1. Chapter 08 The International Monetary System and Financial Forces McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Learning Objectives LO1 Describe the international monetary system’s evolution. LO2 Explain the Triffin paradox. LO3 Describe the floating currency exchange rate system, including the IMF currency arrangements. LO4 Discuss the purpose of the Bank for International Settlements. LO5 Explain the impact of fluctuating currency values. LO1 Describe the international monetary system’s evolution. LO2 Explain the Triffin paradox. LO3 Describe the floating currency exchange rate system, including the IMF currency arrangements. LO4 Discuss the purpose of the Bank for International Settlements. LO5 Explain the impact of fluctuating currency values. 8-2

3. Learning Objectives cont’d LO6 Discuss how foreign exchange is quoted. LO7 Describe the factors that influence exchange rate movement. LO8 Outline the approaches to exchange rate forecasting. LO9 Discuss the influence of currency exchange controls on international business. LO10 Summarize the influences of differences in taxation and inflation rates on international business. LO11 Explain the significance of the balance of payments (BOP) to international business decisions. LO6 Discuss how foreign exchange is quoted. LO7 Describe the factors that influence exchange rate movement. LO8 Outline the approaches to exchange rate forecasting. LO9 Discuss the influence of currency exchange controls on international business. LO10 Summarize the influences of differences in taxation and inflation rates on international business. LO11 Explain the significance of the balance of payments (BOP) to international business decisions. 8-3

4. International Monetary System Key Terms Gold Standard The use of gold at an established number of units per currency Bretton Woods System Monetary system from 1945 to 1971 Used a par value based on gold and the U.S. dollar Fixed Exchange Rate Specific currency exchange equivalence upheld by government Par Value Stated value Key Terms Gold Standard The use of gold at an established number of units per currency Bretton Woods System Monetary system from 1945 to 1971 Used a par value based on gold and the U.S. dollar Fixed Exchange Rate Specific currency exchange equivalence upheld by government Par Value Stated value 8-4

5. Brief History of the Gold Standard Price of gold has risen from 1200 A.D. through today. Traders carried bullion, gold + silver coins till late 19 th C. 1717, Sir Isaac Newton put England on the gold standard based on British currency, pound sterling. Britain converted gold  currency until 1914 and WWI, except during Napoleonic Wars. British sold gold to finance WWI, then stopped gold exchange. Germany, France and Russia followed. Price of gold has risen from 1200 A.D. through today. Traders carried bullion, gold + silver coins till late 19 th C. 1717, Sir Isaac Newton put England on the gold standard based on British currency, pound sterling. Britain converted gold  currency until 1914 and WWI, except during Napoleonic Wars. British sold gold to finance WWI, then stopped gold exchange. Germany, France and Russia followed. 8-5

6. Bretton Woods System Bretton Woods, NH,meeting of WWII Allies to plan post- WWII monetary arrangements. IMF established. IMF Articles of Agreement: Bretton Woods system for fixed exchange rates among member’s currencies, with par value based on gold @ $35/oz and the U.S.$. Bretton Woods system supported huge international trade growth in the 1950ies and 1960ies. Bretton Woods, NH,meeting of WWII Allies to plan post- WWII monetary arrangements. IMF established. IMF Articles of Agreement: Bretton Woods system for fixed exchange rates among member’s currencies, with par value based on gold @ $35/oz and the U.S.$. Bretton Woods system supported huge international trade growth in the 1950ies and 1960ies. 8-6

7. Floating Currency Exchange Rate System Floating Currency Exchange Rates Rates allowed to float against other currencies and determined by market forces. Jamaica Agreement 1976 IMF agreement for flexible exchange rates among members. Precipitated by 1971 French redemption of $ for gold. Nixon stopped gold exchange for $, abandoned gold as reserve currency Floating Currency Exchange Rates Rates allowed to float against other currencies and determined by market forces. Jamaica Agreement 1976 IMF agreement for flexible exchange rates among members. Precipitated by 1971 French redemption of $ for gold. Nixon stopped gold exchange for $, abandoned gold as reserve currency 8-7

8. 8 IMF Currency Arrangements 8-8

9. Currency Arrangements cont’d 8-9

10. Challenges to the Floating Exchange Rate System 2008 central bank liquidity crisis Explosive growth in volume of currency trades in FX markets Japanese yen issues after 2011 quake 2008 central bank liquidity crisis Explosive growth in volume of currency trades in FX markets Japanese yen issues after 2011 quake 8-10

11. 8-11

12. Financial Forces Fluctuating Currency Values Freely floating currencies move against each other Central banks can buy/sell currency to affect supply & demand in FX markets Central banks let major currencies ($,€,£,¥) freely fluctuate Fluctuations can be huge Fluctuating Currency Values Freely floating currencies move against each other Central banks can buy/sell currency to affect supply & demand in FX markets Central banks let major currencies ($,€,£,¥) freely fluctuate Fluctuations can be huge 8-12

13. Foreign Exchange 8-13

14. Exchange Rate Quotations 8-14

15. Exchange Rate Movement Caused by Supply & demand forecasts Inflation Productivity and unit labor cost changes Political developments Government fiscal, monetary, and fx market actions BOP accounts Psychological aspects Supply & demand forecasts Inflation Productivity and unit labor cost changes Political developments Government fiscal, monetary, and fx market actions BOP accounts Psychological aspects 8-15

16. Exchange Rate Movement 8-16

17. Exchange Rate Movement 8-17

18. Exchange rate movements impact Production Sourcing Marketing Finance Exchange rate movements impact Production Sourcing Marketing Finance 8-18

19. Approaches to Exchange Rate Forecasting 8-19

20. Currency Exchange Controls 8-20

21. Taxation – A Significant Financial Force 8-21

22. Inflation raises prices determines the real cost of borrowing in capital markets measured by consumer price index (CPI), the average price changes in a basket of consumer goods Inflation raises prices determines the real cost of borrowing in capital markets measured by consumer price index (CPI), the average price changes in a basket of consumer goods 8-22

23. Inflation and Interest Rates Inflation encourages borrowing (debt) loan will be repaid with inflated, cheaper money high inflation rates bring high interest rates inflation discourages lending lenders fear that the $s repaid + interest will have less value than the $s lent Inflation encourages borrowing (debt) loan will be repaid with inflated, cheaper money high inflation rates bring high interest rates inflation discourages lending lenders fear that the $s repaid + interest will have less value than the $s lent 8-23

24. Inflation and Interest Rates Inflation Affects currency exchange rates Inflated currencies weaken economies People may buy items expected to increase in value, further fueling inflation Causes cost of goods and services to rise, country becomes less globally competitive Export sales are difficult and may lead to BOP deficits in the trade account This leads to more trade restrictions Inflation Affects currency exchange rates Inflated currencies weaken economies People may buy items expected to increase in value, further fueling inflation Causes cost of goods and services to rise, country becomes less globally competitive Export sales are difficult and may lead to BOP deficits in the trade account This leads to more trade restrictions 8-24

25. Sample Interest Rates 8-25

26. Balance of Payments (BOP) 8-26