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Chapter
10
The International
Monetary system
10-2
Turkeys 18th IMF program
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Large and inefficient state sector heavy subsidies
Government debt risen to 60% of gross domestic
product
Rampant inflation
IMF focus
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Reduce inflation
Stabilize value o f currency
Privatization
Reduction of subsidies
Government reforms
Reasons for failure
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10-3
International monetary system (IMF)
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The institutional arrangements that countries
adopt to govern exchange rates
Dollar, Euro, Yen and Pound “float” against
each other
 Floating exchange rate:
 Foreign exchange market determines the
relative value of a currency
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International monetary system (IMF)
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Some countries use other institutional arrangements
to fix their currency’s value
 Pegged exchange rate
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Dirty float
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Value fixed relative to a reference currency
Hold value within range of a reference currency
Fixed exchange rate
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Set of currencies are fixed against each other at some
mutually agreed upon exchange rate
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10-5
The gold standard
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Roots in old mercantile
trade.
Inconvenient to ship
gold, changed to paperredeemable for gold.
Want to achieve
‘balance-of-trade
equilibrium
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Japan
USA
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Balance of trade equilibrium
Decreased
money supply
= price decline.
Trade Surplus
As prices decline, exports
increase and trade goes
into equilibrium.
Gold
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Increased
money supply
= price
inflation.
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10-7
Between the wars
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Post WWI, war heavy expenditures affected
the value of dollars against gold
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US raised dollars to gold from $20.67 to $35
per ounce
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Dollar worth less?
Other countries followed suit and devalued
their currencies
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10-8
Bretton Woods
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In 1944, 44 countries met in New Hampshire
Countries agreed to peg their currencies to
US$ 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
IMF and World Bank created
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10-9
Role of the IMF
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Created to police monetary system by ensuring
maintenance of the fixed-exchange rate
Promote int’l monetary cooperation and facilitate
growth of int’l trade
Wanted to avoid problems following WW1, through
A) Discipline
 Maintaining a fixed exchange rate imposes
monetary discipline, curtails inflation
,
 Brake
on competitive devaluations and stability
to the world trade environment
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Role of the IMF
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B) Flexibility
 Lending facility:
 Lend
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foreign currencies to countries having
balance-of-payments problems
Adjustable parities:
 Allow countries to devalue currencies more
than 10% if balance of payments was in
“fundamental disequilibrium’
Persistent borrowings leads to IMF control of
a country’s economic policy
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Principal duties
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Surveillance of exchange rate policies (No
longer fixed rate exchange)
Financial assistance (including credits and
loans)
Technical assistance (expertise in
fiscal/monetary policy)
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Sources of funds
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182 nations pay into fund according to the
size of their economy
Funds remain their property
Borrower repays loan in 1 to 5 years, with
interest
No nation has ever defaulted; some are given
extensions
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Membership in the IMF
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Open to any country willing to agree to its
rules and regulations
Must pay a deposit (quota)
Quota size reflects global importance of a
nation’s economy
Quota determines voting powers
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Largest contributors
Fig 10.0
18.3
20
15
10
5.7
5.7
5.1
5.1
Percent
5
0
US
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Germany
Japan
Britain
France
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10-15
Role of the World Bank
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International Bank for Reconstruction and
Development (IBRD)
Purpose: To fund Europe’s reconstruction and help 3d
world countries.
Overshadowed by Marshall Plan,
Turns to ‘development’
 Lending money raised by WB bond sales
 Agriculture
 Education
 Population
control
 Urban development
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Collapse of the fixed exchange system
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Pressure to devalue dollar led to collapse
President Johnson financed both the Great Society
and Vietnam by printing money
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August 8, 1971, Nixon announces dollar no longer
convertible into gold.
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High inflation and high spending on imports
Countries agreed to revalue their currencies against the
dollar
March 19, 1972, Japan and most of Europe floated their
currencies
In 1973. Bretton Woods fails when key currency (dollar)
is under speculative attack
Now have a managed-float system
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Long term exchange rate trends 19702001
Fig 10.1
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The floating exchange rate
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Jamaica Agreement - 1976
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Floating rates acceptable
Gold abandoned as reserve asset
IMF quotas increased
IMF continues role of helping countries cope
with macroeconomic and exchange rate
problems
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Exchange rates since 1973
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More volatile:
 Oil crisis -1971
 Loss of confidence in the dollar - 1977-78
 Oil crisis – 1979, OPEC increases price of oil
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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
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Floating exchange rates
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Trade balance
adjustments
Monetary policy
autonomy
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Fixed exchange rates
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Monetary discipline
Speculation
Uncertainty
Trade balance
adjustments
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Fixed versus floating exchange rates
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Floating:
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Monetary policy
autonomy
 Restores control to
government
Trade balance
adjustments
 Adjust currency to
correct trade
imbalances
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Fixed:
 Monetary discipline
 .Speculation
 Limits speculators
 Uncertainty
 Predictable rate movements
 Trade balance adjustments
 Argue no link between
exchange rates and trade
 Link between savings
and investment
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10-23
IMF members exchange rate policy,2002
Fig 10.2
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Exchange rate regimes
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Pegged Exchange Rates.
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Peg own currency to a major currency ($).
Popular among smaller nations
Evidence of moderation of inflation
Currency Boards.
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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
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Crisis management by the IMF
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Role has expanded to meet crisis
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Currency crisis
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Banking crisis
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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
Loss of confidence in the banking system leading to a
run on the banks
Foreign debt crisis
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When a country cannot service its foreign debt
obligations
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Incidence of currency and banking crisis
Fig 10.3
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Crises have common underlying causes
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Common causes:
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High inflation
Widening current account deficit
Excessive expansion of domestic borrowing
Asset price inflation
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Mexican currency crisis of 1995
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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
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Russian Ruble crisis
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Financial markets loss of confidence in
Russia’s ability to meet national and
international payments
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Led to loss of international reserves and roll over
of treasury bills reaching maturity
Financial markets unable to determine ‘who’s
in charge’
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Russian Ruble crisis
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Persistent decline in value of ruble:
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High inflation
Artificial low prices in Communist era
 Shortage of goods
 Liberalized price controls
 Too many rubles chasing too few goods
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Growing public-sector debt
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Refusal to raise taxes to pay for government
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Government actions: Exacerbating the
Situation
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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.
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Decline of the Ruble
0
-1000
1992
1993
1994
1995
-2000
-3000
-4000
-5000
-6000
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The Asian crisis
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Factors leading to the Asian financial crisis of
1997
The investment boom
Excess capacity
The debt bomb
Expanding imports
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The Asian crisis
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Mid 1997 several key Thai financial institutions
were on the verge of default
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Thailand asks IMF for help
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Result of speculative overbuilding
Excess investment (dollar denominated debt)
Deteriorating balance-of payments position
17.2 billion in loans, given with restrictive conditions
Following devaluation of Thai baht speculation hit
other Asian currencies
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Malaysia
Singapore
Indonesia
Korea
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Problems in Asian Market Economies
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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
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Evaluating the IMF policy prescriptions
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Inappropriate policies:
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“One size fits all’
Moral hazard:
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People behave recklessly when they know they will be
saved if things go wrong
 Foreign lending banks could fail
 Foreign lending banks have paid price for rash
lending
Lack of Accountability
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IMF has grown too powerful
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Impact on the countries
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Currency devaluation
Declining investment
Rising prices
Rising unemployment
Rising poverty
Rising resentment?
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Implications for business
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Currency management
Business strategy
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Forward exchange market (months not years
ahead)
Strategic flexibility
Corporate-government relations
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