Slide international business 6e by CHarless hill 07IBChapter 11

• Floating exchange rates occur when the foreign exchange market determines the relative value of a currency • The world’s four major currencies – dollar, euro, yen, and pound – are al

Chapter Eleven

The International Monetary

System

• The international monetary system refers to

the institutional arrangements that govern exchange rates.

• Floating exchange rates occur when the

foreign exchange market determines the relative value of a currency

• The world’s four major currencies – dollar,

euro, yen, and pound – are all free to float against each other

currency is fixed relative to a reference currency

their currency within a range of a reference currency

currencies are fixed against each other at some

mutually agreed upon exchange rate

• Pegged exchange rates, dirty floats and fixed

exchange rates all require some degree of

The Gold Standard

• Roots in old mercantile

Go ld

Tr

ad e

Balance of Trade Equilibrium

= price decline.

As prices decline, exports increase and trade goes into equilibrium.

Between the Wars

• Post WWI, war heavy expenditures affected the

value of dollars against gold

• US raised dollars to gold from $20.67 to $35 per

ounce

- Dollar worth less?

• Other countries followed suit and devalued their

currencies

Bretton Woods

• In 1944, 44 countries met in New Hampshire

• Countries agreed to peg their currencies to US$

which was convertible to gold at $35/oz

• Agreed not to engage in competitive devaluations for trade purposes and defend their currencies

• Weak currencies could be devalued up to 10%

w/o approval

• Created the IMF and World Bank

International Monetary Fund

Agreement were heavily influenced by the worldwide

financial collapse, competitive devaluations, trade

wars, high unemployment, hyperinflation in Germany

and elsewhere, and general economic disintegration

that occurred between the two world wars

that chaos through a combination of discipline and

flexibility

International Monetary Fund

Role of the World Bank

• The official name for the world bank is the

International Bank for Reconstruction and

Collapse of the Fixed Exchange System

• The system of fixed exchange rates established

at Bretton Woods worked well until the late

1960’s

- The US dollar was the only currency that could be

converted into gold

- The US dollar served as the reference point for all other

currencies

- Any pressure to devalue the dollar would cause problems

through out the world

Collapse of the Fixed Exchange System

• Factors that led to the collapse of the fixed

exchange system include

- President Johnson financed both the Great Society and Vietnam

by printing money

- High inflation and high spending on imports

- On August 8, 1971, President Nixon announces dollar no longer

convertible into gold

- Countries agreed to revalue their currencies against the dollar

- On March 19, 1972, Japan and most of Europe floated their

currencies

- In 1973, Bretton Woods fails because the key currency (dollar) is under speculative attack

The Floating Exchange Rate

• The Jamaica agreement revised the IMF’s

Articles of Agreement to reflect the new reality of

floating exchange rates

- Floating rates acceptable

- Gold abandoned as reserve asset

- IMF quotas increased

• IMF continues role of helping countries cope with

macroeconomic and exchange rate problems

Exchange Rates Since 1973

• Exchange rates have been more volatile for a

number of reasons including:

- Oil crisis -1971

- Loss of confidence in the dollar - 1977-78

- Oil crisis – 1979, OPEC increases price of oil

- Unexpected rise in the dollar - 1980-85

- Rapid fall of the dollar - 1985-87 and 1993-95

- Partial collapse of European Monetary System - 1992

- Asian currency crisis - 1997

Long-Term Exchange Rate Trends From 1973 - 2003

Fixed Versus Floating

- Trade balance adjustments

- Predictable rate movements

- Trade balance adjustments

- Argue no link between

exchange rates and trade

investment

Exchange Rate Regimes

• Pegged Exchange Rates

- Peg own currency to a major currency ($)

- Popular among smaller nations

- Evidence of moderation of inflation

• Currency Boards

- Country commits to converting domestic currency on demand into another currency at a fixed exchange rate

- Country holds foreign currency reserves equal to 100% of

domestic currency issued

Exchange Rate Policies for

IMF Members 2004

Crisis Management by the IMF

• The IMF’s activities have expanded because

periodic financial crises have continued to hit

many economies

- Currency crisis

• When a speculative attack on a currency’s exchange value

results in a sharp depreciation of the currency’s value or forces authorities to defend the currency

Incidence of Currency and Banking Crises 1975 - 1997

Mexican Currency

Crisis of 1995

• Peso pegged to U.S dollar

• Mexican producer prices rise by 45% without

corresponding exchange rate adjustment

• Investments continued ($64B between 1990

-1994)

• Speculators began selling pesos and government

lacked foreign currency reserves to defend it

• IMF stepped in

Russian Ruble Crisis

• Financial markets’ loss of confidence in Russia’s

ability to meet national and international

Russian Ruble Crisis

• Persistent decline in value of ruble:

- High inflation

• Artificial low prices in Communist era

• Shortage of goods

• Liberalized price controls

- Too many rubles chasing too few goods

- Growing public-sector debt

• Refusal to raise taxes to pay for government

Government Actions:

Exacerbating the Situation

• Defacto devaluation of the ruble

• Unilateral restructuring of ruble-denominated

public debt

• 90-day moratorium on foreign credits repayment

• Hike in interest rates to defend ruble

• Duma rejects measures designed to alleviate

problems

Decline of the Ruble

The Asian Crisis

• Factors leading to the Asian financial crisis of

The Asian Crisis

• Mid 1997 several key Thai financial institutions

were on the verge of default

- Result of speculative overbuilding

- Excess investment (dollar denominated debt)

- Deteriorating balance-of payments position

• Thailand asks IMF for help

- 17.2 billion in loans, given with restrictive conditions

• Following devaluation of Thai baht speculation hit other Asian currencies

- Malaysia, Singapore, Indonesia, and Korea

Problems in Asian Market

Economies

• Cronyism

• Too much money, dependence on speculative

capital inflows

• Lack of transparency in the financial sector

• Currencies tied to strengthening dollar

• Increasing current account deficits

• Weakness in the Japanese economy

Evaluating the IMF Policy Prescriptions

Implications for Managers

• Currency management

• Business strategy

- Faced with uncertainty about the future value of currencies,

firms should utilize the forward exchange market to insure against exchange rate risk

- Firms should pursue strategies that will increase the

company’s strategic flexibility in the face of unpredictable exchange rate movements — that is, to pursue strategies that reduce the economic exposure of the firm

• Corporate-government relations

Looking Ahead to Chapter 12

• The Strategy of International Business

- Strategy and the Firm

- Global Expansion, Profitability, and Profit Growth

- Cost Pressures and Pressures for Local Responsiveness

- Choosing a Strategy