Monetary System

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
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)
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
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
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
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
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
Jamaica Agreement 1976
Floating rates 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

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?

Case for Floating Exchange Rates

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?
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