International business 5th griffin chapter 07

Chapter Objectives 1 • Discuss the role of the international monetary system in promoting international trade and investment • Explain the evolution and functioning of the gold standard

Chapter Objectives 1

• Discuss the role of the international monetary system in promoting international trade and investment

• Explain the evolution and functioning of the gold standard

• Summarize the role of the World Bank Group and the International Monetary Fund in the post-World War II international monetary

system established at Bretton Woods

Chapter Objectives 2

• Explain the evolution of the flexible

exchange rate system

• Describe the function and structure of the balance of payments accounting system

• Differentiate among the various

definitions of a balance of payments surplus and deficit

International Monetary System

The international monetary system establishes

the rules by which countries value and exchange their currencies and provides a mechanism for correcting imbalances between a country’s

international payments and receipts

History of the International

Monetary System

• The Gold Standard

• The Sterling-Gold Standard

• The Collapse of the Gold Standard

• The Bretton Woods Era

• The End of the Bretton Woods Era

The Gold Standard

Countries agree to buy or sell their paper currencies in exchange for gold on the request of any individual or firm and to allow the free export

of gold bullion and coins

Fixed Exchange Rate System

Sterling-Based Gold Standard

• British pound sterling was the most important currency from 1821 to 1918

• Most firms would accept either gold or British pounds

Map 7.1 The British Empire, 1913

The Collapse of the Gold

Standard

• Economic pressures of WWI

• Countries suspended pledges to buy or sell gold at currencies’ par values

• Gold standard readopted in 1920s

• Dropped during Great Depression

• British pound allowed to float in 1931

– Float: value determined by supply and demand

Figure 7.1 The Contraction of

World Trade, 1929-1933

The Bretton Woods Era

• 44 countries met in Bretton Woods, New

Hampshire, in 1944

• Goal: to create a postwar economic

environment to promote worldwide peace and prosperity

• Renewed gold standard on modified basis

(dollar-based)

• Created International Bank for Reconstruction and Development and International Monetary Fund

International Bank for Reconstruction and

Development (the World Bank)

• Goal 1: to help finance reconstruction of

European economies – Accomplished in mid-1950s

• Goal 2: to build economies of the world’s

developing countries

Figure 7.2 Organization of the

World Bank Group

International Bank for Reconstruction and Development

International Development Association

International Finance Corporation

Multilateral Investment Guarantee Agency

Objectives of the International Monetary Fund 1

• To promote international monetary cooperation

• To facilitate the expansion and balanced growth

of international trade

• To promote exchange stability, to maintain

orderly exchange arrangements among members, and to avoid competitive exchange depreciation

• To assist in the establishment of a multilateral system of payments

Objectives of the International Monetary Fund 2

• To give confidence to members by making the general resources of the IMF

temporarily available to them and to correct maladjustments in their balances of payments

• To shorten the duration and lessen the

degree of disequilibrium in the international balances of payments of members

Membership in the IMF

• Open to any country willing to agree to rules and regulations

• 184 member countries as of April 2006

• Membership requires payment of a quota

The IMF plays a key role in stabilizing the

world’s monetary system.

The Bretton Woods System

• Countries agreed to peg the value of currencies to gold

• U.S $ keystone of system

• Fixed exchange rate system

• Adjustable peg

• Functioned well in times of economic prosperity

The End of the Bretton Woods System

• Susceptible to speculative “runs on the bank”

• U.S $ became only source of liquidity

necessary to expand international trade

• People questioned the ability of U.S to meet

obligations (Triffin Paradox)

• IMF created special drawing rights (SDRs) –

paper gold

• Bretton Woods system ended August 15, 1971

Post-Bretton Woods System

• Most currencies began to float

• Value of U.S $ fell relative to most major currencies

• Group of Ten agreed to restore fixed

exchange rate system with restructured rates of exchange

Table 7.1 The Groups of Five, Seven, and Ten

Netherlands Switzerland

Table 7.2 Key Central Banks

Canada Bank of Canada

European Union European Central Bank

United Kingdom Bank of England

United States Federal Reserve Bank

• ERM participants maintained fixed

exchange rates among their currencies

• Facilitated creation and adoption of euro

International Debt Crisis

• OPEC quadrupled world oil prices

– Resulted in inflationary pressures in oil-importing countries

– Exchange rates adjusted – Transfer of wealth

• Countries borrowed more than they could repay

Figure 7.4 The Asian Contagion

The Balance of Payments

Accounting System

The BOP accounting system is a double-entry

bookkeeping system designed to measure and record all economic transactions between residents of one country and residents of all other countries during a particular time period

Balance of Payments (BOP)

Accounting System

• Measures and records all economic transactions between residents of one country and residents

of all other countries during specified time period

• Provides understanding of performance of each country’s economy in international markets

• Signals fundamental changes in country

competitiveness

• Assists policy makers in designing appropriate public policies

• Records only economic transactions

• Records transactions between residents of one country and all other countries

– Residents include individuals, businesses, government agencies, nonprofit organizations

• Uses a double-entry system

Major Components of the BOP

Accounting System

Current AccountCapital AccountOfficial ReservesErrors and Omissions

Types of Current Account

Transactions

• Exports and imports of goods

• Exports and imports of services

• Investment income

• Gifts

Capital Account

Foreign Direct Investment

Portfolio Investment

Table 7.4 Capital Account Transactions

Maturity Motivation Typical

Investments

Portfolio

international commerce

Checking account balances

Time deposits Commercial paper Bank loans

Government bills, notes, bonds Corporate stocks, bonds

Table 7.5 BOP Entries, Capital Account

Debt (Outflow) Credit (Inflow)

Buying a short-term foreign asset

Selling a domestic term asset to a foreigner

domestic asset from its foreign owner

Selling a short-term foreign asset acquired previously

Buying back a long-term domestic asset from its foreign owner

Selling a domestic term asset to a foreigner

long-Foreign direct

acquired

Official Reserves Account

• Records level of official reserves

• Four types of assets

– Gold – Convertible currencies – SDRs

– Reserve positions at the IMF

Official Reserves Account

Assets

Gold

ConvertiblesecuritiesSDRs

Reservepositions

Errors and Omissions

• BOP must balance

• Current Account + Capital Account + Official Reserves Account = 0

• Current Account + Capital Account + Official Reserves Account + Errors and Omissions = 0

Figure 7.7 The U.S BOP According to Various Reporting Measures