International Business Opportunities and Challenges in a Flattening World Version 3 0 3rd Ca

International Business Opportunities and Challenges

in a Flattening World Version 3 0 3rd Carpenter
Solution Manual

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 COPYRIGHT PAGE:

© 2018 by Mason A. Carpenter & Sanjyot P. Dunung. All rights reserved. Your use of
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© Mason A. Carpenter & Sanjyot P. Dunung, 2018, published by FlatWorld 1

 Chapter 6
International Monetary System

Introduction

Global trade depends on the smooth exchange of currencies between countries. Businesses
rely on a predictable and stable mechanism to manage this monetary exchange. This chapter
takes a look at the recent history of global monetary systems and how they have evolved over
the past two centuries. While the current monetary system continues to evolve, lessons
learned over the past fifty years help determine the best future options. As part of the post–
World War II monetary environment, two institutions—the International Monetary Fund
(IMF) and the World Bank—were created and have expanded to play an increasingly larger
role in the world economy. Understanding the role of the IMF and the World Bank provides
insight into how governments, primarily developing countries, receive funding and partner
with the private sector to implement projects related to trade and monetary policy.

Opening Case: McKinsey & Company: Linking the Business World, Governments, and
Global Institutions

Exercises

1. How does the business of a management consultant illustrate the link between
businesses, governments, and global institutions?
Answer: Students answers will vary. Management consultants help global businesses
understand how to enter new markets around the world, and how to compete more
effectively against their global competitors. They also act as advisors to governments
around the world on diverse issues, including how to amend policy and regulation to
encourage more trade and investment in their countries; developing and
implementing processes for privatizing industries; and creating more efficiency in the
public sector. At the same time, they help global institutions such as the IMF and the
World Bank formulate policy to meet their evolving roles in the world economy.

2. Discuss how a global consulting firm might assist a government client.

Answer: Students answers will vary. A global consulting firm might assist a
government client in the following ways:
a. Amendment of policies to encourage trade and investments.
b. Developing processes for privatizing industries.
c. Creating more efficiencies in the private sector.

3. Why would a global business in the private sector want to hire McKinsey if
McKinsey had already done consulting work for a competitor?
Answer: Students answers will vary. Consultants at McKinsey develop expertise and
can work for direct competitors after short holding periods of one or two years. Other
companies in the same industry often see this as an opportunity to learn more about
their competitors’ strategies—knowing that a competitor has hired McKinsey
provides a strong impetus for companies to seek McKinsey’s assistance themselves.

1. What Is the International Monetary System?

• Understand the role and purpose of the international monetary system.

• Describe the purpose of the gold standard and why it collapsed.
• Describe the Bretton Woods agreement and why it collapsed.

© Mason A. Carpenter & Sanjyot P. Dunung, 2018, published by FlatWorld 2

 • Understand today’s current monetary system, which developed after the Bretton
Woods Agreement collapse.

Section Outline

• International monetary system refers to the system and rules that govern the use
and exchange of money around the world and between countries.
o Each country has its own currency and the international monetary system
governs the rules for valuing and exchanging these different currencies.
• Ancient Egypt and Mesopotamia used a monetary system based on gold and silver
called the bullion.
• The other popular trade system was based barter, the exchange of goods.
• Gradually more countries adopted gold, usually in the form of coins or bullion, and
this international monetary system became known as the gold standard.
o This created a fixed exchange rate system, i.e., the price of one currency in
terms of the second currency.
o It reduced the risks in exchange rate and price fluctuations.
o Countries were force to maintain strict monetary policies.
o It helped correct trade imbalances.
o It helped maintain the trade deficit, i.e., imports exceeding exports.
• The gold standard collapsed from the impact of WWI.
o In 1931, the United Kingdom allowed its currency to float—a currency’s
value increases or decreases depending on supply and demand.
o Other countries also followed suit.
• In July 1944, representatives from forty-four countries met in Bretton Woods, New
Hampshire, to establish a new international monetary system; It lasted until the 1970s
and established several key features:
o It tied the value of all currencies to the US dollar and established a fixed
exchange rate or pegged rates.
o It provided for the devaluation of a currency if required.
o It led to the inception of the International Monetary Fund and the World
Bank.
• The Bretton Woods Agreement ran into challenges in the early 1970s.
o The US trade balance ran into deficits and many countries began to express
concerns.
o Countries do not keep enough gold and silver but maintain a reserve, a
percentage to honour all of their liabilities.
o The concern over the US economy was due to the Triffin Paradox—the
more dollars foreign countries held, the less faith they had in the ability of the
US government to convert those dollars.
o The Vietnam War also worsened this problem, resulting in a huge global sell-
off of the US dollar.
o A series of economic decisions resulted in the US ending the free
convertibility of the US dollar into gold and instituted price and wage freezes
among other economic measures; this resulted in the Nixon Shock in 1971.
o All this eventually led to the collapse of Bretton Woods.
• Later in 1971, the member countries reached the Smithsonian Agreement.
o The US dollar was devalued to $38 per ounce of gold.
o The value of other currencies to the dollar was increased.
o The dollar was still the strongest reserve currency—a main currency that
many countries and institutions hold as part of their foreign exchange
reserves.
o Concerns still continued to be raised and in 1973 this agreement was also
abandoned.

© Mason A. Carpenter & Sanjyot P. Dunung, 2018, published by FlatWorld 3

 • The European Monetary System (EMS) and the creation of a single currency, the
Euro, has been one of the important efforts at a single monetary system after Bretton
Woods.
• In 1976, the Jamaica Agreement established a managed float system of exchange
rates—currencies float against one another with governments intervening only to
stabilize their currencies at set target exchange rates.
o It is in contrast to a free floating exchange rate system in which there is no
government intervention.
o It removed gold as the primary reserve asset of the IMF.
o The role of the IMF was expanded to lend money to countries in bad
economic conditions.
• In the 1980s the value of the US dollar increased, increasing the US trade deficit.
• To solve this problem, five major economies of the world—the US, Great Britain,
France, Germany, and Japan—the Group of Five (G5) focused on forcing down the
value of the dollar.
• In 1987, the G7 (G5 + Canada and Italy) met to stabilize the dollar as it was believed
to be pegged too low.
• The G7 was expanded to include 20 countries in the late 1990s to address the
concerns of the emerging markets.
• The G20 plays a key role in any discussions of economic policies.
• The exchange rate system today is a managed float system, with the US dollar and the
euro competing to be the premier global currency.
o Some smaller nations have chosen to voluntarily set exchange rates against
the dollar while other countries have selected the euro.
o By choosing the euro or the dollar, countries seek currency stability and a
reduction in inflation.

Key Takeaways

• The international monetary system had many informal and formal stages. For more
than one hundred years, the gold standard provided a stable means for countries to
exchange their currencies and facilitate trade. With the Great Depression, the gold
standard collapsed and gradually gave way to the Bretton Woods system.
• The Bretton Woods system established a new monetary system in which the US
dollar effectively replaced gold as the global reserve currency. This system
incorporated some of the disciplinary advantages of the gold system while giving
countries the flexibility they needed to manage temporary economic setbacks, which
had led to the fall of the gold standard.
• The Bretton Woods system lasted until 1971 and provided the longest formal
mechanism for an exchange rate system and forums for countries to cooperate on
coordinating policy and navigating temporary economic crises.
• While no new formal system has replaced Bretton Woods, some of its key elements
have endured, including a modified managed float of foreign exchange, the
International Monetary Fund (IMF), and the World Bank—although each has evolved
to meet changing world conditions.

Exercises

1. What is the international monetary system?

Answer: International monetary system refers to the system and rules that govern the
use and exchange of money around the world and between countries. Each country
has its own currency as money and the international monetary system governs the
rules for valuing and exchanging these currencies.

© Mason A. Carpenter & Sanjyot P. Dunung, 2018, published by FlatWorld 4

 2. What was the gold standard and why did it collapse?
Answer: The pre-WWI global monetary system that used gold, usually in the form of
coins or bullions, as the basis of international exchange system is called the gold
standard. It created a fixed exchange rate system. The gold standard eventually
collapsed from the impact of World War I. During the war, nations on both sides had
to finance their huge military expenses and did so by printing more paper currency.
As the currency in circulation exceeded each country’s gold reserves, many countries
were forced to abandon the gold standard.

3. What was Bretton Woods and why did it collapse?

Answer: In July 1944, representatives from forty-four countries met in Bretton
Woods, New Hampshire, to establish a new international monetary system. Despite a
fixed exchange rate based on the US dollar and more national flexibility, the Bretton
Woods Agreement ran into challenges in the early 1970s. The US trade balance had
turned to a deficit as Americans were importing more than they were exporting.
Throughout the 1950s and 1960s, countries had substantially increased their holdings
of US dollars, which was the only currency pegged to gold.
By the late 1960s, many of these countries expressed concern that the US did not
have enough gold reserves to exchange all of the US dollars in global circulation. A
series of economic decisions called the Nixon Shocks finally led to the collapse of the
Bretton Woods Agreement.

4. What is the current system of exchange rates?

Answer: The exchange rate system today is a managed float system, with the US
dollar and the euro competing to be the premier global currency. Some smaller
nations have chosen to voluntarily set exchange rates against the dollar while other
countries have selected the euro. By choosing the euro or the dollar, countries seek
currency stability and a reduction in inflation.

2. What Is the Role of the IMF and the World Bank?

• Understand the history and purpose of the IMF.

• Describe the IMF’s current role and major challenges and opportunities.
• Understand the history and purpose of the World Bank.
• Describe the World Bank’s current role and major challenges and opportunities.

Section Outline

• Officially, the IMF came into existence in December 1945 with twenty-nine member
countries.
o France was the first country to borrow from the IMF.
o Today it has 189-member countries.
• It has the following purposes:
o Promote international monetary cooperation.
o Facilitate the expansion and balanced growth of international trade.
o Promote exchange stability.
o Establish a multilateral system of payments.
o Provide opportunity to countries to correct maladjustments in their balance of
payments.
o Lessen the degree of disequilibrium in the international balance of payments
of members.

© Mason A. Carpenter & Sanjyot P. Dunung, 2018, published by FlatWorld 5

 • The IMF created the Special Drawing Right (SDR)—an international monetary
reserve asset in 1969 in response to the Triffin Paradox.
o Today the value of an SDR consists of the value of four of the IMF’s biggest
members currencies—the US dollar, the British pound, the Japanese yen, and
the euro.
o However, SDRs are quoted in terms of US dollars.
o Some refer to SDRs as a form of IMF currency.
o Countries are allocated SDRs and these can be exchanged along with
currencies.
o Countries also borrow from the IMF in terms of SDRs.
• The IMF supports many developing nations by helping them overcome monetary
challenges and to maintain a stable international financial system. Yet, it has also
been subject to the following criticisms for its policies:
o Conditions for loans—IMF has some very harsh loan conditions which are
based on the Washington Consensus of liberalisation.
o Lack of country specific reforms—it insists on ‘blanket reforms’ often failing
to understand the dynamics of a country.
o Devaluations—it allows inflationary devaluations.
o Disruption of the Free-market—it allows for dangerous free-market norms.
o Supporting military dictatorships—it has consistently supported military
dictatorships with poor human rights records.
• The financial crisis of 2008 asserted the significance of the IMF as the institution was
inundated with requests for financial and policy support.
o Many recognized the important role that the institution played to avert the
global crisis.
• Recently, the IMF has sought to look at opportunities at policy making such as:
o Flexibility and speed
o Cheerleading
o Adaptability according to the country
o Transparency in policy making
• Many countries have called for the US dollar to be replaced by a new global system
controlled by the IMF.
• The World Bank came into existence in 1944; its formal name is the International
Bank for Reconstruction and Development (IBRD).
o It consists of two bodies—the IBRD and the International Development
Association (IDA), formed in 1960.
o The other bodies include—International Finance Corporation (IFC); it
focuses on interest-free loans.
o Multilateral Investment Guarantee Agency (MIGA)—improving foreign
direct investment in developing countries.
o International Centre for Settlement of Investment Disputes (ICSID)—dispute
resolutions between governments and private investors.
• The World Bank focuses on six strategic themes:
o Poverty reduction and sustainable growth in the poorest countries.
o Solutions to post-conflict countries.
o Development solutions in middle-income countries.
o Addressing global and regional issues across national borders.
o Greater development and opportunity in the Arab world.
o Using knowledge to focus on development.
• The World Bank provides low-interest loans, interest-free credits, and grants to
developing countries.
o There’s always a government (or “sovereign”) guarantee of repayment
subject to general conditions.

© Mason A. Carpenter & Sanjyot P. Dunung, 2018, published by FlatWorld 6

 o The World Bank is directed to make loans for projects but never to fund a
trade deficit.
o These loans must have a reasonable likelihood of being repaid.
• The IDA was created to offer an alternative loan option.
o IDA loans are free of interest and offered for several decades, with a ten-year
grace period before the country receiving the loan needs to begin repayment.
These loans are often called soft loans.
• The World Bank has tried to address the following crucial issues:
o Extreme poverty
o Illiteracy
o Using wealth for humanitarian concerns
o Development challenges in fragile states
• The World Bank, like the IMF, has faced criticism for many of its policies and
practices:
o Administrative incompetence
o Rewarding or supporting inefficient or corrupt countries
o Focusing on large projects rather than local initiatives
o Negative influence on theory and practice
o Dominance of the G7 countries
• It also has the following opportunities to look forward to in the future:
o Increased transparency
o Expanding social issues in the fight against poverty
o Improvements in a country’s competitiveness
o Improving efficiencies in diverse industries and leveraging the private sector.
• The World Bank continues to play a crucial role in helping countries reduce poverty
and improve the well-being of their citizens.

Key Takeaways

• The IMF is playing an expanding role in the global monetary system. The IMF’s key
roles are the following:
o To promote international monetary cooperation.
o To facilitate the expansion and balanced growth of international trade.
o To promote exchange stability.
o To assist in the establishment of a multilateral system of payments.
o To give confidence to members by making the IMF’s general resources
temporarily available to them under adequate safeguards.
o To shorten the duration and lessen the degree of disequilibrium in the
international balances of payments of members.
• The World Bank consists of two main bodies, the IBRD and the International
Development Association (IDA).
• The World Bank Group includes the following interrelated institutions:
o IBRD (International Bank for Reconstruction and Development), which
makes loans to countries with the purpose of building economies and
reducing poverty.
o IDA, which typically provides interest-free loans to countries with sovereign
guarantees.
o IFC (International Finance Corporation), which provides loans, equity, risk-
management tools, and structured finance with the goal of facilitating
sustainable development by improving investments in the private sector.
o MIGA (Multilateral Investment Guarantee Agency), which focuses on
improving the foreign direct investment of the developing countries.

© Mason A. Carpenter & Sanjyot P. Dunung, 2018, published by FlatWorld 7

 o ICSID (International Centre for Settlement of Investment Disputes), which
provides a means for dispute resolution between governments and private
investors, with the end goal of enhancing the flow of capital.

Exercises

1. What is the IMF, and what role does it play?

Answer: IMF stands for the International Monetary Fund, established in 1945 as a
result of the Bretton Woods Agreement. It has the following purposes—
o Promote international monetary cooperation.
o Facilitate the expansion and balanced growth of international trade.
o Promote exchange stability.
o Establish a multilateral system of payments.
o Provide opportunity to countries to correct maladjustments in their
balance of payments.
o Lessen the degree of disequilibrium in the international balance of
payments of members.

2. What are two criticisms of the IMF and two of its opportunities for the future?
Answer: The IMF has faced criticisms for its policies and practices. Two include:
a. It insists on ‘blanket reforms’ without paying attention to the dynamics of a
country.
b. It allows for inflationary devaluations.
However, it also has opportunities to look forward to:
a. Flexibility and speed
b. Providing loans as reassurance to countries

3. Discuss whether the SDRs or another global currency created by the IMF should
replace the US dollar as the international reserve currency.
Answer: Students answers will vary. SDRs are Special Drawing Rights, or special
international monetary reserve assets created in 1969. There has been periodic talk of
replacing the US dollar with SDRs as the international reserve currency, but it is not likely to
happen in the near future. The SDR as the reserve currency that is disconnected from
individual nations may provide stability. However, over 60% of all countries (accounting for
more than 70% of world GDP) use the US dollar as their anchor currency. The euro is a
distant second. As a result of this reliance on the US dollar, it’s not likely that the SDR can
replace it in the near term.
4. What is the World Bank and what role does it play?
Answer: The World Bank came into existence in 1944; its official name is the
International Bank for Reconstruction and Development (IBRD). It consists of two
bodies – the IBRD and the International Development Association (IDA), formed in
1960. The World Bank focuses on six strategic themes:
a. Poverty reduction and sustainable growth in the poorest countries.
b. Solutions to post-conflict countries.
c. Development solutions in middle-income countries.
d. Addressing global and regional issues across national borders.
e. Greater development and opportunity in the Arab world.
f. Using knowledge to focus on development.
It has tried to address the following crucial issues of extreme poverty, illiteracy,
utilising wealth for social and humanitarian causes and development challenges in
fragile states.

5. What are two criticisms of the World Bank and two of its opportunities for the future?
Answer: Students answers will vary. The World Bank has been criticized for the
following:

© Mason A. Carpenter & Sanjyot P. Dunung, 2018, published by FlatWorld 8

 a. Supporting corrupt/inefficient governments
b. Focusing too much on large projects
However, it also has the following opportunities to look forward to:
a. Increased transparency
b. Improvements in a country’s competitiveness

3. Understanding How International Monetary Policy, the IMF, and the World Bank
Impact Business Practices

• Understand how the current monetary environment, the IMF and the World Bank
impact business.
• Explore how you can work in the international development arena with a business
background.

Section Outline

• All businesses seek to operate in a stable and predictable environment.

• International businesses make efforts to reduce risks and unexpected issues that can
impact both operations and profitability.
• Global firms monitor the policies and discussions of the G20 and other economic
organizations so that they can identify new opportunities and use their leverage to
protect their markets and businesses.
• The IMF and the World Bank have considerable influence and use to make countries
to reduce trade barriers and adjust the value of their currencies.
o A July 2010 report from the IMF stated that China’s trade surplus will
increase unless the government takes steps to increase more domestic
consumption by the Chinese and also by letting the Chinese currency, the
renminbi, appreciate or increase in value.
• International businesses are affected by policies of these quasigovernmental
institutions because their developmental works are primarily done by the private
sector.
o McKinsey, BearingPoint, Pricewaterhouse-Coopers (PwC), and others
actively solicit projects from the World Bank and other development
organizations.
• These firms hire people with business degrees, expertise in foreign languages of
technical skills.
• People who wish to work in such projects can follow some of these steps:
o Start by looking at the Devex site. It is the biggest and best-known web
resource for development work.
o Explore organizational training programs.
o Research World Bank site and sites of the other institutions in the World
Bank Group to identify which firms are winning bids; then apply to those
firms.
o Read global business publications to learn more about projects, loans and
activities of these institutions.

Key Takeaways

• Businesses seek to operate in a stable and predictable environment by reducing risks

and unexpected issues that can impact both operations and profitability.
• Global firms monitor the policies and discussions of the G20 and other economic
organizations so that they can identify new opportunities and use their leverage to
protect their markets and businesses.

© Mason A. Carpenter & Sanjyot P. Dunung, 2018, published by FlatWorld 9

International Business Opportunities and Challenges in a Flattening World Version 3 0 3rd

• Global business in the private sector is heavily impacted by the IMF, the World Bank,
and other development organizations.
• Many of the projects that the World Bank Group funds in specific countries are
managed by the local governments, but the actual work is typically done by a private
sector firm.

Exercises

1. Why are the IMF and the World Bank relevant for global businesses?
Answer: All businesses seek to operate in a stable and predictable environment.
International businesses make efforts to reduce risks and unexpected issues that can
impact both operations and profitability. The IMF and the World Bank have
considerable influence and use this influence to make countries reduce trade barriers
and adjust the value of their currencies. Many of the projects that the World Bank
Group funds in specific countries are put up for competitive bidding by the
government of the country receiving the funds; the projects are then managed by a
government department. However, global companies in the private sector almost
always carry out the actual work. Hence, there is a vast industry focused on obtaining
these often lucrative and secure contracts.

2. What types of entities carry out the projects funded by the World Bank?
Answer: Many of the projects that the World Bank Group funds in specific countries
are put up for competitive bidding by the government of the country receiving the
funds; the projects are then managed by a government department. However, global
companies in the private sector almost always carry out the actual work. Hence there
is a vast industry focused on obtaining these often lucrative and secure contracts.

© Mason A. Carpenter & Sanjyot P. Dunung, 2018, published by FlatWorld 10

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