1. The International Monetary System
Chapter 10
The International Monetary System
Chapter 10: The International Monetary System

2. Introduction
Question: What is the international monetary system?
Answer:
The international monetary system refers to the institutional arrangements that govern exchange rates
recall that the foreign exchange market is the primary institution for determining exchange rates
You know, from our discussion in Chapter 9, what an exchange rate is and how its value is determined, but did you know that there are international agreements that also govern exchange rates? In this chapter we’re going to talk about the international monetary system and its implications for international business. First, though, let’s go over some definitions.
The international monetary system refers to the institutional arrangements that countries adopt to govern exchange rates.

3. Introduction
A floating exchange rate system exists in countries where the foreign exchange market determines the relative value of a currency
Examples - the U.S. dollar, the European Union’s euro, the Japanese yen, and the British pound
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
Many developing countries have pegged exchange rates
You know, from our discussion in Chapter 9, what an exchange rate is and how its value is determined, but did you know that there are international agreements that also govern exchange rates? In this chapter we’re going to talk about the international monetary system and its implications for international business. First, though, let’s go over some definitions.
The international monetary system refers to the institutional arrangements that countries adopt to govern exchange rates.
When the foreign exchange rate market, or supply and demand, determine the relative values of currencies, a floating exchange rate system exists. The U.S., the EU, Japan, and Great Britain all have floating exchange rate systems.
A pegged exchange rate system exists when the value of a currency is fixed to a reference country and the exchange rate between that currency and other currencies is determined by the reference currency exchange rate. As you might recall from the Opening Case, Latvia used this system. Latvia pegged its currency, the lat, to the euro, and then the lat/euro rate was determined based on the dollar/euro rate. When the dollar shifted, so did the value of the peso.

4. Introduction
A 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
China adopted this policy in 2005
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)
A dirty float exists when the value of a currency is determined by market forces, but the central bank intervenes if it depreciates too rapidly against an important reference currency. China has used this system since The yuan is allowed to float against a basket of currencies that include the dollar, the euro, and the yen, but only within very tight limits.
Countries that adopt a fixed exchange rate system fix the values of their currencies against each other. Prior to the introduction of the euro, some EU countries operated under fixed exchange rates within the context of the European Monetary System.

5. Introduction
Question: What role does the international monetary system play in determining exchange rates?
Answer:
To answer this question, we have to look at the evolution of the international monetary system
The Gold Standard
The Bretton Woods system
The International Monetary Fund
The World Bank
How do all of these systems work together? Well, to understand the current international monetary system, we have to go back to the 1930s and the time of the Gold Standard and its successor the Bretton Woods Agreement to see the evolution of today’s system.

6. The Gold Standard Answer:
Question: What is the Gold Standard?
Answer:
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
How do all of these systems work together? Well, to understand the current international monetary system, we have to go back to the 1930s and the time of the Gold Standard and its successor the Bretton Woods Agreement to see the evolution of today’s system.
The origin of the gold standard dates back to ancient times when gold coins were the medium of exchange. When there was little international trade, international transactions were made in gold or silver, but after the Industrial Revolution, a new system was needed, and the gold standard was established.

7. Mechanics of the Gold Standard
The gold standard refers to 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
Under the gold standard, each currency was linked to a fixed amount of gold. The dollar for example, was equal to grains of fine gold. The exchange rate between currencies then was based on the gold par value, or the amount of a currency needed to purchase one ounce of gold. In other words, if you had dollars, and needed francs, you would convert your dollars to gold at the rate of grains of gold per dollar, and then convert the gold to francs at the franc/gold rate.

8. 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
many people today believe the world should return to the gold standard
The main attraction of the gold standard was that it had a powerful mechanism for simultaneously achieving balance of trade equilibrium for all countries. We say that a country has 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.
What does this mean? Well, if Japan has a trade surplus with the U.S., or exports more to the U.S. than it imports, we see dollars flowing out if the U.S. to pay for the imports. After the Japanese exporters cash the dollars in for yen at the Japanese bank, the Japanese bank will trade them for gold with the U.S. The outflow of gold from the U.S. will reduce the U.S money supply and increase Japan’s money supply causing higher prices in Japan and lower prices in the U.S. So, demand for Japanese goods will drop, while demand for American products will rise, and balance of payments equilibrium will be achieved.

9.
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
The gold standard worked well from the 1870s until the start of World War I when it was abandoned. By the end of the war in 1918, prices were higher everywhere because countries had printed money to finance their war expenditures. Again, recall the relationship between the money supply and inflation that we talked about in Chapter 9! .
Then, in an effort to encourage exports and domestic employment, countries started to devalue their currencies. Recall, that if a country’s currency is worth less, imports will be more expensive, and exports will be cheaper.
People began to lose confidence in the system and started to demand gold for their currency putting pressure on countries’ gold reserves and forcing them to suspend convertibility. By the start of World War II in 1939, the gold standard had been abandoned.

10. The Bretton Woods System
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
In 1944, a new international monetary system was established. Representatives from 44 countries met at Bretton Woods, New Hampshire with the goal of building an enduring economic order that would facilitate postwar economic growth.
As part of the agreement, two multinational institutions were established.
The first, the International Monetary Fund or IMF, was designed to maintain order in the international monetary system. The goal of the second, the World Bank, was to promote general economic development.

11. The Bretton Woods System
Under the Bretton Woods Agreement
the US 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
Under the Bretton Woods system, the only currency that was to be convertible to gold was the dollar. Other countries set their exchange rates relative to the dollar. So, the dollar was set against gold at $35 per ounce, and then each country determined its exchange rate relative to the dollar.
Devaluations were not allowed for competitive purposes, and a country couldn’t devalue its currency by more than 10 percent without IMF approval.

12. The Role of the IMF
The IMF was responsible for avoiding a repetition of the chaos that occurred between the wars through a combination of
1. 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
The IMF, using a combination of flexibility and discipline, was responsible for executing the main objectives of the Bretton Woods agreement, with the goal of avoiding the repeating the chaos that occurred during the time between the wars.
Let’s talk a bit more about the discipline imposed by the IMF. The fixed exchange rate system provides discipline in two ways. First, the need to maintain a fixed exchange rate limits competitive devaluations and brings stability to the world trade environment.
Second, because the system imposes monetary discipline on countries, inflation is limited.
So, fixed exchange rates help control inflation and force economic discipline on countries.

13. The Role of the IMF 2. Flexibility
A rigid policy of fixed exchange rates would be too inflexible
So, the IMF was 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 percent with IMF approval
Why was it important to have a flexible system as well as a disciplined system? Well, representatives at the meeting recognized that a rigid policy of fixed exchange rates would be too inflexible in a more global world.
So, instead, the IMF created a fund using contributions from members that gave it the ability to lend foreign currencies to members to tide them over during short term balance of payments deficits when implementing a rapid tightening of monetary or fiscal policy would harm the domestic employment situation.

14. The Role of the World Bank
The World Bank lends money in two ways
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)
Now, let’s move on to talk about the World Bank, or as it’s officially known, the International Bank for Reconstruction and Development. The World Bank was initially designed to lend money to help rebuild Europe, but shifted its role to helping Third World nations after the Marshall Plan was implemented.
The World Bank makes loans in two ways. The first method involves raising money through bond sales in the international capital market. Borrowers pay a market rate of interest which is calculated based on the bank’s cost plus expenses.
The second method, which is overseen by the International Development Agency, raises money through subscriptions from wealthy members like the U.S. These loans only go to very poor countries which have 50 years to repay at a 1 percent per year rate of interest.

15. The Collapse of the Fixed System
Question: What caused the collapse of the Bretton Woods system?
Answer:
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
The foreign exchange system that was established at Bretton Woods worked well until the late 1960s when it began to collapse. Under President Johnson, the U.S. began to finance increases in its welfare program and the costs related to the Vietnam War by increasing the money supply. Recall that an increase in the money supply leads to price inflation. This led to a deterioration of the U.S. foreign trade position, and speculation that the dollar would have to be devalued.
However, remember that under the Bretton Woods system, devaluing the dollar meant that all other currencies would have to be revalued—a prospect that wasn’t appealing to other countries that would see the price of their products rise relative to American products!

16. The Collapse of the Fixed System
The Bretton Woods system relied on an economically well managed U.S.
So, 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
In 1971, President Nixon announced that the dollar would no longer be convertible to gold, and that a 10 percent tariff on all imports would be implemented unless countries agreed to revalue their currencies. The dollar was eventually devalued by about 8 percent, but problems continued to persist. The U.S. continued to expand its money supply, run high trade deficits, and experience high inflation. The Bretton Woods system was only viable when the U.S. inflation rate was low, and the U.S. did not run a balance of payments deficit, and so it collapsed, and currencies began to float against each other.

17. The Floating Exchange Rate Regime
Question: What followed the collapse of the Bretton Woods exchange rate system?
Answer:
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
After the collapse of Bretton Woods, IMF members got together in 1976 in Jamaica to formalize the new floating exchange rate system.

18. The Jamaica Agreement
At the Jamaica meeting, the IMF's Articles of Agreement were revised to reflect the new reality of floating exchange rates
Under the Jamaican agreement
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 $300 billion)
Under the Jamaica Agreement, floating rates were deemed acceptable, gold was abandoned as a reserve asset, and IMF quotas, or the amounts that countries contributed to the IMF, were increased.

19. Exchange Rates Since 1973
Since 1973, exchange rates have become more volatile and less predictable because of
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 rise in the dollar between 1980 and 1985
the partial collapse of the European Monetary System in 1992
the 1997 Asian currency crisis
the decline in the dollar in the mid to late 2000s
Since 1973, exchange rates have become more volatile and less predictable for several reasons including the 1971 oil crisis, the loss of confidence in the dollar that came after the U.S. inflation rate spiked in , the 1979 oil crisis that doubled the price of oil, the unanticipated rise in the dollar between 1980 and 1985, the partial collapse of the European Monetary System in 1992, and the 1997 Asian currency crisis that saw various Asian currencies lose between 50 and 80 percent of their value!

20. Fixed vs. Floating Exchange Rates
Question: Which is better – a fixed exchange rate system or a floating exchange rate system?
Answer:
Disappointment with floating rates in recent years has led to renewed debate about the merits of a fixed exchange rate system
Because of the volatile nature of the floating exchange rate system, there’s been renewed interest in a fixed exchange system in recent years. Which is better? It’s hard to say.

21. The Case for Floating Rates
A floating exchange rate system provides two attractive features
monetary policy autonomy
automatic trade balance adjustments
A floating exchange rate system offers monetary policy autonomy and automatic trade balance adjustments. Let’s look at what each of these features means.

22. The Case for Floating Rates
1. 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
Supporters of floating exchange rates note that governments gain control over their monetary policy when they don’t have to maintain exchange rate parity. Why is this important? Well, suppose a government wanted to stimulate domestic demand to reduce domestic employment. Under a floating exchange rate system, the government could choose to expand the money supply to encourage people to buy more without worrying about maintaining parity.
Under a fixed exchange rate system, the government doesn’t have this ability because it has to maintain exchange rate parity.

23. The Case for Floating Rates
2. 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
Advocates of floating exchange rates also point out the automatic trade balance adjustments that are part of the system are important. Under the fixed exchange rate system, if a country couldn’t correct a balance of payments deficit using domestic policy, it was required to get IMF approval to devalue its currency.
Under a floating exchange rate system, the trade balance would be automatically corrected. For example, if a country is running a trade deficit, buying more than it sells, the outflow of money will eventually lead to a depreciation of its currency. This depreciation will make its goods cheaper in foreign markets, and imports more expensive, and the trade deficit should eventually correct itself.

24. The Case for Fixed Rates
A fixed exchange rate system is attractive because
of the monetary discipline it imposes
it limits speculation
it limits uncertainty
of the lack of connection between the trade balance and exchange rates
So, why are some people calling for a return to fixed exchange rates? The answer to this question lies in arguments about monetary discipline, uncertainty, and the lack of connection between trade balances and exchange rates. Let’s talk about each one beginning with monetary discipline.

25. The Case for Fixed Rates
1. 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
2. Speculation
A fixed exchange rate regime prevents destabilizing speculation
Supporters of fixed exchange rates argue that the monetary discipline required by a fixed exchange rate system ensures that governments will not expand their money supplies at inflationary rates. Advocates of fixed exchange rates also note that the speculation that occurs with floating exchange rate regimes can cause currency fluctuations. For example, the dollar fluctuated sharply in the 1980s, and critics of floating regimes argue that this was the result of speculation not comparative inflation rates or trade deficits.

26. The Case for Fixed Rates
3. Uncertainty
The uncertainty associated with floating exchange rates makes business transactions more risky
4. Trade Balance Adjustments
Floating rates help adjust trade imbalances
Similarly, when speculation about a currency is high, the uncertainty that is part of a floating exchange rate system also becomes apparent. For companies, this uncertainty makes planning more challenging than it would be under a predictable fixed exchange rate system.
Finally, advocates of floating exchange rates argue that floating rates help adjust trade imbalances, but critics argue that this link may not really be true. Instead, they claim trade deficits reflect the balance between savings and investment in a country.

27. Who is Right? There is no real agreement as to which system is better
History shows that 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
So, who’s right? Is a fixed exchange rate system better, or should we have a floating exchange rate system? So, far, economists can’t agree on an answer. We know that a Bretton Woods type of system won’t work, but a different type of fixed exchange rate system might be an option, particularly if it facilitates growth in international trade and investment. .

28. Exchange Rate Regimes in Practice
Currently, there are several different exchange rate regimes in practice
In 2006
14% of IMF members allow their currencies to float freely
26% of IMF members follow a managed float system
28% of IMF members have no legal tender of their own
the remaining countries use less flexible systems such as pegged arrangements, or adjustable pegs
You may be wondering what exchange rate system is currently in place? There are several regimes currently in practice including managed floats, free floats, pegged arrangements and adjustable pegs.

29. Exchange Rate Regimes in Practice
Figure 10.2: Exchange Rate Policies, IMF Members, 2008
As you can see, about 14 percent of IMF members follow a free float policy, 28 percent follow a managed float, 22 percent have no legal tender of their own like the EU countries that have adopted the euro, and the remaining countries use less flexible systems like pegged arrangements or adjustable pegs.

30. 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
Let’s look at the pegged exchange rates systems a little more closely. Countries under a pegged exchange rate system link the value of their currency to a major currency like the dollar. As you’ll see in the Closing Case, China linked the yuan to the dollar between 1993 and Pegged arrangements are popular among the world’s smaller nations like Belize.
Countries adopt this type of system because in theory, it imposes monetary discipline and leads to low inflation, however an IMF study showed that pegged regimes don’t actually moderate inflationary pressures.

31. 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– at the fixed exchange rate – equal 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
Some countries adopt what’s known as a currency board where they commit to converting their domestic currency on demand into another currency at a fixed exchange rate. Hong Kong was successful with this type of arrangement during the Asian crisis in Hong Kong backed its currency 100 percent by the dollar, and was able to withstand several speculative attacks.

32. Crisis Management by the IMF
Question: What has been the role of the IMF in the international monetary systems since the collapse of Bretton Woods?
Answer:
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 186 countries in 2010, 54 of which has some type of IMF program in place
We’ve talked a bit about various crises that have shocked the international monetary system, now let’s look at them more closely, and how the IMF handles them. Recall that the IMF was originally established to help maintain the exchange rate system that was set at Bretton Woods. Today, however, many of the original reasons for its existence are no longer there.
So, the IMF, which in 2010 had 186 members, has redefined its mission, and focuses on lending money to countries that are in financial crisis. For example, the IMF lent money to several Asian countries in 1997.

33. Financial Crises Post-Bretton Woods
Three types of financial crises that have required involvement by the IMF are
1. A 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
What constitutes a financial crisis? Well, there are three types of crises - currency crises, banking crises, and foreign debt crises - that attract attention from the IMF. Let’s look more closely at each one.
A currency crisis occurs when a speculative attack on the exchange value of a currency results in a sharp depreciation in the currency, or forces the government to expend large amounts of international currency reserves and sharply increase interest rates in an effort to maintain the prevailing exchange rate.

34. Financial Crises Post-Bretton Woods
2. A banking crisis - refers to a situation in which a loss of confidence in the banking system leads to a run on the banks, as individuals and companies withdraw their deposits
3. A foreign debt crisis - a situation in which a country cannot service its foreign debt obligations, whether private sector or government debt
Two crises that are particularly significant are
the 1995 Mexican currency crisis
the 1997 Asian currency crisis
A banking crisis refers to a situation in which a loss of confidence in the banking system leads to a run on the banks when everyone withdraws their deposits.
A foreign debt crisis is a situation in which a country can no longer service its foreign debt obligations.
Sometimes these crises occur simultaneously like they did in the 1997 Asian crisis and the Argentinean crisis. IMF data show that developing countries are far more likely to experience a currency crisis than developed countries.

35. The Mexican Currency Crisis of 1995
The Mexican currency crisis of 1995 was a result of high Mexican debts, and a pegged exchange rate that did not allow for a natural adjustment of prices
in order to keep Mexico from defaulting on its debt, a $50 billion aid package was created by the IMF
By 1997, Mexico was well on the way to recovery
Let’s look more closely at two financial crises that have occurred recently, the Mexican crisis of 1995, and the Asian crisis of We’ll begin with the Mexican crisis. The crisis in Mexico was the result of high debt and a pegged exchange rate that didn’t allow for the natural adjustment of prices.
Mexico’s pegged currency was the result of its 1982 financial crisis that had required an IMF bailout. The IMF believed that the peg was necessary to limit growth in the money supply and to contain inflation. However, by the mid-1980s, producer prices had risen significantly in Mexico without a corresponding adjustment in the exchange rate. By the mid-1990s, Mexico’s trade deficit was $17 billion, and investors, reassured by the government’s pledge to maintain the peg, poured money into the country. Eventually though, currency traders concluded that a devaluation of the peso was necessary, and began to dump the currency. The government, after initially trying to maintain the exchange rate, suddenly devalued the peso, which combined with other selling, added up to a 40 percent drop in value!
At this point, the IMF stepped in to provide assistance and help the country get back on track.

36. The Asian Crisis Answer:
Question: What were the causes of the1997 Asian financial crisis?
Answer:
The causes of the crisis can be traced to the previous decade when the region was experiencing unprecedented growth
1. The Investment Boom
fueled by export-led growth
large investments were often based on projections about future demand conditions that were unrealistic
The causes of the financial crisis that swept across Southeast Asia in 1997 were actually the result of various factors that had occurred in the previous decade.
During the decade prior to the crisis, huge increases in exports helped to fuel a boom in commercial and residential property, industrial assets, and infrastructure. While some of the investment made sense, a lot of it was based on unrealistic expectations about future demand, and so, there was a significant amount of excess industrial and office capacity as a result.

37. The Asian Crisis 2. Excess Capacity
investments made on the basis of unrealistic projections about future demand conditions created significant excess capacity
3. The Debt Bomb
investments were often supported by dollar-based debts
when inflation and increasing imports put pressure on the currencies, the resulting devaluations led to default on dollar denominated debts
4. Expanding Imports
by the mid 1990s, imports were expanding across the region causing balance of payments deficits
The balance of payments deficits made it difficult for countries to maintain their currencies against the U.S. dollar
Some countries saw investments in new factories as a means of boosting economic growth. In South Korea for example, the chaebol were encouraged to build, but then, because the factories were based on unrealistic demand expectations, companies had trouble making the payments on the debt they had taken on to do so.
Many of the debts were dollar based, and when inflation and increasing imports put downward pressure on currencies, the debt payments became even more difficult to make. Remember, if you’ve taken on a debt at one rate of exchange and then you have to pay it back by buying dollars with a currency that has lost value, the debt becomes more expensive!
Keep in mind that imports across the region were continuing to rise during the 1990s, and many countries had current account deficits. Indonesia’s current account deficit represented 3.5 percent of its GDP for example, and Thailand’s was more than 8 percent!

38. The Asian Crisis
By mid-1997, it became clear that several key Thai financial institutions were on the verge of default
After struggling to defend the peg, the Thai government abandoned its defense and announced that the baht would float freely against the dollar
Things came to head in Thailand in mid-1997 when it became evident that several key financial institutions were on the brink of default. They had made loans to companies that weren’t being repaid, making it difficult to meet their own debt obligations.
Speculation about the baht was high, and short selling began. Initially, the Thai government tried to defend its currency, but then more or less gave up, and allowed the baht to float against the dollar. The value of the baht dropped by 55 percent!

39. The Asian Crisis Thailand turned to the IMF for help
Speculation continued to affect other Asian countries including Malaysia, Indonesia, Singapore which all saw their currencies drop
these devaluations were mainly a result of excess investment, high borrowings, much of it in dollar denominated debt, and a deteriorating balance of payments position
South Korea was the final country in the region to fall
Thailand turned to the IMF for help, but speculation continued to affect the region, and the currencies of Malaysia, Indonesia, and Singapore all fell. Traders were worried that many of the same factors that affected Thailand like excess investment, high levels of debt, and trade deficits would also cause distress in other parts of Asia, and so, dumped those currencies as well causing the countries to also turn to the IMF for assistance.

40. Evaluating the IMF’s Policies
Question: How successful is the IMF at getting countries back on track?
Answer:
In 2009, 54 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 for three reasons
So, how has the IMF done? In 2006, it was committed to helping 59 countries. All of its packages come with conditions that typically involve tight macroeconomic policy and tight monetary policy. However, not everyone thinks this is the right policy to take. You can see the package that was given to Turkey in the Country Focus in your text.

41. Evaluating the IMF’s Policies
1. Inappropriate Policies
The IMF has been criticized for having a “one-size-fits-all” approach to macroeconomic policy that is inappropriate for many countries
2. Moral Hazard
The IMF has also been criticized for exacerbating moral hazard (when people behave recklessly because they know they will be saved if things go wrong)
The IMF has been criticized for having a one-size-fits-all approach to macroeconomic policy. Critics argue that what might be right for one country isn’t necessarily best for another country. For example, many critics felt that applying the same policies that were used for countries with excessive government spending to Asia, where there was significant private sector debt, was not appropriate.
Critics have also complained that the IMF has been exacerbating moral hazard which occurs when people behave recklessly because they know they’ll be saved if things go wrong. In other words, because the IMF provides a safety net, countries may not always make the best decisions for their economies. For example, banks in Japan were willing to extend loans to overextended Asian companies during the 1990s when they shouldn’t have.

42. Evaluating the IMF’s Policies
3. Lack of Accountability
The final criticism of the IMF is that it has become too powerful for an institution that lacks any real mechanism for accountability
Question: Who is right?
Answer:
As with many debates about international economics, it is not clear who is right
Finally, there is concern that the IMF has too much power, and too little accountability. Keep in mind, that while the IMF has its detractors, it also has its supporters.