Chapter 5 International Monetary System PDF

CHAPTER 5 INTERNATIONAL MONETARY SYSTEM MGT 361: CHAPTER 5_FPP UITM LEARNING OBJECTIVES: 1. Discuss the history and role of the international monetary system in promoting international trade and investment. 2. Discuss the impact of the World Bank Group and...

CHAPTER 5 INTERNATIONAL MONETARY SYSTEM MGT 361: CHAPTER 5_FPP UITM LEARNING OBJECTIVES: 1. Discuss the history and role of the international monetary system in promoting international trade and investment. 2. Discuss the impact of the World Bank Group and the International Monetary Fund established at Bretton Woods. MGT 361: CHAPTER 5_FPP UITM International Monetary System: Definitions  The system exists because most countries have their own currencies  Establishes the rules by which countries value and exchange their currencies  Provides a mechanism for correcting imbalances between a country’s international payments and its receipts  A country’s payments include money flowing out, such as for imports, foreign investments, and debt repayments.  Its receipts include money flowing in, such as from exports, foreign aid, or investment inflows.  An imbalance occurs when payments exceed receipts (deficit) or receipts exceed payments (surplus). History of the International Monetary System: The Gold Standard Under the gold standard, In 1821 the United Kingdom countries agree to buy or sell became the first country to their paper currencies in adopt the gold standard exchange for gold Sterling-based Gold The gold standard effectively Standard: Most firms created a fixed exchange rate accepted either gold or British system pounds in settlement of transactions THE GOLD STANDARD  The goal standard created a fixed exchange rate system  It is because each country tied, or pegged the value of its currency to gold  Under a fixed exchange rate system, the price of a given currency does not change relative to each other currency History of the International Monetary System: Collapse of the Gold Standard World War I The Great Depression Competitive Devaluations Beggar-Thy-Neighbor Policies World War II The Collapse of the Gold Standard  World War I  The sterling-based gold standard came unraveled; however, it was readopted in the 1920s  Normal commercial transactions between countries ceased  War pressured countries to suspend their pledges to buy or sell gold at their currencies’ par values  Conferences at Brussels (1920) and Genoa (1922) yielded general agreements – to return to the prewar gold standard  Great Depression  The Bank of England – unable to honor its pledge to maintain the value of pound  Allowed pound to float – the value is determined by the forces of supply and demand The Collapse of the Gold Standard  Competitive Devaluations  US, France, UK, Belgium, Latvia, Netherlands, Switzerland, Italy engaged in a series of competitive devaluations of their currencies  Beggar-thy-neighbor policies  Lowering (devaluing) the value of each own currency, hoping to make its own goods cheaper in world markets, thereby stimulating its exports and reducing its imports  Countries raised tariffs on imported goods and trade restrictions to protect domestic industries  World War II  Countries once again abandoned gold to finance military operations History of the International Monetary System: Bretton Woods Era (1944)  Bretton Woods conferees agreed to:  Renew the gold standard on a greatly modified basis  The creation of two new international organizations  International Bank for Reconstruction and Development (IBRD) - World Bank  International Monetary Fund (IMF)  Both would assist in rebuilding the world economy and the international monetary system International Bank for Reconstruction and Development (1 of 2)  Official name of the World Bank.  Initial Goal: Help finance the reconstruction of the war-torn European economies.  New mission: Build the economies of the world’s developing countries.  Four affiliated organizations:  International Development Association (IDA)  International Finance Corporation (IFC)  Multilateral Investment Guarantee Agency (MIGA)  International Centre for Settlement of Investment Disputes (ICSID) International Bank for Reconstruction and Development (2 of 2)  International Development Association (IDA)  Offers soft loans (loans that bear some risks of not being repaid)  Low or zero interest rates, although may collect small service charge  Loans focus on the least-developed countries  Ex: $25million loans to Guinea to reduce water pollution and lesser waterborne diseases  International Finance Corporation (IFC)  Help promoting the development of the private sector in developing countries  Collaboration with private investors to provide debt and equity capital for promising commercial activities  Multilateral Investment Guarantee Agency (MIGA)  To overcome private sector reluctance to invest in developing countries because of perceived political riskiness  Encourages direct investment in developing countries by offering private investors insurance against noncommercially risks  International Centre for Settlement of Investment Disputes (ICSID)  The smallest organizations, provide negotiation services when disputes arise between foreign investors and sovereign states International Monetary Fund The objectives of the IMF are as follows:- ▪ To promote international monetary cooperation ▪ To facilitate the expansion and balanced growth of international trade ▪ To promote exchange stability and maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation ▪ To assist in the establishment of a multilateral systems of payments ▪ To give confidence to members by making the general resources of the IMF temporarily available to them and to correct maladjustments in their balance of payments ▪ To shorten the duration and lessen the degree of disequilibrium in the international balance of payments of members International Monetary Fund: Quotas and Voting Power  As of 2018, 189 countries were members.  To join, a country must pay a deposit (quota).  A country’s quota determines  Country’s voting power within the IMF  Serves as a part of the nation’s official reserves  Country’s borrowing power from the IMF  A country is allowed to borrow up to 25 percent of its quota from the IMF. Additional borrowings require that countries agree to IMF conditionality.  I M F conditionality: IMF policy allows additional borrowings contingent on the member country’s agreeing to IMF-imposed restrictions. Dollar-Based Gold Standard U.S. DOLLAR–BASED FIXED EXCHANGE ADJUSTABLE PEG GOLD STANDARD RATE SYSTEM History of the International Monetary System: The End of the Bretton Woods System  Collapsed because it depended so heavily on the stability of the dollar.  Speculative “Runs on the Bank”: There was little risk in converting a suspect currency into dollars.  Triffin Paradox: Foreigners needed to increase their holdings of dollars to finance international trade.  Special Drawing Rights (S D Rs)  Nixon’s 1971 Speech  Smithsonian Conference History of the International Monetary System: Performance of the IMF since 1971  Flexible (or Floating) Exchange Rate System  Managed Float (or, a Dirty Float)  Jamaica Agreement – Country was free to adopt whatever exchange rate system best met its own requirements  Flexible exchange rate system legitimized  Pegged exchange rate  Crawling pegs  European Monetary System (EMS)  Current system: an amalgam of fixed and flexible exchange rates Other Post–World War II Conferences  The Plaza Accord:  In which the central banks agreed to let the dollar’s value fall on currency markets.  The Louvre Accord:  This accord signaled the commitment of these five countries to stabilizing the dollar’s value. International Debt Crisis Financial Crisis  International Debt Crisis  The Baker Plan  The Brady Plan  Asian Currency Crisis :  Subprime Meltdown Financial Crisis: International Debt Crisis ▪ Start during the Arab-Israeli War in 1973 when Arabs increased the price of oil. ▪ To overcome the crisis, banks recycled the petrodollar in the form of loans to countries that were damaged by the rising oil prices. ▪ To solve this crisis: 1. Baker Plan,1985 Stressed the importance of 2. Brady Plan, 1989 debt rescheduling, tight- Need to reduce the debts of the IMF imposed controls over troubled countries by writing off domestic monetary and fiscal policies, and parts of the debts or by providing continued leading to the debtor the countries with funds to buy countries in hopes that back their loan notes at below economic growth would face value. allow them to repay them creditors. Financial Crisis: Asian Currency Crisis ▪ Erupted in July 1997, when Thailand, which had pegged its currency to a dollar-dominated basket of currencies, was forced to unpeg its currency, the baht after investors began to distrust the abilities of Thai borrowers to repay their foreign loans and of the Thai government to maintain the baht’s value. As investors realized that other countries in the region were also overly dependent on short-term foreign capital, their currencies also came under attack, and their stock markets were devastated. All told, the IMF and developed countries pledged over $100 billion in loans to help restore these countries to economic health. Financial Crisis: Subprime Meltdown ▪ The latest financial crisis to plague the international capital market began with the so-called subprime meltdown, which resulted from the bursting of the U.S. housing bubble. The problems created by this collapse affected financial markets throughout the world. Review Questions  What is the function of the international monetary system?  What is the gold standard? What accelerated the collapse of the gold standard in the international monetary system?  Identify the main international institutions in international trade.  What is the IFC and what are its goals?  What is the purpose of the International Monetary Fund?  Why does the European Union use the European Monetary System?  Differentiate between the institutional duties of the World Bank and the International Monetary Fund. Copyright This work is protected by United States copyright laws and is provided solely for the use of instructors in teaching their courses and assessing student learning. Dissemination or sale of any part of this work (including on the World Wide Web) will destroy the integrity of the work and is not permitted. The work and materials from it should never be made available to students except by instructors using the accompanying text in their classes. All recipients of this work are expected to abide by these restrictions and to honor the intended pedagogical purposes and the needs of other instructors who rely on these materials. END OF SLIDE THANK YOU MGT 361: CHAPTER 5_FPP UITM