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McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. CHAPTER The Global Monetary System
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Key Issues How does the Global Monetary System affect exchange rates? How did the current system evolve? What are the differences between the fixed and floating exchange system? What is the role of the International Monetary Fund and the World Bank in the Global Monetary System? What are the implications of the global monetary system for currency management and business strategy?
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. International Monetary System Currency exchange rates depend on the structure of the international monetary system Generally they are not freely convertible and do not float freely –Only 51 were freely convertible in 1997 –Another 50 were pegged to the exchange rate of major currencies such as the US Dollar and the French Franc or to baskets of other currencies –Another 45 currencies were allowed by their governments to float within a range of another currency –This is 146 of 188 UN member nations in 1999 Slide 9-1
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Evolution of the International Monetary System Gold Standard –Currencies pegged to the value of gold; convertibility guaranteed –By 1880 most countries were on the gold standard –Achieves balance of trade equilibrium for all countries (value of exports equals value of imports); flow of gold was used to make up differences –Abandoned in 1914; attempt to resume after WWI failed with Great Depression Bretton Woods (1944) Slide 9-2
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Bretton Woods (1944 - 1973) 44 countries met to design a new system in 1944 Established International Monetary Fund (IMF) and World Bank –IMF maintained order in monetary system –World Bank promoted 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; government had to buy/sell their currency to maintain level Slide 9-3
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Role of the IMF per Bretton Woods Exchange rate discipline –National governments had to manage inflation through their money supply Exchange rate flexibility –Provided loans to help members states with temporary balance-of-payment deficit; Allowed time to bring down inflation Relieved pressures to devalue –Excessive drawing from IMF funds came with IMF supervision of monetary and fiscal policies –Allowed up to 10% devaluations and more with IMF approval Slide 9-4
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Role of the World Bank World Bank (IBRD-International Bank for Reconstruction and Development) role –Refinance post-WWII reconstruction and development –Provide low-interest long term loans to developing economies The International Development Agency (IDA), an arm of the bank created in 1960 –Raises funds from member states –Loans only to poorest countries –50 year repayment at 1% per year interest Slide 9-5
McGraw-Hill/Irwin © 2004 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 1971 –US dollar was devalued and dealers started speculating against it for further devaluation –Bretton Woods fixed exchange rates abandoned in January 1972 Slide 9-6
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Jamaica Agreement 1976 Floating rates declared acceptable Gold abandoned as reserve asset; –IMF returned its gold reserves to its members at current prices –Proceeds were placed in a 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 Slide 9-7
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Case for Floating Exchange Rates –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? Slide 9-8
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Recent Activities and the IMF Mexican crisis 1995 Russian crisis1995 Asian crisis 1997/1998 –The investment boom –Excess capacity –The debt bomb –Expanding imports –The crisis Slide 9-9 How did the IMF do? –Inappropriate policies? –Moral hazard Reckless behavior No consequences –Lack of accountability Record mixed
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Implications for Business Currency management –The monetary system is not perfect –Both speculative activity and government intervention affect the system –Companies must use risk management instruments Business strategy –Minimize risk by placing assets in different parts of the world, e.g., production –Contract manufacturing –Manage company-government relations Slide 9-11
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