1. International Business, 4th Edition Griffin & Pustay
Chapter 7: The International Monetary System and the Balance of Payments
International Business, 4th Edition
Griffin & Pustay
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2. Chapter Objectives_1
Discuss the role of the international monetary system in promoting international trade and investment
Explain the evolution and functioning of the gold standard
Explain the evolution of the flexible exchange rate system
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3. Chapter Objectives_2
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
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
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4. 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
Adopted by the U.K. in 1821
Created a fixed exchange rate
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5. Exchange Rates
Exchange rate: price of a one currency in terms of a second currency
Fixed exchange rate system: price of a given currency does not change relative to each other currency
Under the gold standard, each country pegged the value of its currency to gold
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6. 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
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7. Map 7.1 The British Empire in 1913
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8. Figure 7.1 The Contraction of World Trade, 1929-1933
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9. 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
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10. International Bank for Reconstruction and Development
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
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11. Figure 7.2 Organization of the World Bank Group
International Bank for
Reconstruction and Development
Makes hard loans; $15 billion annually
International
Development
Association
Offers
soft loans;
$7 billion
annually
International
Finance
Corporation
Promotes
private
sector
development
Multilateral
Investment
Guarantee
Agency
Provides
political risk
insurance
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12. Objectives of the International Monetary Fund_1
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
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13. Objectives of the International Monetary Fund_2
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
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14. Membership in the IMF
Open to any country willing to agree to rules and regulations
184 country members as of August 2003
Membership requires payment of a quota
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15. Relevance of the IMF Quota
Quota size reflects global importance of country’s economy and political considerations
The quota
determines voting power
serves as part of official reserves
determines country’s borrowing power
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16. Brazilian students protesting the IMF conditions for a $30 billion loan
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17. 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
Triffin Paradox:
foreigners increased holdings of dollars
Increased holdings decreased faith in U.S ability
Increased demand for redeeming dollars for gold
IMF created special drawing rights (SDRs) – paper gold
Bretton Woods system ended August 15, 1971
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18. Post-Bretton Woods System
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
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19. Table 7.1 The Groups of Five, Seven, and Ten
Group of 5
Group of 7
Group of 10
% World GDP
United States
32.5
Japan
13.6
Germany
6.0
United Kingdom
4.5
France
4.2
Italy
3.5
Canada
2.2
Netherlands
1.2
Switzerland .8
Belgium .7
Sweden
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20. 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
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21. Table7.2 Key Central Banks
Country
Bank
Canada
Bank of Canada
European Union
European Central Bank
Japan
Bank of Japan
United Kingdom
Bank of England
United States
Federal Reserve Bank
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22. 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
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23. Map 7.2 Exchange Rate Arrangements, 2002
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24. Other Post-World War II Conferences
Plaza Accord
Louvre Accord
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25. 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
Crisis approaches
Baker Plan (1985)
Brady Plan (1989)
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26. Figure 7.4 The Asian Contagion
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27. Balance of Payments (BOP) Accounting System
Double entry bookkeeping 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
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28. BOP Statistics Identify emerging markets Warn of possible new policies
Indicate reductions in a country’s foreign-exchange reserves
Signal increased riskiness of lending to particular countries
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29. 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
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30. Major Components of the BOP Accounting System
Current Account
Capital Account
Official Reserves
Errors and Omissions
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31. Current Account Four types of transactions
Exports and imports of goods
Exports and imports of services
Investment income
Gifts
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32. Table 7.3 BOP Entries, Current Account
Debit
Credit
Goods
Buy
Sell
Services
Dividends and interest
Pay
Receive
Gifts
Give
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33. Current Account Balances
Balance on merchandise trade
Difference between a country’s exports and imports of goods
Balance on services trade
Difference between a country’s exports of services and its imports of services
Current account balance
Measures the net balances resulting from merchandise trade, service trade, investment income, and unilateral transfers
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34. Capital Account
Records capital transactions (purchases and sales of assets)
Foreign Direct Investment
Portfolio Investment
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35. Table 7.4 Capital Account Transactions
Maturity
Motivation
Typical Investments
Portfolio (short-term)
One year or less
Investment in or facilitation of international commerce
Checking account balances
Time deposits
Commercial paper
Bank loans
Portfolio (long-term)
More than one year
Investment income
Government bills, notes, bonds
Corporate stocks, bonds
Foreign Direct Investment
Indeterminate
Active control of organization
Foreign subsidiaries
Foreign factories
Joint ventures
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36. 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
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37. Official Reserves Account
Records level of official reserves
Four types of assets
Gold
Convertible currencies
SDRs
Reserve positions at the IMF
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38. 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
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39. Table 7.6 U.S. BOP, 2002 (in billions of dollars)
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40. Figure 7. 6 Media event for the first shipment of U. S
Figure 7.6 Media event for the first shipment of U.S. citrus fruit to China
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41. Figure 7.6 Trade Between the U.S. and Its Major Trading Partners, 2002
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42. Figure 7.7 The U.S. BOP According to Various Reporting Measures
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