Download Lecture 5 (POWER POINT)

International Finance
FINA 5331
Lecture 5
History of Monetary Institutions
Read: Chapters 2 & 3
Aaron Smallwood Ph.D.
Additionally
• What exchange rate systems exist today?
– The choice between a fixed system and a flexible
system.
• How does another country’s exchange rate
system affect you? How does China’s changing
exchange rate system affect you?
• What are currency crises and how can they
impact your business?
• What is the euro? Will the euro-zone expand?
How does expansion of the euro-zone affect
you?
Interwar Period: 1918-1941
• Exchange rates fluctuated as countries
widely used “predatory” depreciations of their
currencies as a means of gaining advantage
in the world export market.
• Attempts were made to restore the gold
standard, but participants lacked the political
will to “follow the rules of the game”.
• The result for international trade and
investment was profoundly detrimental.
• Smoot-Hawley tariffs
• Great Depression
Economic Performance and Degree of Exchange Rate
Depreciation During the Great Depression
Bretton Woods System: 1945-1971
• Named for a 1944 meeting of 44
nations at Bretton Woods, New
Hampshire.
• The purpose was to design a postwar
international monetary system.
• The goal was exchange rate stability
without the gold standard.
• The result was the creation of the IMF
and the World Bank.
Bretton Woods System: 1945-1971
• Under the Bretton Woods system, the U.S. dollar
was pegged to gold at $35 per ounce and other
currencies were pegged to the U.S. dollar.
• Each country was responsible for maintaining its
exchange rate within ±1% of the adopted par value
by buying or selling foreign reserves as necessary.
• The U.S. was only responsible for maintaining the
gold parity.
• Under Bretton Woods, the IMF was created.
• The Bretton Woods is also known as an adjustable
peg system. When facing serious balance of
payments problems, countries could re-value their
exchange rate. The US and Japan are the only
countries to never re-value.
The Fixed-Rate Dollar Standard, 1945-1971
• In practice, the Bretton Woods system
evolved into a fixed-rate dollar standard.
Industrial countries other than the United States :
Fix an official par value for domestic currency in terms
of the US$, and keep the exchange rate within 1% of
this par value indefinitely.
United States : Remain passive in the foreign change
market; practice free trade without a balance of
payments or exchange rate target.
Bretton Woods System: 1945-1971
British
pound
German
mark
French
franc
Par
Value
U.S. dollar
Pegged at $35/oz.
Gold
Purpose of the IMF
The IMF was created to facilitate the
orderly adjustment of Balance of
Payments among member countries by:
• encouraging stability of exchange rates,
• avoidance of competitive devaluations,
and
• providing short-term liquidity through loan
facilities to member countries
Composition of SDR
(Special Drawing Right)
Collapse of Bretton Woods
• Triffin paradox – world demand for $ requires U.S. to
run persistent balance-of-payments deficits that
ultimately leads to loss of confidence in the $.
• SDR was created to relieve the $ shortage.
• Throughout the 1960s countries with large $ reserves
began buying gold from the U.S. in increasing
quantities threatening the gold reserves of the U.S.
• Large U.S. budget deficits and high money growth
created exchange rate imbalances that could not be
sustained, i.e. the $ was overvalued and the DM and
£ were undervalued.
• Several attempts were made at re-alignment but
eventually the run on U.S. gold supplies prompted
the suspension of convertibility in September 1971.
• Smithsonian Agreement – December 1971
The Floating-Rate Dollar Standard, 1973-1984
• Without an agreement on who would set
the common monetary policy and how it
would be set, a floating exchange rate
system provided the only alternative to
the Bretton Woods system.
The Floating-Rate Dollar Standard, 1973-1984
Industrial countries other than the United States :
Smooth short-term variability in the dollar exchange rate,
but do not commit to an official par value or to long-term
exchange rate stability.
United States : Remain passive in the foreign exchange
market; practice free trade without a balance of
payments or exchange rate target. No need for sizable
official foreign exchange reserves.
The Plaza-Louvre Intervention Accords and
the Floating-Rate Dollar Standard, 1985-1999
• Plaza Accord (1985):
– Allow the dollar to depreciate following
massive appreciation…announced that
intervention may be used.
• Louvre Accord (1987) and “Managed
Floating”
– G-7 countries will cooperate to achieve
exchange rate stability.
– G-7 countries agree to meet and closely
monitor macroeconomic policies.
Value of $ since 1965
IMF Classification of Exchange Rate
Regimes
•
•
•
•
•
Independent floating
Managed floating
Exchange rate systems with crawling bands
Crawling peg systems
Pegged exchange rate systems within horizontal
bands
• Conventional pegs
• Currency board
• Exchange rate systems with no separate legal tender