1. Monetary System

2. Monetary System
 Relationship between monetary
system and foreign exchange rates
 Historical development
 Fixed vs floating exchange rates
 Role of the IMF and World Bank
 Implications for managers

3. International Monetary System
 Currency exchange rates depend on the structure of
the international monetary system
 In 2003 of all IMF members currencies
– Only 19% were free floating
– 25% were managed float
– 8% were adjustable peg
– 22% were fixed peg
– 4% were fixed by a currency board
– 22% were not currency of their own (use Euro, US
Dollar)

5. Evolution of the International
Monetary System
 Gold Standard: currencies pegged to gold
value
– Convertibility guaranteed
– By 1880 most on gold standard
– Balance of trade equilibrium for all countries
 Value of exports should equal value of imports
 Flow of gold used to make up differences
– Abandoned in 1914
 Failed resumption after WWI
 Great Depression

6. Bretton Woods (1944 - 1973)
 44 countries met to design a new system in 1944
 Established:
International Monetary Fund (IMF) and World
Bank
– IMF: maintain order in monetary system
– World Bank: promote general economic
development
– Fixed exchange rates pegged to the US Dollar
– US Dollar pegged to gold at $35 per ounce
– Countries maintained their currencies ± 1% of the
fixed rate; buy/sell own currency to maintain level

7. The Role of the IMF
 IMF maintained exchange rate
– discipline
 National governments had to manage inflation through their
money supply
– flexibility
 Provides loans to help members states with temporary
balance-of-payment deficit;
– Allows time to bring down inflation
– Relieves pressures to devalue
 Excessive drawing from IMF funds came with IMF
supervision of monetary and fiscal policies
– Allowed to 10% devaluations and more with IMF approval
 187 members by 2003

8. The Role of the World Bank
 World Bank (IBRD) role
(International Bank for Reconstruction &
Development)
– Refinanced post-WWII reconstruction and development
– Provides low-interest long term loans to developing
economies
 The International Development Agency (IDA), an
arm of the bank created in 1960
– Raises funds from member states
– Loans only to poorest countries
– 50 year repayment at 1% per year interest

9. Collapse of Bretton Woods
 Devaluation pressures on US dollar after 20
years
– Lyndon Johnson policies
 Vietnam war financing
 Welfare program financing
– Nixon ended gold convertibility of US dollar in
1971
– US dollar was devalued and dealers started
speculating against it for further devaluation
– Bretton Woods fixed exchange rates abandoned
in January 1972

10. Jamaica Agreement 1976
Floatingrates declared acceptable
Gold abandoned as reserve asset;
– IMF returned gold reserves to members at current
prices
– Proceeds placed in trust fund to help poor nations
– IMF quotas – member country contributions –
increased; membership now 182 countries
– Less-develop, non-oil exporting countries given more
access to IMF
 IMF continued its role of helping countries cope with
macroeconomic and exchange rate problems

11. Case for Floating Exchange Rates
– Monetary policy autonomy
– Trade balance adjustments helped
The Case for Fixed Exchange Rates
– Monetary discipline
– Speculation limited
– Uncertainty reduced
– Trade balance adjustment effects on inflation
controlled
Who is right?

12. Recent Activities and the IMF
 Mexican Crisis 1995
 Russian Ruble crisis1995
 Asian crisis 1997/1998
– Events
 The investment boom
 Excess capacity
 The debt bomb
 Expanding imports
 The crisis
 How does the IMF achieve results?
– Inappropriate policies?
– Moral Hazard?
– Lack of accountability?

13. Managerial Implications
 Currency management
– Currency market does not always work as expected
– Government intervention
– Speculative activity
 Business strategy
– Movements in exchange rates are difficult to predict
– Forward market is imperfect predictor of exchange rate
movements
– Forward exchange rate market covers risk for months not years
– Maintenance of strategic flexibility required
 Disperse manufacturing
 Outsource
– Corporate-government relations