The International Monetary System

1
The International Monetary System

• Dr Carol Reade
• Bus 187

2
Learning Objectives

• Understand the evolution and functioning of the
  international monetary system.
• Explore the debate on fixed versus floating
  exchange rates.
• Evaluate the role of the World Bank and IMF
• Assess the implications of the international
  monetary system for the practice of international
  business.

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Introduction

• The international monetary system refers to the
  institutional arrangements that countries adopt
  to govern exchange rates.
• institutional arrangements government
  intervention in the foreign exchange markets

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Evolution of the International Monetary System

• Gold standard
• Fixed exchange rates
• Floating exchange rates
• Managed-float or dirty-float system

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The Gold Standard

• Roots in old mercantile trade
• Inconvenient to ship gold, changed to paper-
  redeemable for gold
• Want to achieve balance-of-trade equilibrium

Trade
USA
Japan

Gold
6
Bretton Woods

• In 1944, 44 countries met in Bretton Woods, New
  Hampshire
• Key Components of the Agreement
• Established a fixed exchange rate system
• Created the World Bank and the International
  Monetary Fund
• Plus
• Agreed not to engage in competitive devaluations
  for trade purposes and defend their currencies

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Fixed Exchange Rate System

• Fixed exchange rate occurs when a set of
  currencies are fixed against each other at some
  mutually agreed upon exchange rate

8
Collapse of the Fixed Exchange System

• The system of fixed exchange rates established at
  Bretton Woods worked well until the late 1960s
• 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 throughout the world

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The Floating Exchange Rate

• Floating exchange rates occur when the foreign
  exchange market determines the relative value of
  a currency
• The worlds four major currencies dollar, euro,
  yen, and pound are all free to float against
  each other

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Exchange Rates Since 1973

• Since 1973, exchange rates have become more
  volatile and less predictable than they were
  between 1945 and 1973, due to
• Oil crisis -1971
• Loss of confidence in the dollar - 1977-78
• Oil crisis 1979, OPEC increases price of oil
• Unexpected rise in the dollar - 1980-85
• Rapid fall of the dollar - 1985-87 and 1993-95
• Partial collapse of European Monetary System -
  1992
• Asian currency crisis - 1997

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Exchange Rates Since 1973

• Figure 10.1 Major Currencies Dollar Index,
  1973-2006

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Fixed vs. Floating Exchange Rates

• The merits of each continue to be debated
• There is no agreement as to which system is
  better
• Many countries today are disappointed with the
  floating exchange rate system

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Exchange Rate Regimes

• IMF Members, 2006

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Role of the World Bank and IMF

• The agreement reached at Bretton Woods
  established two multinational institutionsthe
  World Bank and the International Monetary Fund
  (IMF).
• Since WWII, both institutions have played an
  important role in the world economy.

15
Role of the World Bank

• Official name International Bank for
  Reconstruction and Development
• Purpose To fund Europes 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 development

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Role of the IMF

• The role of the IMF is to maintain order in the
  international monetary system
• (1) to avoid a repetition of the competitive
  devaluations of the 1930s, and
• (2) to control price inflation by imposing
  monetary discipline on countries.

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Video Discussion

• The IMF has come under considerable fire from
  those who believe that its actions target the
  poor.
• What would happen to the poor in these nations if
  the IMF had not stepped in?

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Evaluating the IMF Policy Prescriptions

• Critics worry about
• Inappropriate policies
• The IMFs one-size-fits-all approach to
  macroeconomic policy is inappropriate for many
  countries
• Moral hazard
• People behave recklessly when they know they will
  be saved if things go wrong
• Lack of Accountability
• The IMF has become too powerful for an
  institution that lacks any real mechanism for
  accountability

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Implications For Managers

• For managers, understanding the international
  monetary system is important for
• currency management
• business strategy
• corporate-government relations

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Currency Management

• Managers must recognize that the current
  international monetary system is a managed float
  system in which government intervention can help
  drive the foreign exchange market
• Under the present system, speculative buying and
  selling of currencies can create volatile
  movements in exchange rates

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Business Strategy

• Managers need to recognize that while exchange
  rate movements are difficult to predict, their
  movement can have a major impact on the
  competitive position of businesses
• To contend with this situation, managers need
  strategic flexibility
• Eg., dispersing production to different locations

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Corporate-Government Relations

• Managers need to recognize that businesses can
  influence government policy towards the
  international monetary system
• Companies should promote an international
  monetary system that facilitates international
  growth and development