yuan to keep its value low against the dollar to boost Chinese exports
Yuan devalued in 1980s to improve competitiveness of Chinese exports
Pressure to let currency appreciate as exports grew
In 2005, country adopted managed floating exchange rate system
Allowed for appreciation of yuan
This data suggests that far from artificially trying to keep their currency undervalued, since July 2005, the Chinese have allowed the yuan to increase in value against other currencies, albeit within the constraints imposed by the managed float. In late 2015, this commitment was put to the test when a slowdown in the rate of growth of the Chinese economy led to an outflow of capital from China, which put downward pressure on the yuan.

5. Introduction 1 of 2
The international monetary system is the institutional arrangement that govern exchange rates
Recall that the foreign exchange market is the primary institution for determining exchange rates
A floating exchange rate system exists where the foreign exchange market determines the relative value of a currency
A pegged exchange rate system exists when the value of a currency is fixed to a reference country and then the exchange rate between that currency and other currencies is determined by the reference currency exchange rate

6. Introduction 2 of 2
A managed float or dirty float exists when the value of a currency is determined by market forces, but with central bank intervention if it depreciates too rapidly against an important reference currency
With a fixed exchange rate system countries fix their currencies against each other at a mutually agreed upon value
Prior to the introduction of the euro, some European Union countries operated with fixed exchange rates within the context of the European Monetary System (EMS)

7. The Gold Standard 1 of 4
The origin of the gold standard dates back to ancient times when gold coins were a medium of exchange, unit of account, and store of value
To facilitate trade, a system was developed so that payment could be made in paper currency that could then be converted to gold at a fixed rate of exchange
LO Describe the historical development of the modern global monetary system.

8. The Gold Standard 2 of 4 Mechanics of the Gold Standard
The gold standard is the practice of pegging currencies to gold and guaranteeing convertibility
Under the gold standard one U.S. dollar was defined as equivalent to grains of "fine” (pure) gold
The exchange rate between currencies was based on the gold par value: the amount of a currency needed to purchase one ounce of gold

9. The Gold Standard 3 of 4 Strength of the Gold Standard
The key strength of the gold standard was its powerful mechanism for simultaneously allowing all countries to achieve balance-of-trade equilibrium
When the income a country’s residents earn from its exports is equal to the money its residents pay for imports
Some people today believe the world should return to the gold standard.

10. The Gold Standard 4 of 4 The Period Between the Wars: 1918-1939
The gold standard worked fairly well from the 1870s until the start of World War I
After the war countries started regularly devaluing their currencies to try to encourage exports
Confidence in the system fell, and people began to demand gold for their currency putting pressure on countries' gold reserves, and forcing them to suspend gold convertibility
The Gold Standard ended in 1939

11. The Bretton Woods System 1 of 4
A new international monetary system was designed in 1944 in Bretton Woods, New Hampshire
The goal was to build an enduring economic order that would facilitate postwar economic growth
The Bretton Woods Agreement established two multinational institutions
The International Monetary Fund (IMF) to maintain order in the international monetary system
The World Bank to promote general economic development
LO Explain the role played by the World Bank and the IMF in the international monetary system.

12. The Bretton Woods System 2 of 4
Under the Bretton Woods Agreement
The U.S. dollar was the only currency to be convertible to gold, and other currencies would set their exchange rates relative to the dollar
Devaluations were not to be used for competitive purposes
A country could not devalue its currency by more than 10% without IMF approval

13. The Bretton Woods System 3 of 4
The Role of the IMF
Discipline
A fixed exchange rate puts a brake on competitive devaluations and brings stability to the world trade environment
A fixed exchange rate regime imposes monetary discipline on countries, thereby curtailing price inflation
Flexibility
IMF ready to lend foreign currencies to members to tide them over during short periods of balance-of-payments deficits
A country could devalue its currency by more than 10% with IMF approval

14. The Bretton Woods System 4 of 4
The Role of the World Bank
Under the IBRD scheme, money is raised through bond sales in the international capital market and borrowers pay what the bank calls a market rate of interest - the bank's cost of funds plus a margin for expenses.
Under the International Development Agency scheme, loans go only to the poorest countries
The official name of the World Bank is the International Bank for Reconstruction and Development (IBRD).

15. Does the World Bank Make Global Markets Less Competitive?
The World Bank was created in 1944 as an international financial institution of the United Nations that would provide loans to developing countries for capital investments in the country. Broadly, the World Bank’s official goal is the reduction of poverty in the global marketplace. According to its Articles of Agreement, all of the World Bank’s decisions must be guided by a commitment to the promotion of foreign investment and international trade and to the facilitation of capital investment. These goals are admirable to most people and countries, but what effect does lending to developing countries have on the rest of the world? Would it be better or worse if lending was only based on risk assessments and financial opportunities of countries in a free market system?

16. Collapse of the Fixed Exchange Rate System 1 of 2
The collapse of the Bretton Woods system can be traced to U.S. macroeconomic policy decisions (1965 to 1968)
During this time, the U.S. financed huge increases in welfare programs and the Vietnam War by increasing its money supply which then caused significant inflation
Speculation that the dollar would have to be devalued relative to most other currencies forced other countries to increase the value of their currencies relative to the dollar
LO Describe the historical development of the modern global monetary system.

17. Collapse of the Fixed Exchange Rate System 2 of 2
The Bretton Woods system relied on an economically well managed U.S.
When the U.S. began to print money, run high trade deficits, and experience high inflation, the system was strained to the breaking point
The Bretton Woods Agreement collapsed in 1973

18. The Floating Exchange Rate Regime 1 of 3
Following the collapse of the Bretton Woods agreement, a floating exchange rate regime was formalized in 1976 in Jamaica
The rules for the international monetary system that were agreed upon at the meeting are still in place today
LO Describe the historical development of the modern global monetary system.

19. The Floating Exchange Rate Regime 2 of 3
The Jamaica Agreement
At the Jamaica meeting, the IMF's Articles of Agreement were revised to reflect the new reality of floating exchange rates
Floating rates were declared acceptable
Gold was abandoned as a reserve asset
Total annual IMF quotas - the amount member countries contribute to the IMF - were increased to $41 billion (today, this number is $767 billion)

20. The Floating Exchange Rate Regime 3 of 3
Exchange Rates Since 1973
Have become more volatile and less predictable
The oil crisis in 1971
The loss of confidence in the dollar after U.S. inflation jumped between 1977 and 1978
The oil crisis of 1979
The unexpected rise in the dollar between 1980 and 1985
Rapid fall of dollar against Japanese yen and German deutsche mark
The partial collapse of the European monetary system in 1992
The 1997 Asian currency crisis
The global financial crisis of and the EU sovereign debt crisis during
Country Focus: The U.S. Dollar, Oil Prices, and Recycling Petrodollars
Summary
This feature explores what oil producing nations are likely to do with the dollars they have earned. In 2008, oil prices reached new highs as a result of higher than expected demand, tight supplies, and perceived geopolitical risks. Since oil is priced in dollars, oil producers have seen their dollar reserves increase significantly. Now, speculation abounds as to what will happen to the petrodollars. Some believe that the dollars will go toward public infrastructure projects, others think that it is more likely that investments will be made in dollar denominated assets like U.S. bonds, stocks, and real estate, or in non-dollar denominated assets such as European or Japanese bonds and stocks. Discussion of the feature can revolve around the following questions:
Suggested Discussion Questions
1. With oil prices at record highs, there is significant speculation as to what oil producing states will do with the dollars they are earning. Discuss how a decision to invest in non-dollar denominated assets could affect the value of the U.S. dollar.
Suggested Discussion Points: As a result of higher demand from countries like China and India, tight supplies and perceived geo-political risks, oil prices reached a new high in For oil producing countries, this has proved to be an unexpected windfall. In 2007, the countries together earned over $1 trillion. Most students will probably recognize that if the countries decide to invest their earnings in non-dollar denominated assets, the value of the dollar could drop sharply.
2. How could a decision by oil producing countries to invest their petrodollars in public infrastructure projects help the value of the dollar?
Suggested Discussion Points: If the oil producing states invest the petrodollars in public infrastructure projects such as roads, telecommunications systems, and education, the U.S. dollar could actually rise in value. The infrastructure investments are likely to generate economic growth in the nations, which could then translate into market opportunities for U.S. firms.
Lecture Note: To extend this discussion, consider { { and {

21. Figure 11.1 Major Currencies Dollar Index 1973-2016
Source: Data from
Jump to Appendix 1 long image description

22. Did You Know?
Did you know that China has recently been trying to stop its currency from falling in value on foreign exchange markets?
Click to play video

23. Fixed Versus Floating Exchange Rates 1 of 5
The Case for Floating Exchange Rates
Monetary Policy Autonomy
The removal of the obligation to maintain exchange rate parity restores monetary control to a government
With a fixed system, a country's ability to expand or contract its money supply is limited by the need to maintain exchange rate parity

24. Fixed Versus Floating Exchange Rates 2 of 5
The Case for Floating Exchange Rates continued
Trade Balance Adjustments
The balance of payments adjustment mechanism works more smoothly under a floating exchange rate regime
Under the Bretton Woods system (fixed system), IMF approval was needed to correct a permanent deficit in a country’s balance of trade that could not be corrected by domestic policy alone
Crisis Recovery
Supporters of floating rates argue that they automatically help countries deal with economic crises

25. Fixed Versus Floating Exchange Rates 3 of 5
The Case for Fixed Exchange Rates
Monetary Discipline
Because a fixed exchange rate system requires maintaining exchange rate parity, it also ensures that governments do not expand their money supplies at inflationary rates
Speculation
A fixed exchange rate regime prevents destabilizing speculation

26. Fixed Versus Floating Exchange Rates 4 of 5
The Case for Fixed Exchange Rates continued
Uncertainty
Uncertainty associated with floating exchange rates makes business transactions more risky
Trade Balance Adjustments and Economic Recovery
Floating rates help adjust trade imbalances and can help with economic recovery after a crisis

27. Fixed Versus Floating Exchange Rates 5 of 5
Who is Right?
There is no real agreement as to which system is better
History shows that a fixed exchange rate regime modeled along the lines of the Bretton Woods system will not work
A different kind of fixed exchange rate system might be more enduring and might foster the kind of stability that would facilitate more rapid growth in international trade and investment

28. Floating or Fixed Exchange Rates?
The case for a floating exchange rate includes monetary policy autonomy, trade balance adjustments, and crisis recovery issues. The case for a fixed exchange rate includes monetary discipline, speculation issues, uncertainty, trade balance adjustments and economic recovery. We conclude these topics with a short section on “who is right” without actually addressing this very complex issue. But, what do you think? Who is right? Should we have a floating or fixed exchange rate system?

29. Exchange Rate Regimes in Practice 1 of 3
Currently, there are several different exchange rate regimes in practice
21% of IMF members allow their currencies to float freely
23% of IMF members follow a managed float system
5% of IMF members have no legal tender of their own (excluding EU countries that use the euro)
The remaining countries use less flexible systems such as pegged arrangements, or adjustable pegs
LO Identify exchange rate regimes used in the world today and why countries adopt different exchange rate regimes.

30. Exchange Rate Regimes in Practice 2 of 3
Pegged Exchange Rates
Under a pegged exchange rate regime countries peg the value of their currency to that of other major currencies
Popular among the world’s smaller nations
There is some evidence that adopting a pegged exchange rate regime moderates inflationary pressures in a country

31. Exchange Rate Regimes in Practice 3 of 3
Currency Boards
A country with a currency board commits to converting its domestic currency on demand into another currency at a fixed exchange rate
The currency board holds reserves of foreign currency equal at the fixed exchange rate to at least 100% of the domestic currency issued
Additional domestic notes and coins can be introduced only if there are foreign exchange reserves to back it
Since its establishment in 1983, the Hong Kong currency board has weathered several storms, including the latest. This success persuaded several other countries in the developing world to consider a similar system.

32. Crisis Management by the IMF 1 of 4
The IMF has redefined its mission, and now focuses on lending money to countries experiencing financial crises in exchange for enacting certain macroeconomic policies
Membership in the IMF has grown to 188 countries in 2014, of which 33 has some type of IMF program in place
LO 11-5

33. Crisis Management by the IMF 2 of 4
Financial Crises in the Post-Bretton Woods Era
Currency crisis occurs when a speculative attack on the exchange value of a currency results in a sharp depreciation in the value of the currency, or forces authorities to expend large volumes of international currency reserves and sharply increase interest rates in order to defend prevailing exchange rates
Banking crisis refers to a loss of confidence in the banking system that leads to a run on the banks
Foreign debt crisis is when a country cannot service its foreign debt obligations, whether private sector or government debt
These crises tend to have common underlying macroeconomic causes: high relative price inflation rates, a widening current account deficit, excessive expansion of domestic borrowing, high government deficits, and asset price inflation (such as sharp increases in stock and property prices)

34. Christine Lagarde heads the IMF.

35. Is the International Monetary Fund Needed?
The International Monetary Fund (IMF) is an organization of 188 countries working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world. It is a specialized agency of the United Nations but has its own charter, governing structure, and finances. Its members are represented through a quota system broadly based on their relative size in the global economy. The Board of Governors, the highest decision-making body of the IMF, consists of one governor and one alternate governor for each member country. The governor is appointed by the member country and is usually the minister of finance or the governor of the central bank. Should the IMF’s one-size fits-all approach (see the section on "Inappropriate Policies" in this chapter) be evaluated? If yes, how would you change it? If no, why not?
Source:

36. Crisis Management by the IMF 3 of 4
Evaluating the IMF’s Policy Prescriptions
In 2016, 30 countries were working IMF programs
All IMF loan packages come with conditions attached, generally a combination of tight macroeconomic policy and tight monetary policy
Many experts have criticized these policy prescriptions
Inappropriate policies
Moral hazard
Lack of accountability

37. Crisis Management by the IMF 4 of 4
Evaluating the IMF’s Policy Prescriptions continued
Inappropriate Policies
The IMF has been criticized for having a “one-size-fits-all” approach to macroeconomic policy that is inappropriate for many countries
Moral Hazard
The IMF has also been criticized for exacerbating moral hazard: people behave recklessly because they know they will be saved if things go wrong
Lack of Accountability
The IMF has become too powerful for an institution that lacks any real mechanism for accountability
As with many debates about international economics, it is not clear which side is correct about the appropriateness of IMF policies

38. Focus on Managerial Implications 1 of 4
Currency Management, Business Strategy, and Government Relations
The international monetary system affects international managers in three ways
Currency management
Business strategy
Corporate-government relations
LO Explain the implications of the global monetary system for currency management and business strategy.

39. Focus on Managerial Implications 2 of 4
Currency Management
The current exchange rate system is a managed float
Government intervention and speculative activity influence currency values
Firms can protect themselves from exchange rate volatility through forward markets and swaps

40. Focus on Managerial Implications 3 of 4
Business Strategy
The forward market can offer some protection from volatile exchange rates in the shorter term
Firms can protect themselves from exchange rate uncertainty over the longer term by building strategic flexibility into their operations that minimizes economic exposure
Firms can disperse production to different locations
Firms can outsource manufacturing
Exchange rate movements can have a major impact on the competitive position of businesses.
Management Focus: Airbus and the Euro
Summary
This feature describes how Airbus is protecting itself from exchange rate fluctuations. French aircraft maker Airbus prices its planes in dollars. However, because over half the company’s costs are in euros, the company has the potential to see significant fluctuations in its earnings if it does not hedge its foreign exchange exposure. The following questions can help in the discussion of the feature:
Suggested Discussion Questions
1. What type of foreign exchange exposure does Airbus face? How can Airbus protect itself from its exposure to changing exchange rates? How does the company’s switch to more U.S. suppliers help the company?
Discussion Points: Students should easily recognize the transaction exposure facing Airbus. Some students will point out that economic exposure is also a problem for the company. Airbus can hedge its transaction exposure in the foreign exchange markets using forward contracts, however to manage its economic exposure, the company is trying to reduce its costs by shifting to American suppliers, and asking European suppliers to price in dollars.
2. Airbus has asked its European based suppliers to start pricing in U.S. dollars. What does Airbus hope to gain by this request? What does it mean for suppliers?
Discussion Points: Airbus’ decision to ask suppliers to price their components in dollars is an effort to control exchange rate risk. The company prices its planes in dollars, but was paying for components in a variety of currencies. By shifting to a strictly dollar run business, the company not only consolidates all of its transactions and so hedges its exposure more easily and cheaply, it also increases the proportion of its costs that are in dollars. For American suppliers, the shift to pricing in dollars is beneficial because it eliminates exchange rate risk. For other suppliers however, the shift may mean an introduction of exchange rate risk. Teaching Tip: Students can learn more about Airbus by going to the company’s web site at {
Lecture Note: Fluctuating exchange rates have had both positive and negative implications for Airbus. To learn more, consider {

41. Focus on Managerial Implications 4 of 4
Corporate-Government Relations
Firms can influence government policy towards the international monetary system
Firms should focus their efforts on encouraging the government
Promote the growth of international trade and investment
Adopt an international monetary system that minimizes volatile exchange rates

42. Summary In this chapter we have
Described the historical development of the modern global monetary system.
Explained the role played by the World Bank and the IMF in the international monetary system.
Compared and contrasted the differences between a fixed and a floating exchange rate system.
Identified exchange rate regimes used in the world today and why countries adopt different exchange rate regimes.
Understood the debate surrounding the role of the IMF in the management of financial crises.
Explained the implications of the global monetary system for currency management and business strategy.