2. Monetary System
Relationship between monetary
system and foreign exchange rates
Historical development
Fixed vs floating exchange rates
Role of the IMF and World Bank
Implications for managers
3. International Monetary System
Currency exchange rates depend on the structure of
the international monetary system
In 2003 of all IMF members currencies
– Only 19% were free floating
– 25% were managed float
– 8% were adjustable peg
– 22% were fixed peg
– 4% were fixed by a currency board
– 22% were not currency of their own (use Euro, US
Dollar)
4.
5. Evolution of the International
Monetary System
Gold Standard: currencies pegged to gold
value
– Convertibility guaranteed
– By 1880 most on gold standard
– Balance of trade equilibrium for all countries
Value of exports should equal value of imports
Flow of gold used to make up differences
– Abandoned in 1914
Failed resumption after WWI
Great Depression
6. Bretton Woods (1944 - 1973)
44 countries met to design a new system in 1944
Established:
International Monetary Fund (IMF) and World
Bank
– IMF: maintain order in monetary system
– World Bank: promote 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; buy/sell own currency to maintain level
7. The Role of the IMF
IMF maintained exchange rate
– discipline
National governments had to manage inflation through their
money supply
– flexibility
Provides loans to help members states with temporary
balance-of-payment deficit;
– Allows time to bring down inflation
– Relieves pressures to devalue
Excessive drawing from IMF funds came with IMF
supervision of monetary and fiscal policies
– Allowed to 10% devaluations and more with IMF approval
187 members by 2003
8. The Role of the World Bank
World Bank (IBRD) role
(International Bank for Reconstruction &
Development)
– Refinanced post-WWII reconstruction and development
– Provides 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
9. 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
10. Jamaica Agreement 1976
Floatingrates declared acceptable
Gold abandoned as reserve asset;
– IMF returned gold reserves to members at current
prices
– Proceeds placed in 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
11. 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?
12. Recent Activities and the IMF
Mexican Crisis 1995
Russian Ruble crisis1995
Asian crisis 1997/1998
– Events
The investment boom
Excess capacity
The debt bomb
Expanding imports
The crisis
How does the IMF achieve results?
– Inappropriate policies?
– Moral Hazard?
– Lack of accountability?
13. Managerial Implications
Currency management
– Currency market does not always work as expected
– Government intervention
– Speculative activity
Business strategy
– Movements in exchange rates are difficult to predict
– Forward market is imperfect predictor of exchange rate
movements
– Forward exchange rate market covers risk for months not years
– Maintenance of strategic flexibility required
Disperse manufacturing
Outsource
– Corporate-government relations