Global dimensions of business quiz
othman1995
GBU355Ch.11.pptxGBU 355
Chapter 11
The International Monetary System
Opening Case: China’s Exchange Rate Regime
Claims by U.S. that China has manipulated its currency, the yuan, to keep its value low against other major currencies.
Is it true?
Is it possible?
China case (2)
Historically, the yuan was pegged to the $US at a fixed exchange rate.
In the 1980s, China devalued the yuan to make exports more competitive
China has spent around $600 billion in yuan to support the value of its currency since its economy began to slow in 2015
Pegged rate was moved in 1994 from ¥1.50/$US1 to ¥8.62/$US1
Fixed in early 2000s at ¥8.27/$US1
In 2005, China adopted a managed float
Allowed to move 0.3% against a basket of currencies, had increased to 2% by 2014
Goals and objectives
To describe the history of the modern monetary system
To explain the roles of the World Bank and IMF in the system
To compare and contrast the differences between fixed and floating rate systems
To identify exchange rate regimes used in the world today
To understand the debate surrounding the IMF
Terms
International monetary system
Institutional arrangements that govern exchange rates
Secures the stability of the monetary system
188 countries
Fosters monetary cooperation
Facilitates trades
Promotes high employment and sustainable growth
Reduces poverty
Exchange rate regimes
Floating exchange rate
The foreign exchange market (supply and demand) determines the relative value of the currency
Pegged exchange rate
The value of the currency is fixed relative to a reference currency
The exchange rate between that currency and others is determined by the reference currency exchange rate
Exchange rate regimes (2)
Dirty Float System
Aka, managed float
Does not adopt a formal peg
Floats because the value is determined by market forces BUT
The government intervenes to try to maintain the value of the currency if it depreciates
China has this policy
Fixed exchange rate
Value of a set of currencies are fixed against each other at a mutually-agreed-upon exchange rate
This was done immediately after WWII but abandoned in 1973
The Gold Standard
Established in ancient times
Payment between countries was done in gold or silver
Became impractical with the industrial revolution
It’s been estimated that about $60 billion in gold, silver, and other treasure is at the bottom of the sea
Gold standard
Governments decided to allow payment in paper currency that would be converted into gold on demand at a fixed rate
Pegging currency to gold and guaranteeing convertibility is The Gold Standard
How did it work?
If a country had adopted the gold standard, it agreed on the measure.
i.e., $1US was equal to 23.22 grains of pure gold (1 ounce of gold cost $20.67)
There are 480 grains in an ounce
Gold par value
The amount of currency needed to purchase one ounce of gold
Gold par value today: $1,276.30
Exchange rate was calculated by figuring the gold par value for two different currencies, then dividing
Gold Standard & Balance of Trade
This provided a mechanism for keeping trade balance in equilibrium
Merchant submits non-domestic currency to bank, exchanges for domestic currency.
Bank submits non-domestic currency to foreign government, exchanges for gold
As these exchanges take place, the government’s supply of gold swells or is depleted, depending on the currency in or out
Affect on prices and supply
As money supply increases, price inflation occurs, and demand falls.
As money supply decreases, prices decrease, and demand increases.
Why has the Gold Standard been abandoned?
After WWI Great Britain returned to the gold standard, pegging pound to pre-war value
U.S. returned to standard, but devalued the dollar so that exports were less costly
Government printing money that can’t be backed by gold reserves
Other countries did the same thing, and the gold standard collapsed.
U.S. used monetary policy as a trade instrument – have accused China of doing same.
Bretton Woods System
Resulted from collapse of Gold Standard, the Great Depression, and the need for a system
To avoid competitive devaluations
Some leeway was allowed if a currency became weak
Created the IMF
All countries agreed to fix exchange rates to gold, but not convert to gold.
Only the $US was convertible to gold
$35/ounce
Advantages of IMF oversight in fixed system
Discipline
Stability and no competitive devaluations
Flexibility
Lending
Loans of gold and cash to avoid unemployment and recession
Adjustable parities
Allowed devaluation of country’s currency by more than 10% if a country’s balance of payments was in fundamental disequilibrium
Permanent adverse shifts in demand for products
How does the World Bank fit in?
IBRD was also established in the Bretton Woods agreement
Originally was established to finance redevelopment of Europe with low interest loans
Marshall Plan (by U.S.) loaned money directly to Europe, so WB redirected its mission to developing nations
IBRD loans through bond sales and IDA (International Development Association) loans
Wealthy members subscribe and loan the money
Fixed Exchange Rate System Collapse
The U.S. spending increase was not backed by increased taxes, but by an increase in the money supply
Inflation followed
Additional money prompted higher consumer spending on imports
U.S. trade balance deteriorated
Collapsed in 1973
We’ve had a managed float system
U.S. government spending increased in the 1960s
Vietnam war
Social programs
Speculation ensued
Deutsche marks were purchased on speculation that they would be revalued if $US was devalued
German central bank propped up the DM
Then allowed currency to float
Dollar couldn’t float unless all countries agreed
Floating Exchange
IMF Jamaica Agreement (1973)
formalized floating exchange as o.k.
Abandoned gold as a reserve asset
IMF quotas were increased
Exchange rates are volatile
Oil crises
Confidence & lack of confidence in $
Partial collapse of EMS (European Monetary System) in 1992
Asian currency crisis 1997
Global financial crisis 2008-2010
Which is better?
Floating exchange
Monetary policy autonomy
Trade balance adjustments
Adjustments in exchange rate are forced by supply/demand
Crisis recovery control
Fixed exchange
Monetary discipline
Target for speculation
Uncertainty due to speculation
Makes planning difficult
Currency board
A currency board is usually introduced to provide more flexibility when a country’s currency is facing some type of crisis or threat
Two articles will interest you and provide a different perspective from Hill & Hult (2016):
The article references IMF
Moral hazard
Moral hazard occurs when people behave recklessly because they know they will be saved if something goes wrong.
It is not the same as assuming reasonable risk.
Country focus
The IMF and Iceland’s Economic Recovery
Background
Iceland suffered more than most from the 2008 global financial crisis
Biggest banks had expanded when banking sector was privatized
Iceland’s population totals 320,000
Banks expanded beyond Iceland’s borders
Deposits carried high interest rates
Expansion was financed through short-term (12-month) loans that had to be refinanced
When global financial markets were frozen, Iceland couldn’t re-finance its debt
Iceland lets the big 3 fail
The government couldn’t bail out the banks
Stock market plunged
Unemployment soared
Krona fell on foreign market exchanges
Import prices increased
Export prices decreased
Economy shrank 7% the first year, 4% the next
IMF to the rescue
Iceland borrowed $10 billion from the IMF to secure deposits and tried to boost domestic consumer spending
Exports surged
Pumped money into economy
Imports slumped
Inflation followed
Within 3 years, economy had grown 3.1% and unemployment had declined from 10% to 4.4%
Floating exchange rate is credited.
Iceland today
http:// www.heritage.org/index/country/iceland
http://www.indexmundi.com/iceland/gdp_(purchasing_power_parity). html
Summary terms
Currency crisis
Speculative attack on exchange value of currency forces intervention or depreciation
Banking crisis
Loss of confidence in system leads to a run on the banks
Foreign debt crisis
A country cannot service its foreign debt obligations
Public or private
Moral hazard
People behave recklessly knowing they will be saved
Did we meet our objectives?
To describe the history of the modern monetary system
To explain the roles of the World Bank and IMF in the system
To compare and contrast the differences between fixed and floating rate systems
To identify exchange rate regimes used in the world today
To understand the debate surrounding the IMF
