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International Business: The Challenges of Globalization Tenth Edition Chapter 11 International Monetary System Copyright © 2023,...

International Business: The Challenges of Globalization Tenth Edition Chapter 11 International Monetary System Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Learning Objectives 11.1 Describe the importance of currency values to business activities. 11.2 Outline the factors that help determine exchange rates. 11.3 Explain attempts to construct a system of fixed exchange rates. 11.4 Describe efforts to create a system of floating exchange rates. Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved The Euro Europe’s single currency – Used by 19 EU countries – In circulation since 2002 – Respected global currency – Trades at around $1.14/€ $1.14/ € – Beneficial to companies within the eurozone Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Importance of Currency Values Devaluation Intentionally lowering the value of a nation’s currency – Lowers the price of a country’s exports on world markets and increases the price of its imports because the value of the country’s currency is now lower on world markets Revaluation Intentionally raising the value of a nation’s currency – Increases the price of exports, reduces the price of imports, and increases buying power in the home currency Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Figure 11.1: Major World Currency Exchange Rates Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Importance of Currency Values: Stability and Predictability Unfavorable movements in currency values can be costly for businesses – As unpredictability surrounding the value of currencies increases, so too does the cost of insuring against the accompanying risk. Stable currencies and exchange rates improve the accuracy of financial planning and make cash-flow forecasts more precise. Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Figure 11.2: Trade-Weighted Value of the US Dollar Over Time Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Importance of Currency Values: Efficient v Inefficient Market View ersus Efficient market view View that prices of financial instruments reflect all publicly available information at any given time Inefficient market view View that prices of financial instruments do not reflect all publicly available information Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Importance of Currency Values: Forecasting Techniques Fundamental analysis Technique that uses statistical models based on fundamental economic indicators to forecast exchange rates Technical analysis Technique that uses charts of past trends in currency prices and other factors to forecast exchange rates Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Cultural Insights: The Long Arm of the Law US Patent and Trademark Office (USPTO): The USPTO is a noncommercial federal bureau within the Department of Commerce. By issuing patents, it provides incentives to invent, invest in, and disclose new technologies. US International Trade Commission (USITC): The USITC is an independent, quasi-judicial federal agency. Federal Trade Commission (FTC): The FTC enforces a variety of federal antitrust and consumer protection laws. US Consumer Product Safety Commission (CPSC): The CPSC is an independent federal regulatory agency created to protect the public from injury and death. Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Quick Study 11.1 1. How might a weakening currency influence the price of a nation’s exports and imports? 2. What two overall features do managers prefer currencies and exchange rates to embody? 3. What is the main difference between the two views of whether or not prices of financial instruments reflect all publicly available information? 4. What are the names of the two techniques used to analyze and forecast exchange rates? Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Factors That Determine Exchange Rates: Law of One Price (1 of 2) Law of one price Principle that an identical item must have an identical price in all countries when the price is expressed in a common currency – When this does not hold, there is an opportunity for arbitrage Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Factors That Determine Exchange Rates: Law of One Price (2 of 2) Example: Market exchange rate between the currencies of Brazil and the United States is R$5/$ – So, one pound of soybeans costing R$20 in Brazil should cost $4 R$20 R$5  in the United States But suppose that soybeans in the United States cost only $3 per pound – This price is equivalent to R$15 $3 R$5  in Brazilian reais at the exchange rate of R$5/$ The law of one price is being violated here because the price of soybeans in the United States (equivalent to R$15) is not identical to the price in Brazil (R$20) Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Factors That Determine Exchange Rates: Purchasing Power Parity (1 of 4) Purchasing power parity (PPP) theory: – An exchange rate between two nations’ currencies is equal to the ratio of their price levels – Economic forces will push an actual market exchange rate toward that predicted by PPP or else an arbitrage opportunity would arise Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Factors That Determine Exchange Rates: Purchasing Power Parity (2 of 4) McCurrency – Big Mac Index Exchange rates and inflation – Exchange rates adjust to different rates of inflation in different countries ▪ Rising inflation increases prices and erodes purchasing power Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Factors That Determine Exchange Rates: Purchasing Power Parity (3 of 4) Example: Suppose a basket of goods costs 2,000 pesos in Mexico and $100 in the United States – Implies an exchange rate of 20 pesos/$ 2,000 100  Suppose also that inflation in Mexico is 5% per year, whereas prices are constant in the United States In one year, the basket of goods in Mexico will cost 2,100  2,000 1 .05  PPP predicts that the exchange rate between the peso and dollar will shift to 21 pesos/$ 2,100 100  Inflation has depreciated the value of the peso 5%  21  20  20  , by exactly the rate of inflation in Mexico Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Factors That Determine Exchange Rates: Purchasing Power Parity (4 of 4) Money Supply Governments use two types of policies designed to influence a nation’s money supply – Monetary policy refers to activities that directly affect a nation’s interest rates or money supply – Fiscal policy involves using taxes and government spending to influence the money supply indirectly Unemployment and Interest Rates High employment raises wages, which are embodied in consumer prices High interest rates lower borrowing and spending, which lowers inflation Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Factors That Determine Exchange Rates: Evaluating PPP Impact of added costs – PPP assumes no transportation costs Impact of trade barriers – PPP assumes no barriers to international trade ▪ But governments establish trade barriers Impact of business confidence and psychology – PPP overlooks the human aspect of exchange rates ▪ Business confidence survey Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Photo and Discussion Question (1 of 3) Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Quick Study 11.2 1. What is the name for the principle that an identical item must have an identical price in all countries when price is expressed in a common currency? 2. What do we mean by the expression, “an implied PPP exchange rate”? 3. How does inflation in a country influence its currency’s exchange rate with other currencies? 4. What factors can influence the power of purchasing power parity to accurately predict exchange rates? Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Fixed Exchange Rate Systems International monetary system Collection of agreements and institutions that govern exchange rates Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Fixed Exchange Rate Systems: The Gold Standard (1 of 4) In the earliest days of international trade, gold was the internationally accepted currency for payment of goods and services – Limited supply so in high demand and highly valued – Resistant to corrosion so could be stored – Could be used for large and small purchases – Expensive to transport – Potential for physical loss Gold standard International monetary system in which nations link the value of their paper currencies to specific values of gold Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Fixed Exchange Rate Systems: The Gold Standard (2 of 4) Par value The value of a currency expressed in terms of gold is called its par value – All nations fixing their currencies to gold also indirectly linked their currencies to one another Fixed exchange rate system System in which the exchange rate for converting one currency into another is fixed by international governmental agreement – US dollar was originally fixed at $20.67/oz of gold and the British pound at £4.2474/oz ▪ The exchange rate between the dollar and pound was $4.87/£ $20.67 £4.2474  Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Fixed Exchange Rate Systems: The Gold Standard (3 of 4) Advantages of the gold standard Reduced the risk in exchange rates Imposed strict monetary policies Help correct a nation’s trade imbalance Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Fixed Exchange Rate Systems: The Gold Standard (4 of 4) Collapse of the gold standard Aggressive printing of paper currency caused high inflation Decision of the United States to devalue its currency and Britain’s decision not to do so: – Lowered the price of US exports on world markets – Increased the price of imports from Britain (and other countries), lowering its export earnings – Countries devalued their currencies in retaliation Competitive devaluations – No longer an accurate indicator of a currency’s true value – By 1939, gold standard was effectively dead Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Photo and Discussion Question (2 of 3) Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Fixed Exchange Rate Systems: Bretton Woods Agreement (1 of 3) Bretton Woods Agreement Agreement (1944) among nations to create a new international monetary system based on the value of the US dollar – Balanced the strict discipline of the gold standard with the flexibility that countries needed in order to deal with temporary domestic monetary difficulties Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Fixed Exchange Rate Systems: Bretton Woods Agreement (2 of 3) Fixed exchange rates Incorporated fixed exchange rates – The par value of the US dollar was fixed at $35/o z of gold ▪ Other currencies were given par values against the U S dollar instead of gold Built in flexibility – Fundamental disequilibrium World Bank – Established to finance post WWII European reconstruction, later needs of developing countries International Monetary Fund (I MF) – Established to regulate the fixed exchange rate system ▪ Special drawing right (S DR) Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Fixed Exchange Rate Systems: Bretton Woods Agreement (3 of 3) Collapse of the Bretton Woods Agreement US trade and budget deficits – Smithsonian Agreement ▪ Arrangement (1971) among IMF members to restructure and strengthen the international monetary system created at Bretton Woods Final days – A weak US dollar – A large sell-off of dollars on world financial markets Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Quick Study 11.3 1. The gold standard is an example of what type of international monetary system? 2. What were the main advantages of the gold standard? 3. What were the most important elements of the Bretton Woods international monetary system? Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Floating Exchange Rate System (1 of 2) Jamaica Agreement Arrangement (1976) among IMF members to formalize the existing system of floating exchange rates as the new international monetary system – Managed float system ▪ Exchange rate system in which currencies float against one another, with governments intervening to stabilize their currencies at particular target exchange rates – Free float system ▪ Exchange rate system in which currencies float freely against one another, without governments intervening in currency markets Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Floating Exchange Rate System (2 of 2) Later Accords The Plaza Accord – Caused traders to sell the dollar, and its value fell The Louvre Accord – Affirmed that the US dollar was appropriately valued Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Floating Exchange Rate System: Today’s Exchange Rate Arrangements Pegged exchange rate arrangement – “Peg” a country’s currency to a more stable and widely used currency in international trade Currency board – Monetary regime based on an explicit commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Global Manager: Adjusting to Currency Swings Prune operations Adapt products Source abroad Freeze price Source at home Grow at home Push exports Reduce expenses Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Floating Exchange Rate System: Recent Financial Crises Developing nations’ debt crisis – Brady Bonds Mexico’s peso crisis – IMF and private bank loans to shore up economy Southeast Asia’s currency crisis – IMF and World Bank funding Russia’s ruble crisis – IMF funds Argentina’s peso crisis – IMF loans Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Photo and Discussion Question (3 of 3) Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Floating Exchange Rate System: The Future Calls for a new system designed to meet the realities and challenges of the global economy – Potential revision of the IMF and its policy prescriptions – Involvement of the private sector to prevent and resolve financial crises – Debtor countries Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved Quick Study 11.4 1. What do we call an exchange-rate system in which currencies float against one another with governments intervening to stabilize currencies at target rates? 2. What is the name for an exchange-rate system in which currencies float freely against one another without government interference? 3. What are some of the countries that have recently faced currency crises and received assistance from the IMF? Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved 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. Copyright © 2023, 2019, 2016 Pearson Education, Inc. All Rights Reserved