International Monetary System

Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

Chapter Preview
List the benefits of stable and predictable exchange rates Discuss the law-of-one-price principle Describe purchasing power parity and the factors that affect exchange rates Explain how the gold standard functioned

Discuss the experience with Bretton Woods

Describe todays international monetary system
Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall International Business 5e
Chapter 10 - 2

Currency Values and Business

Exchange rates affect activities of both domestic and international firms
Devaluation
lowers raises

Revaluation export prices import prices

International Business 5e

raises

lowers
Chapter 10 - 3

Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

Major World Currencies

Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

International Business 5e

Chapter 10 - 4

Stability and Predictability

Stable exchange rates Predictable exchange rates

Improve accuracy of financial planning

Reduce surprises of unexpected rate changes

Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

International Business 5e

Chapter 10 - 5

Value of U.S. Dollar

Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

International Business 5e

Chapter 10 - 6

Law of One Price

Identical item must have an identical price in all countries when expressed in a common currency
Undervalued or overvalued

McCurrency

Fairly good rate predictor Limited use in business decisions

Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

International Business 5e

Chapter 10 - 7

Big Mac Index

Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

International Business 5e

Chapter 10 - 8

Purchasing Power Parity

Relative ability of two nations currencies to buy the same basket of goods in those two nations
Considers price levels in adjusting relative currency values
Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

Purchasing power of a currency is eroded by inflation

Chapter 10 - 9

International Business 5e

Inflation: Key Factors

Money supply Monetary policy directly affects interest rates and money supply Fiscal policy indirectly affects taxes and spending

Employment

High employment raises wages, which are embodied in consumer prices

Interest rates

High rates lower borrowing and spending, which lowers inflation Exchange rates adjust to maintain PPP
International Business 5e
Chapter 10 - 10

Adjustment

Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

Interest Rates

Fisher Effect

Nominal Interest rate = real interest rate + inflation rate

International Fisher Effect

Difference in nominal interest rates supported by two nations currencies will cause an equal but opposite change in their spot exchange rates
International Business 5e
Chapter 10 - 11

Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

Evaluating PPP

Added costs
Business confidence & psychology

Trade barriers

Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

International Business 5e

Chapter 10 - 12

Forecasting Exchange Rates

Efficient (inefficient) market views
Prices reflect (dont reflect) all public information

Forecasting techniques
Fundamental analysis Technical analysis
Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall International Business 5e
Chapter 10 - 13

Adjusting to Currency Swings

Export strategies in the face of currency swings

Strong currency:
Prune operations
Adapt products Source abroad Freeze prices
Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

Weak currency:
Source domestically

Grow at home
Push exports Reduce expenses
International Business 5e
Chapter 10 - 14

Gold Standard
International monetary system that linked nations currencies to specific values of gold
In place from 1700s to 1939
Reduced exchange-rate risk Restricted monetary policies

Corrected trade imbalances

Ended by competitive devaluation
Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall International Business 5e
Chapter 10 - 15

Bretton Woods Agreement

International monetary system based on value of U.S. dollar (1944 to 1973)
Fixed exchange rates Built-in flexibility World Bank and IMF Ended by weak U.S. dollar
Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall International Business 5e
Chapter 10 - 16

Jamaica Agreement
Formalized the system of floating exchange rates as the new international monetary system (1976)

Managed float system

Currencies float with government intervention
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Free float system

Currencies float without government intervention
Chapter 10 - 17

International Business 5e

The System Today

Managed float system Pegged exchange rates Currency board

European monetary system

Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall International Business 5e
Chapter 10 - 18

Recent Financial Crises

Developing nations Mexico Southeast Asia Russia

Argentina

Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

International Business 5e

Chapter 10 - 19

Chapter Review
List the benefits of stable and predictable exchange rates Discuss the law-of-one-price principle Describe purchasing power parity and the factors that affect exchange rates Explain how the gold standard functioned

Discuss the experience with Bretton Woods

Describe todays international monetary system
Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall International Business 5e
Chapter 10 - 20

International Monetary System

Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

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Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall