IntroductionIntroductionThe Gold StandardBalance of Trade EquilibriumBetween the WarsBretton WoodsInternational Monetary FundInternational Monetary FundRole of the World BankCollapse of the Fixed Exchange SystemCollapse of the Fixed Exchange SystemThe Floating Exchange RateExchange Rates Since 1973Long-Term Exchange Rate Trends From 1973 - 2003Fixed Versus Floating Exchange RatesExchange Rate RegimesExchange Rate Policies for IMF Members 2004Crisis Management by the IMFIncidence of Currency and Banking Crises 1975 - 1997Mexican Currency Crisis of 1995Russian Ruble CrisisRussian Ruble CrisisGovernment Actions: Exacerbating the SituationDecline of the RubleThe Asian CrisisThe Asian CrisisProblems in Asian Market EconomiesEvaluating the IMF Policy PrescriptionsImplications for ManagersLooking Ahead to Chapter 12Chapter ElevenThe International Monetary System11 - 3McGraw-Hill/IrwinInternational Business, 6/e© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.Introduction• The international monetary system refers to the institutional arrangements that govern exchange rates.• Floating exchange rates occur when the foreign exchange market determines the relative value of a currency• The world’s four major currencies – dollar, euro, yen, and pound – are all free to float against each other11 - 4McGraw-Hill/IrwinInternational Business, 6/e© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.Introduction• Pegged exchange rates occur when the value of a currency is fixed relative to a reference currency• Dirty float occurs when countries hold the value of their currency within a range of a reference currency• Fixed exchange rate occurs when a set of currencies are fixed against each other at some mutually agreed upon exchange rate• Pegged exchange rates, dirty floats and fixed exchange rates all require some degree of government intervention11 - 5McGraw-Hill/IrwinInternational Business, 6/e© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.The Gold Standard• Roots in old mercantile trade• Inconvenient to ship gold, changed to paper-redeemable for gold• Want to achieve ‘balance-of-trade equilibriumUSAJapanGoldTrade11 - 6McGraw-Hill/IrwinInternational Business, 6/e© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.Balance of Trade EquilibriumTrade SurplusGoldIncreased money supply = price inflation.Decreased money supply = price decline.As prices decline, exportsincrease and trade goesinto equilibrium.11 - 7McGraw-Hill/IrwinInternational Business, 6/e© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.Between the Wars• Post WWI, war heavy expenditures affected the value of dollars against gold• US raised dollars to gold from $20.67 to $35 per ounce- Dollar worth less?• Other countries followed suit and devalued their currencies11 - 8McGraw-Hill/IrwinInternational Business, 6/e© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.Bretton Woods• In 1944, 44 countries met in New Hampshire• Countries agreed to peg their currencies to US$ which was convertible to gold at $35/oz• Agreed not to engage in competitive devaluations for trade purposes and defend their currencies• Weak currencies could be devalued up to 10% w/o approval• Created the IMF and World Bank11 - 9McGraw-Hill/IrwinInternational Business, 6/e© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.International Monetary Fund• The International Monetary Fund (IMF) Articles of Agreement were heavily influenced by the worldwide financial collapse, competitive devaluations, trade wars, high unemployment, hyperinflation in Germany and elsewhere, and general economic disintegration that occurred between the two world wars• The aim of the IMF was to try to avoid a repetition of that chaos through a combination of discipline and flexibility11 - 10McGraw-Hill/IrwinInternational Business, 6/e© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.International Monetary Fund• Discipline- Maintaining a fixed exchange rate imposes monetary discipline, curtails inflation- Brake on competitive devaluations and stability to the world trade environment• Flexibility- Lending facility:• Lend foreign currencies to countries having balance-of-payments problems- Adjustable parities:• Allow countries to devalue currencies more than 10% if balance of payments was in “fundamental disequilibrium”11 - 11McGraw-Hill/IrwinInternational Business, 6/e© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.Role of the World Bank• The official name for the world bank is the International Bank for Reconstruction and Development• Purpose: To fund Europe’s reconstruction and help 3rd world countries.• Overshadowed by Marshall Plan, so it turns towards development- Lending money raised through WB bond sales• Agriculture• Education• Population control• Urban development11 - 12McGraw-Hill/IrwinInternational Business, 6/e© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.Collapse of the Fixed Exchange System• The system of fixed exchange rates established at Bretton Woods worked well until the late 1960’s- The US dollar was the only currency that could be converted into gold- The US dollar served as the reference point for all other currencies- Any pressure to devalue the dollar would cause problems through out the world11 - 13McGraw-Hill/IrwinInternational Business, 6/e© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.Collapse of the Fixed Exchange System• Factors that led to the collapse of the fixed exchange system include- President Johnson financed both the Great Society and Vietnam by printing money- High inflation and high spending on imports- On August 8, 1971, President Nixon announces dollar no longer convertible into gold- Countries agreed to revalue their currencies against the dollar- On March 19, 1972, Japan and most of Europe floated their currencies- In 1973, Bretton Woods fails because the key currency (dollar) is under speculative attack11 - 14McGraw-Hill/IrwinInternational Business, 6/e© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.The Floating Exchange Rate• The Jamaica agreement revised the IMF’s Articles of Agreement to reflect the new reality of floating exchange rates- Floating rates acceptable- Gold abandoned as reserve asset- IMF quotas increased• IMF continues role of helping countries cope with macroeconomic and exchange rate problems11 -