Slide 0Slide 1Chapter Two OutlineEvolution of the International Monetary SystemBimetallism: Before 1875Gresham’s LawClassical Gold Standard: 1875-1914Slide 8Slide 9Price-Specie-Flow MechanismSlide 11Interwar Period: 1915-1944Bretton Woods System: 1945-1972Slide 14Slide 15The Flexible Exchange Rate Regime: 1973-Present.Current Exchange Rate ArrangementsEuropean Monetary SystemWhat Is the Euro?What are the Different Denominations of the Euro Notes and Coins ?How Did the Euro Affect Contracts Denominated in National Currency?Euro AreaValue of the Euro in U.S. DollarsThe Long-Term Impact of the EuroCosts of Monetary UnionSlide 26The Mexican Peso CrisisSlide 28Slide 29The Asian Currency CrisisThe Argentinean Peso CrisisSlide 32Slide 33Currency Crisis ExplanationsFixed versus Flexible Exchange Rate RegimesSlide 36Slide 37Flexible Exchange Rate RegimesSlide 39Slide 40Slide 41End Chapter TwoINTERNATIONALFINANCIALMANAGEMENTEUN / RESNICKFifth EditionCopyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/IrwinChapter Objective:This chapter serves to introduce the student to the institutional framework within which:International payments are made.The movement of capital is accommodated.Exchange rates are determined.2Chapter TwoThe International Monetary System2-2Evolution of the International Monetary SystemCurrent Exchange Rate ArrangementsEuropean Monetary SystemEuro and the European Monetary UnionThe Mexican Peso CrisisThe Asian Currency CrisisThe Argentine Peso CrisisFixed versus Flexible Exchange Rate RegimesChapter Two Outline2-3Evolution of the International Monetary SystemBimetallism: Before 1875Classical Gold Standard: 1875-1914Interwar Period: 1915-1944Bretton Woods System: 1945-1972The Flexible Exchange Rate Regime: 1973-Present2-4Bimetallism: Before 1875A “double standard” in the sense that both gold and silver were used as money.Some countries were on the gold standard, some on the silver standard, some on both.Both gold and silver were used as international means of payment and the exchange rates among currencies were determined by either their gold or silver contents. 2-5Gresham’s LawGresham’s Law implied that it would be the least valuable metal that would tend to circulate. Suppose that you were a citizen of Germany during the period when there was a 20 German mark coin made of gold and a 5 German mark coin made of silver.If Gold suddenly and unexpectedly became much more valuable than silver, which coins would you spend if you wanted to buy a 20-mark item and which would you keep?2-6Classical Gold Standard: 1875-1914During this period in most major countries:Gold alone was assured of unrestricted coinageThere was two-way convertibility between gold and national currencies at a stable ratio.Gold could be freely exported or imported.The exchange rate between two country’s currencies would be determined by their relative gold contents.2-7For example, if the dollar is pegged to gold at U.S. $30 = 1 ounce of gold, and the British pound is pegged to gold at £6 = 1 ounce of gold, it must be the case that the exchange rate is determined by the relative gold contents:Classical Gold Standard: 1875-1914$30 = 1 ounce of gold = £6$30 = £6$5 = £12-8Classical Gold Standard: 1875-1914Highly stable exchange rates under the classical gold standard provided an environment that was conducive to international trade and investment.Misalignment of exchange rates and international imbalances of payment were automatically corrected by the price-specie-flow mechanism.2-9Price-Specie-Flow MechanismSuppose Great Britain exported more to France than France imported from Great Britain.This cannot persist under a gold standard.Net export of goods from Great Britain to France will be accompanied by a net flow of gold from France to Great Britain.This flow of gold will lead to a lower price level in France and, at the same time, a higher price level in Britain.The resultant change in relative price levels will slow exports from Great Britain and encourage exports from France.2-10Classical Gold Standard: 1875-1914There are shortcomings:The supply of newly minted gold is so restricted that the growth of world trade and investment can be hampered for the lack of sufficient monetary reserves.Even if the world returned to a gold standard, any national government could abandon the standard.2-11Interwar Period: 1915-1944Exchange rates fluctuated as countries widely used “predatory” depreciations of their currencies as a means of gaining advantage in the world export market.Attempts were made to restore the gold standard, but participants lacked the political will to “follow the rules of the game”.The result for international trade and investment was profoundly detrimental.2-12Bretton Woods System: 1945-1972Named for a 1944 meeting of 44 nations at Bretton Woods, New Hampshire.The purpose was to design a postwar international monetary system.The goal was exchange rate stability without the gold standard.The result was the creation of the IMF and the World Bank.2-13Bretton Woods System: 1945-1972Under the Bretton Woods system, the U.S. dollar was pegged to gold at $35 per ounce and other currencies were pegged to the U.S. dollar.Each country was responsible for maintaining its exchange rate within ±1% of the adopted par value by buying or selling foreign reserves as necessary.The Bretton Woods system was a dollar-based gold exchange standard.2-14Bretton Woods System: 1945-1972German markBritish poundFrench francU.S. dollarGoldPegged at $35/oz.Par ValuePar ValuePar Value2-15The Flexible Exchange Rate Regime: 1973-Present.Flexible exchange rates were declared acceptable to the IMF members.Central banks were allowed to intervene in the exchange rate markets to iron out unwarranted volatilities.Gold was abandoned as an international reserve asset.Non-oil-exporting countries and less-developed countries were given greater access to IMF funds.2-16Current Exchange Rate ArrangementsFree Float The largest number of countries, about 48, allow market forces to determine their currency’s value.Managed Float About 25 countries combine government intervention with market forces to set exchange rates.Pegged to another currency Such as the U.S. dollar or euro (through franc or mark).No national
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