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AOF Business in the Global Economy
Lesson 8
The International Monetary
System
Student Resources
Resource
Description
Student Resource 8.1
Reading: The Development of the International Monetary System
Student Resource 8.2
Timeline: The International Monetary System
Student Resource 8.3
Reading: The IMF and the World Bank
Student Resource 8.4
Worksheet: The IMF and the World Bank
Student Resource 8.5
Worksheet: Balance of Trade
Student Resource 8.6
Case Study: International Financial Management
Student Resource 8.7
Organizer: Economic Policy Recommendation Letter
Copyright © 20092012 National Academy Foundation. All rights reserved.
AOF Business in a Global Economy
Lesson 8 The International Monetary System
Student Resource 8.1
Reading: The Development of the International
Monetary System
Directions: Make sure you understand the terms at the top of the page before you begin reading. When
you encounter the terms in your reading, underline them.
Terms:
Fixed exchange rate: An exchange rate for a currency that government policy determines should be
fixed (“pegged”) to the market value of another currency, a group of currencies, or another measure of
value (such as the price of gold). Fixed exchange rates tend to help keep inflation in check, but also tend
to hide a currency’s true market value.
Floating exchange rate: An exchange rate that is determined by supply and demand in the foreign
exchange market, mostly without government intervention, and is therefore free to rise or fall.
Gold standard: An exchange rate policy that pegs the value of a currency to the price of gold and
guarantees that all issued currency can be converted to gold on demand at a gold par value.
Gold par value: The amount of currency that is needed to purchase one ounce of gold.
1870s–1914: Industrialism
From ancient times until the Industrial Revolution, when individuals, companies, or governments
purchased goods or services, they generally paid for the goods with gold or silver; or with currency whose
value in gold or silver was well established and trusted. The rise of industrialism caused an explosion in
trade, and by the 1880s shipping heavy gold and silver as payment was seen to be impractical, especially
for international trade. Major trading countries came up with a more efficient means of paying for goods:
paper currency. The values of these countries’ different currencies were defined and protected by the
gold standard. This meant that the value of the currency was pegged to the value of gold; the issuing
governments or central banks promised that they would support the paper currency by exchanging it for a
fixed amount of gold on demand, always keeping as much gold stored as there was paper currency in
circulation. This built confidence in the paper currency, since people knew they could exchange their
paper currency for gold. Major trading countries continued with the gold standard until 1914, when World
War I broke out and these countries, needing money to fill their war chests, began printing a lot more
paper money, often without having gold to back it.
1918–1939: Economic Turbulence
After World War I ended in 1918, the major trading economies slowly returned to the gold standard. But,
when a country’s government decided to return to the gold standard, it had to determine the gold par
value for its currencyand this became a problem. For instance, the British pound suffered high inflation
during World War I because too much money was in circulation, pushing up prices. In 1925, when the
British government decided to return to the gold standard, it did so at the prewar gold par value, making
the value of the pound artificially high. This proved to be huge economic policy mistake; it made the price
of British goods to buyers in other countries skyrocket, pricing them out of foreign markets. This harmed
UK exports, production, and employment long before the 1929 world stock market crash inflicted further
harm; and the cumulative effect of all this, and the associated disruption of world trade, led by 1931 to a
very severe economic depression. The United States was facing economic problems of its own at this
time, and the US government looked for a policy that would avoid the kind of trouble that had happened
with the pound. The US government decided to devalue the dollar, which made the prices of American
exports more competitive in other countries. The goal of the policy was to increase US exports, and
Copyright © 20092012 National Academy Foundation. All rights reserved.
AOF Business in a Global Economy
Lesson 8 The International Monetary System
hence production and employment in the US. Unfortunately, governments of other trading countries
realized they could do the same; they soon followed suit and devalued their own currencies. Thus a cycle
of competitive devaluations began, in which each country would devalue its currency to match (or even
exceed) the devaluation of the others. This caused severe international economic instability, placing
severe pressure on the gold reserves held by central banks. By 1939, when World War II began, the gold
standard was dead because governments and central banks could not afford to honor their promise to
exchange gold for the paper money they had issued.
1944–1973: Bretton Woods and the Gold Standard
By 1945, when World War II ended, the international economy was in serious trouble. The gold standard
had collapsed; almost all of Europe was suffering from colossal war damage and economic depression;
the economies of Germany and Japan had been largely destroyed. Much of world trade had disappeared
as a result of the 1929–1934 depression, followed by extreme protectionism, competitive devaluations,
and war. The US economy was thriving at home, but there were concerns that unless international trade
was revived, the US would have difficulty as well, unless international trade was revived.
This is why representatives of 44 countries met at Bretton Woods, New Hampshire, to design a new
international monetary system. Two important international financial institutions were formed at Bretton
Woods: the International Monetary Fund (IMF), which would work to maintain order and stability in the
global financial and currency exchange system; and the World Bank, which would promote post-war
reconstruction and longer-term economic development.
One major problem with the old system was the gold standard. The gold standard could not be sustained.
Nevertheless, the participants at Bretton Woods did feel it was best to stay with a fixed exchange rate
regime to help keep the world’s economy stable. However, the participants also felt that the new
exchange rate regime must be more flexible than the gold standard had been; and a cycle of competitive
devaluations of the kind that created huge disruption in the 1930s had to be avoided. That is why they
required the exchange rate of each currency to be fixed to the US dollar (and thus indirectly to the value
of gold) at levels agreed between the member countries; but also decided that the exchange rates could
occasionally be changed, after international consultations. Though the Bretton Woods agreement
restored a link between the value of each currency and the price of gold, it did not require convertibility
into gold: people holding paper currency were not guaranteed they could exchange it for gold.
The IMF was mandated to monitor exchange rates, and help member countries’ governments keep their
exchange rates within 1% of the value established at Bretton Woods.
The major weakness of this exchange rate regime arose from the way that each currency’s value was tied
to the value of gold indirectly via the US dollar. Dollars were used for vast numbers of international
transactions. Most countries’ central banks kept (and still keep) a large part of their currency reserves in
US dollars. Linking currencies to gold via the US dollar worked well in the 1950s, but its success was
dependent of the stability of the dollar in relation to gold: that is, in terms of the amount of gold that one
US dollar could buy. That meant that if the US experienced high inflation, or had a large trade deficit,
there might then be too many dollars in circulation for the US central bank, the Federal Reserve, to be
able to back with gold. That is what began happening in the mid-1960s, when American government
spending and money supply increased dramatically. In 1971, the US abandoned the gold standard, and
by 1973, it had disappeared, worldwide.
1973–Present: Regional and Global Financial Crises
In 1976, the IMF’s member countries agreed that floating exchange rates were now acceptable. Since
then, the world has operated a mixed exchange rate system, which is also called a managed float. This
means that some currencies are allowed to float freely, but other currencies are actively managed by
central banks, and often pegged in value to another currency or to a basket of currencies. This managed
float exchange rate regime has generally led to more volatile exchange rates than before the world
abandoned the gold standard in 1973. There have been long periods when the floating exchange rates
were fairly stable, and distinctly less volatile than many had originally feared. On the other hand, there
Copyright © 20092012 National Academy Foundation. All rights reserved.
AOF Business in a Global Economy
Lesson 8 The International Monetary System
have also been periods of extreme instability with volatile exchange rates contributing to currency crises
such as the Asian Financial Crisis of 1997. During that crisis several Asian countries, including Malaysia
and South Korea, saw the exchange rates of their currencies decrease by 80% in only a few months.
The IMF often intervenes when such currency crises occur, providing financial assistance {loans) and
expert advice for countries attempting to keep the value of their currency sufficiently stable in the face of
the crisis, and minimize disruption to their economy. In February 2009, the IMF began working with the
governments of the US and other major countries in an effort to moderate the global financial crisis, limit
the economic damage, and help create favorable conditions for recovery.
Copyright © 20092012 National Academy Foundation. All rights reserved.
AOF Business in a Global Economy
Lesson 8 The International Monetary System
Student Resource 8.2
Timeline: The International Monetary System
Student Name:_______________________________________________________ Date:___________
Directions: Fill out the important events that happened during the years described in Student Resource
8.1, Reading: The Development of the International Monetary System. Be ready to share your answers.
Copyright © 20092012 National Academy Foundation. All rights reserved.
AOF Business in a Global Economy
Lesson 8 The International Monetary System
Student Resource 8.3
Reading: The IMF and the World Bank
In 1944, as World War II was coming to a close, governments of more than 40 countries met in Bretton
Woods, New Hampshire for the United Nations Monetary and Financial Conference. There, they formed
two organizations through which they would collaborate to manage the global economy. One of these
organizations was the International Monetary Fund (IMF), and the other was the World Bank. The
countries involved wanted to prevent worldwide economic troubles that could lead to instability throughout
the world, and might even eventually lead to war.
The participating countries created these two international financial institutions (IFIs) to help prevent a
new meltdown in the worldwide economy, and also to help countries in need rebuild, which they saw as
being in the common interest of people in all parts of the world. Though the two IFIs have many
similarities, at least on the surface, each one serves a distinct purpose.
During their creation, the IFIs were controversial. For instance, governments of participating countries
argued about how much influence each would have over the IFIs, and how much money they would each
need to invest. The IMF and World Bank were intended to foster peace and prosperity throughout the
world, and many people feel that they have generally done so; others view the IFIs as oppressive tools
that prosperous countries use to impose their will on developing countries.
Copyright © 20092012 National Academy Foundation. All rights reserved.
AOF Business in a Global Economy
Lesson 8 The International Monetary System
When the founding member countries came together to create the IMF, they did so in order to deal with
international monetary difficulties; to ensure free convertibility of currencies (which would help
international trade grow); to ensure that international currency exchange rates remained stable; to ensure
instability in exchange rates and interest rates did not hurt trade; and to ensure that debts owed by one
country to another could be repaid in an orderly way.
The IMF does its job by performing three functions: surveillance, financial assistance, and technical
assistance. In performing the surveillance function, the IMF staff visits each member country and
examines many aspects of its economy, such as its exchange rate, monetary policies, and fiscal policies.
The IMF also does research on regional communities of countries, such as the European Union; and on
the global economy.
Providing financial assistance when major international crises happen is the IMF’s primary function. But in
order to get the money, the country seeking an IMF loan must usually agree to make changes to its
economic policies, based on the IMF’s analysis of what got the country into economic trouble in the first
place. The loans come at a variety of interest rates and for various lengths, depending on the state of the
borrowing country’s economy, and on what it needs the money for. The IMF also provides technical
assistance in such areas as monetary and tax policy and in collecting economic data.
Copyright © 20092012 National Academy Foundation. All rights reserved.
AOF Business in a Global Economy
Lesson 8 The International Monetary System
There are two bodies that control the International Monetary Fund, which is based in Washington, DC.
First is the board of governors. Each of the 184 member countries has a representative on this board.
These representatives meet once a year to deal with big issues and to vote on what’s to be done.
But for daily tasks, the 24-member executive board makes the decisions. Certain member countries—the
United States, the United Kingdom, China, France, Germany, Japan, Russia, and Saudi Arabia—are
permanently on this board, while the 16 other executive board members have two-year terms that rotate
among countries from broad regions, such as Africa or Southeast Asia. The members of the executive
board run different departments within the IMF. For instance, there are groups for various regions of the
world as well as for a variety of issues, such as fiscal planning and research and statistics. One managing
director, with a five-year term, runs this board.
Finally, the International Finance and Monetary Committee also has 24 members and meets twice a year.
Its purpose is to provide the IMF staff with suggestions and advice.
For all three bodies, a country’s voting power is based on a complex set of rules which give by far the
most votes to the countries with the largest economies and which have provided the largest amount of
funding to the IMF over time.
Copyright © 20092012 National Academy Foundation. All rights reserved.
AOF Business in a Global Economy
Lesson 8 The International Monetary System
The World Bank Group deals with money in both the public and private sectors. Developing countries can
borrow money from the IBRD and IDA. These two organizations within the group also offer governments
advice and provide research to help them manage their economic policies. The other three parts of the
World Bank Group deal with money in the private sector, helping out private business projects that benefit
the economy, by making loans and by helping to resolve disputes.
The overall goal of the World Bank is to reduce poverty. It also tries to increase access to education and
medical care and to protect the environment, all while promoting economic development. It does this by
offering loans for projects that improve an area’s economy. Projects have included things like building
roads to connect communities in rural Peru, giving microcredit (less than $1,000) loans to small-business
owners in developing countries, and helping poor mothers and children in Bangladesh get access to
medical care.
World Bank Acronyms:
IBRD: International Bank for Reconstruction and Development
MIGA: Multilateral Investment Guarantee Agency
IDA: International Development Association
IFC: International Finance Committee
ICSID: International Centre for Settlement of Investment Disputes
Copyright © 20092012 National Academy Foundation. All rights reserved.
AOF Business in a Global Economy
Lesson 8 The International Monetary System
The World Bank is organized in a broadly similar way to the IMF. It too has a board of governors that is
made up of one member from each member country. Voting power here is unequal, as it is in the IMF: it
broadly corresponds to how much money each country contributes to the World Bank.
The day-to-day functions come under the control of the World Bank’s 22 executive directors, who
together are the executive board. Five of these directors are from the member countries permanently
represented on the executive board: the United States, France, Germany, Japan, and the United
Kingdom. The other 17 representatives are elected by all the other countries that are members of the
World Bank.
The organization has a president and vice presidents. The vice presidents each manage a region of the
world or a function, such as poverty reduction or finance. The president of the World Bank is always a US
citizen.
Copyright © 20092012 National Academy Foundation. All rights reserved.
AOF Business in a Global Economy
Lesson 8 The International Monetary System
Though these two IFIs are different, they do have many similarities. They were both created at the same
time by a large group of countries as part of a UN effort to help the global economy run in a smooth and
stable way. Both of the IFIs have similar structures, with governing bodies made up of representatives
from the member countries.
Both organizations have come under criticism from those who say their policies put poor people at a
disadvantage and help rich corporations; and from those who feel that they threaten national sovereignty.
Though the IMF and World Bank are alike in many ways, they have distinct purposes. The IMF’s main
goal is to make sure that the system of payments between countries runs smoothly. It lends money to
governments when they need it, but it also monitors the policies and actions that determine countries’
currency exchange rates. It deals with large economic issues that are occurring between countries.
The World Bank, on the other hand, helps developing countries pay for economic development projects
and needed services. It lends money to the governments of these poor countries to help pay for such
projects. Unlike the IMF, which is focused on monetary issues, currency, banking and macroeconomics,
the World Bank is focused on microeconomic policies and structures for particular sectors of the economy
(such as electricity or transportation), and on the funding of specific projects in those sectors.
Copyright © 20092012 National Academy Foundation. All rights reserved.
AOF Business in a Global Economy
Lesson 8 The International Monetary System
Student Resource 8.4
Worksheet: The IMF and the World Bank
Student Names:_______________________________________________________ Date:___________
Directions: Find at least three differences between the IMF and the World Bank and write them in the
appropriate spaces on the Venn Diagram. Then find at least two similarities and record them in the
shared space.
IMF
World Bank
Copyright © 20092012 National Academy Foundation. All rights reserved.
AOF Business in a Global Economy
Lesson 8 The International Monetary System
Student Resource 8.5
Worksheet: Balance of Trade
Student Name:_______________________________________________________ Date:___________
Directions: Answer the questions based on the rules of thumb and the data on the chart. Be ready to
share how you arrived at your answers.
Balance of Trade Rules of Thumb

A country’s balance of payments is the difference between the total of all payments into a
country from other countries (including incoming payments for exported goods and services and
incoming investments); and the total of all payments out from the country (including payments for
imported goods and services and outgoing investments) in a specific time period.

The total balance of payments can be broken down into various parts. One of these is the current
account balance of payments (“current account” for short). The current account shows the flows
of money into and out of a country other than flows of money for the purpose of making
investments.

Economists look to the current account, which measures imports and exports, to determine the
country’s trade balance. A positive number in the current account signifies a trade surplus; a
negative number signifies a trade deficit.

Trade deficits decrease the demand for a country’s currency compared with what it would be if the
country’s imports and exports balanced. Those buying a country’s exports first have to buy its
currency in order to do so. This represents demand for the country’s currency in the FX market.
Those who sell imports into that country are generally paid in its currency; this represents supply
of the currency in the FX market. It follows that if the country has a trade deficit (its imports exceed
its exports) the supply of the currency will exceed the demand; and therefore the currency will tend
to decrease in value. Trade surpluses have the opposite effect: they increase demand for a
currency, and tend to increase its value.

Inflation is a general increase in prices, reducing the purchasing power of a country’s currency.

Exports help maintain high employment levels; slow economic growth raises unemployment rates.

GDP changes can cause currency rate fluctuations.
2007 Balance of Trade Figures for (M)BRIC(K) Countries in US Dollars
GDP
(PPPadjusted)
GDP
Growth
Rate (%)
Exchange
rate yearly
change (%)
Inflation Rate
(%)
Current Account
Balance ($
mlllion)
Unemployment
Rate (%)
MEXICO
$1.4 trillion
-1.60%
+27.76%
6.04%
-6
4.65%
BRAZIL
$1.8 trillion
1.27%
+30.77%
5.61%
-1,645
9.00%
RUSSIA
$2 trillion
1.20%
+40.80%
14.00%
8,595
9.50%
INDIA
$3 trillion
5.30%
+24.02%
7.81%
-15
7.32%
CHINA
$10.8 trillion
9.90%
-2.38%
-1.29%
191,718
4.20%
S. KOREA
$1.2 trillion
-4.30%
+34.79%
3.88%
3,682
3.70%
Copyright © 20092012 National Academy Foundation. All rights reserved.
AOF Business in a Global Economy
Lesson 8 The International Monetary System
Balance of Trade Questions:
1. Which countries have trade deficits?
2. Which countries have trade surpluses?
3. GDP reflects the purchasing power of consumers. If a country’s GDP falls, consumers are less
able to purchase foreign goods, so the country’s imports decline. This means that if the country
had a current account surplus that surplus would increase; or if the country had a current account
deficit, that deficit would diminish, or even turn into a surplus. Which countries may see a change
in the value of their currency due to this effect? Why?
4. How might the negative GDP growth rates of Mexico and China in 2007 affect these countries’
balance of payments?
5. Which countries may see a change in employment numbers? Why?
Copyright © 20092012 National Academy Foundation. All rights reserved.
AOF Business in a Global Economy
Lesson 8 The International Monetary System
Student Resource 8.6
Case Study: International Financial Management
Student Name:_______________________________________________________ Date:___________
Directions: Read the policy China implemented and circle your best guess about what the effect was.
Then read about what happened.
Balance of trade is a key indicator of what is happening in a country’s economy, and that is why
governments implement policies to manage it. Many countries seek trade balance (when the income a
country earns from its exports is equal to the money paid to other countries for exports), but others seek
to maximize exports. The Chinese government has managed its economy and its currency so that it will
have a large trade surplus.
Trade Policy
Policy: The Chinese government makes its trade policies as export-friendly as possible.
Effect: China enjoys a trade surplus/deficit.
China is one of the trade leaders in the world. In 2008, the US imported $340 billion worth of goods from
China while exporting only $70 billion there. The world imported $1.4 trillion worth of Chinese goods,
while China imported only $1.1 trillion.
Currency Management
Policy: The Chinese government keeps the value of its currency, known as the renminbi, artificially low.
Effect: This will affect China’s balance of trade by increasing/decreasing exports.
The Chinese government uses a pegged rate for its currency, the renminbi (the major unit of Chinese
currency is called the yuan). China uses a pegged exchange rate regime, meaning that the exchange rate
only fluctuates within a limited range decided upon by the Chinese government. To maintain its controlled
exchange rate, the Chinese government buys or sells its currency to offset market fluctuations. Buying or
selling the renminbi is controlled by law.
In 1997, in order to make Chinese goods more competitive in the US, the Chinese government devalued
the renminbi against the dollar and pegged the exchange rate at 8.27 yuan to the dollar. This made
imports of Chinese goods artificially cheap for Americans, which contributed to the ever-increasing US
trade deficit. (In 2006, the US trade deficit was $817.3 billion, or 6% of the nation’s GDP!) In addition, the
Chinese manufacturing base grew at the expense of the American one. This is why the American
government applied pressure on the Chinese government to revalue the yuan; it did so by pegging the
rate to a basket of currencies in 2008, making the rate 7 yuan to 1 dollar. Nonetheless, economists see
this rate as undervaluing the yuan because you can buy much more in China for 7 yuan than you can in
the US for 1 dollar. The IMF estimates that on a purchasing power parity basis, the true exchange rate
between the yuan and dollar should be 3.69:1.
Copyright © 20092012 National Academy Foundation. All rights reserved.
AOF Business in a Global Economy
Lesson 8 The International Monetary System
Inflation Rates
Policy: The Chinese government has lowered/raised interest rates.
Effect: Chinese exports will be cheaper, increasing/decreasing trade.
For the past decade or so, inflation has been one of the biggest concerns the government of China has
had about the performance of the Chinese economy. In February 2008, China’s general inflation rate was
8.7% and the inflation rate on food was 23.3%. High rates of inflation can seriously destabilize
economies. The Chinese government had previously raised interest rates several times, making it more
costly to borrow, presumably because this restrains business which seemed to be “overheating”, creating
scarcities of goods and services, and thus bidding up prices. It seems the Chinese government was trying
to combat inflation, but to limited effect. However, the contraction of the US economy in 2008-2009
impacted China’s economy, by lowering the demand in the US for goods imported from China. In 2009,
consumer prices in China dropped 1.6%. In other words, in 2009 China was undergoing deflation, or
negative inflation rate growth.
While inflation can cause problems for a country’s economy, so can deflation. For example, persistent
deflation can result in a fall in the demand for goods and services, in part because consumers hold off on
buying goods in the hope that prices fall further. This can lead to a downturn in the economy which is
difficult to reverse: this has happened repeatedly in the Japanese economy since the 1990s.
Copyright © 20092012 National Academy Foundation. All rights reserved.
AOF Business in a Global Economy
Lesson 8 The International Monetary System
Student Resource 8.7
Organizer: Economic Policy Recommendation Letter
Student Name:_______________________________________________________ Date:___________
Directions: Use Student Resource 8.6, Case Study: International Financial Management to answer the
questions below. Work on questions 1-6 with a partner. These answers will become the three examples in
your letter. Then write down your own ideas for question 7. This information will also be added to the
letter.
1. What is one trade policy change China could make?
2. What would be the result of this change?
3. What is one way China could change the way it manages its currency?
4. What would be the result of this change?
5. What is one way China could alter its interest rates?
6. How might a change in interest rates affect its trade balance?
7. Of the different economic policy changes China could make, which would you recommend and
why?
Copyright © 20092012 National Academy Foundation. All rights reserved.