103897054-international-financial-management.pdf

8/14/2019 103897054-international-financial-management.pdf

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INTERNATIONAL MONETARY SYSTEM

Review the systems evolution. The Gold Standard. Bretton Woods - 1944.

Reasons for the Bretton Woods failure. The present system.

loat versus fi!ed.


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The institutional arran"ements that #ountries adopt to"overn e!#han"e rates.

$ollar% &uro% 'en and (ound )float* a"ainst ea#hother. loatin" e!#han"e rate+

orei"n e!#han"e mar,et determines the relativevalue of a #urren#y.

Some #ountries use other institutional arran"ements tofi! their #urren#ys value


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Some #ountries use+(e""ed e!#han"e rate.

alue of #urren#y is fi!ed relative to a referen#e

#urren#y.$irty float.

old #urren#y value within some ran"e of areferen#e #urren#y.

i!ed e!#han"e rate.Set of #urren#ies are fi!ed a"ainst ea#h other atsome mutually a"reed upon e!#han"e rate.


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Introduction

/n reality% the assumption of #omplete e!#han"e ratefle!i0ility is rarely a##urate. /ndustrialied #ountries operate under a hy0rid system

of managed floating exchange rates. 2 system in whi#h "overnments attempt to moderate

e!#han"e rate movements without ,eepin" e!#han"erates ri"idly fi!ed.

2 num0er of developin" #ountries have retained some

form of "overnment e!#han"e rate fi!in".


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Bimetallism+ Before 135 ree #oina"e was maintained for 0oth "old and

silver Greshams 6aw+ 7nly the a0undant metal was used

as money% divin" more s#ar#e metals out of#ir#ulation 8lassi# "old standard+ 135-1914

Great Britain introdu#ed full-fled"ed "old standardin 131% ran#e :effe#tively; in the 135apan in 139. Gold alone is assured of unrestri#ted #oina"e

The Monetary System


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There is a two-way #onverti0ility 0etween"old and national #urren#ies at a sta0leratio.

Gold may 0e freely e!ported and imported 8ross-0order flow of "old will help #orre#t

misali"nment of e!#han"e rates and willalso re"ulate 0alan#e of payments.

The "old standard provided a 4< year

period of unpre#edented sta0ility ofe!#han"e rates whi#h served to promoteinternational trade.


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The Gold Standard

&a#h #ountry fi!es the pri#e of its #urren#y in terms of"old.

?o sin"le #ountry o##upies a privile"ed position within thesystem.

The @e#hani#s of a Gold Standard &!#han"e rates 0etween any two #urren#ies were fi!ed.

&!ample+ /f the dollar pri#e of "old is pe""ed at A5 peroun#e 0y the ederal Reserve while the pound pri#e of"old is pe""ed at C14.53 per oun#e 0y the Ban, of

&n"land% the dollarDpound e!#han"e rate must 0e#onstant at A.4< per pound.


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7ri"ins of the Gold Standard The "old standard had its ori"in in the use of "old #oins

as a medium of e!#han"e% unit of a##ount% and store ofvalue.

The =.S. Gold Standard 2#t of 19


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Symmetri# @onetary 2dEustment =nder a GoldStandard Whenever a #ountry is losin" reserves and its money

supply shrin,s as a #onseFuen#e% forei"n #ountries are

"ainin" reserves and their money supplies e!pand.

Benefits and $raw0a#,s of the Gold Standard Benefits+

/t pla#es #onstraints on the "rowth of #ountries

money supplies.


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$raw0a#,s+ /t pla#es undesira0le #onstraints on the use of

monetary poli#y to fi"ht unemployment. /t ensures a sta0le overall pri#e level only if the

relative pri#e of "old and other "oods and servi#es issta0le.

/t ma,es #entral 0an,s #ompete for reserves and 0rin"a0out world unemployment.

/t #ould "ive "old produ#in" #ountries :li,e Russia andSouth 2fri#a; too mu#h power.


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World War / ended the #lassi#al "old standard in 1914 Trade in "old 0ro,e down 2fter the war% many #ountries suffered hyper inflation 8ountries started to )#heat* :steriliation of "old;

(redatory devaluations :re#overy throu"h e!ports; The =S% Great Britain% Switerland% ran#e and the

S#andinavian #ountries restored the "old standard in the19


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%retton &oods system: !$"#!'(

=.S. dollar was pe""ed to "old at A5.


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The ,ey role of "old in the Bretton Woods system was#onne#ted to the #onverti0ility of the =.S dollar into"old at a fi!ed pri#e. This meant that the =nited Statesstood ready to sell "old to forei"n #entral 0an,s% 0ut

not to private #itiens in e!#han"e for =.S. dollars at afi!ed pri#e of A5 per oun#e.

The Bretton Woods system operated on the 0asis of a"old e!#han"e standard. =nder a "old e!#han"e

standard% #ountries are e!pe#ted to redeem their#urren#ies into #onverti0le #urren#ies : 0ut notne#essarily in the form of "old itself;.


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=nder Bretton Woods% most #entral 0an,s ,ept a lar"epart of their international reserves in the form of dollardenominated assets% su#h as dollar deposits or =.S.Treasury 0ills. The dollar 0e#ame the systems main

reserve #urren#y% a role it had 0een #hippin" awayfrom the pound sterlin" ever sin#e World War 1.

&!#han"e rates were maintained within the narrowlimits allowed 0y the /@ 0y means of #entral 0an,

intervention in forei"n e!#han"e mar,ets.


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The = S A played a predominant role here 0e#ause itwas used as an intervention #urren#y 0y forei"n#entral 0an,s.

/n a nutshell% the Bretton Woods system was anadEusta0le pe" re"ime operatin" under a "olde!#han"e standard in whi#h most #urren#ies were#onverti0le into =.S. dollar and the dollar% in turn% was#onverti0le into "old.


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The Economic E)perience under %retton

&oods

The "enerally low levels of international reserves held0y the maEor forei"n industrial #ountries after the warand their lar"e trade defi#its with the =nited States0e#ame asso#iated with a massive dollar shorta"e

a0road and with a#ute 0alan#e-of-payments diffi#ultiesfor those #ountries in the late 194


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/t was not until 1953 that their #urren#ies really0e#ame fully #onverti0le to the dollar.

/n the 195


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/n the fa#e of "rowin" pur#hases of "old on the part offorei"n 0an,s and private #itiens% the "old#onverti0ility of the =.S dollar was threatened.

The Bretton Woods system literally #ollapsed in 191.With rampant e!pe#tations that an in#rease in thedollar pri#e of "old was imminent and that a maEordevaluation of the dollar vi-a-vis most other maEor#urren#ies was soon forth#omin"% the resultin"

spe#ulative run on the dollar 0e#ame unsustaina0le.


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/n @ay 191% in the fa#e of massive short-term #apitalinflows asso#iated with spe#ulation a"ainst the dollar%Germany de#ided to its #urren#y float vis-J-vis thedollar. The ?etherlands followed suit% and Switerland

and 2ustria also 0oth revalued their #urren#ies.&arly in 19% the maEor &uropean #urren#ies and the

>apanese yen started floatin" vis-a Kvis dollar.


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The Bretton Woods system operated well while itlasted. /t supported a flourishin" re"ime ofinternational trade and finan#e% with sta0ility andrelatively hi"h "rowth rates% 0y histori#al standards%

and with relatively low unemployment and inflationrates. Given this re#ord% and ta,in" into a##ount thatthe period from 191 to 19 was not dire#tly#onne#ted to any maEor war involvin" the &uropean

industrial #ountries% the #ollapse of the Bretton Woodssystem appears parado!i#al. ?evertheless% its historyshows a num0er of 0asi# pro0lems.


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&hy did it* %&S+ ,ail-

The a0sen#e of e!ternal payments adEustment stepson the part of the =.S. meant that non-reserve#urren#ies had the 0urden of adEustment under BWS.

&uropean #ountries and >apan had to su0Eu"ate theirpoli#y attention toward e!ternal 0alan#e.

When the supply of dollars in 19< and 191e!ploded% strainin" to its limits the internal "oals ofpri#e sta0ility in non-reserve #urren#y #ountries% the

latter rea#ted 0y #onvertin" dollars into "old% steriliin"in#reases in reserves and finally % 0y lettin" their#urren#ies float vis-J-vis the dollar.


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The in#onsisten#y of the e!plosion in internationalliFuidity with the national poli#y autonomy and "oals ofnon-reserve #urren#y #ountries finally pushed theBretton Woods system into #ollapse.


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Broad Real US dollar IndexSource: www.federalreserve.gov

4anL

>an

>an3

>an9

>an3an31

>an3

>an3B

>an34

>an35

>an3L

>an3

>an33

>an39

>an9an91

>an9

>an9B

>an94

>an95

>an9L

>an9

>an93

>an99

>ananananan


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>amai#a 2"reement :19L; 8entral 0an,s were allowed to intervene in the forei"n

e!#han"e mar,ets to iron out unwarranted volatilities. Gold was offi#ially a0andoned as an international reserve

asset. alf of the /@s "old holdin"s were returned to the

mem0ers and the other half were sold% with pro#eeds usedto help poor nations. ?on-oil e!portin" #ountries and less-developed #ountries

were "iven "reater a##ess to /@ funds. (laa 2##ord :1935;

G-5 #ountries :ran#e% >apan% Germany% the =.M.% and the

=.S.; a"reed that it would 0e desira0le for the =.S. dollar todepre#iate. 6ouvre 2##ord :193;

G- #ountries :8anada and /taly were added; would#ooperate to a#hieve "reater e!#han"e rate sta0ility.

G- #ountries a"reed to more #losely #onsult and #oordinate

their ma#roe#onomi# poli#ies.

The Monetary System


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43 maEor #urren#ies% su#h as the =.S. dollar% the >apanese yen%the &uro% and the British pound are determined lar"ely 0ymar,et for#es.

5 #ountries% in#ludin" the 8e#h Repu0li#% Russia% andSin"apore% adopt some forms of )@ana"ed loatin"* system.

#ountries do not have their own national #urren#ies

3 #ountries% in#ludin" 8hina% on" Mon"% and &stonia% do havetheir own #urren#ies% 0ut they maintain a pe" to the =.S. dollaror the &uro.

The remainin" #ountries have some mi!ture of fi!ed and floatin"e!#han"e-rate re"imes.

.urrent E)chan/e Rate Arran/ements


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(rodu#t of the desire to #reate a more inte"rated&uropean e#onomy.

&leven &uropean #ountries adopted the &uro on

>anuary 1% 1999+ 2ustria% Bel"ium% inland% ran#e% Germany% /reland% /taly%

6u!em0our"% ?etherlands% (ortu"al% and Spain.

The followin" #ountries opted out initially+ $enmar,% Gree#e% Sweden% and the =.M.

Gree#e adopted the &uro in


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Thin, a0out+ (otential 0enefits and #osts of adoptin" the euro.

onomi# and politi#al #onstraints fa#in" the #ountry.

The potential impa#t of British adoption of the euro onthe international finan#ial system% in#ludin" the role ofthe =.S. dollar.

The impli#ations for the value of the euro of e!pandin"the &= to in#lude% e.".% &astern &uropean #ountries.

&ill the 01 *Sweden+ 2oin the Euro-


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3orei/n E)chan/e *34+Mar5et

7ne #urren#y is e!#han"ed for another #urren#y onthe forei"n e!#han"e mar,et.

=ntil the 19


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/n 191% the =.S.suspended the #onverti0ility of thedollar to "old% and 0y 19 the =.S. and other nationshad a##epted floatin" e!#han"e rates.

The #han"e of floatin" e!#han"e rates% the "rowth in

international trade% and the in#rease in #apital flowsaround the world led to the rapid "rowth of the forei"ne!#han"e mar,et.

The =.S. dollar is involved in a maEority of alltransa#tions in the forei"n e!#han"e mar,et% and in


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3i)ed 6ersus 3loatin/ E)chan/e Rates loatin"+

@onetary poli#y autonomy. Restores #ontrol to

"overnment. Trade 0alan#e adEustments.

2dEust #urren#y to #orre#ttrade im0alan#es.

"ixed:

@onetary dis#ipline.

Spe#ulation.

6imits spe#ulators. =n#ertainty.

(redi#ta0le rate movements.

Trade 0alan#e adEustments. 2r"ue no lin,a"e 0etween

e!#han"e rates and trade. 6in,a"e 0etween savin"s and

investment.Which system is better?Evidence is unclear.


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.0RREN.Y .RISIS $/&R&?8& B&TW&&?

8=RR&?8' 8R/S/S

B2?M/?G 8R/S/S 7R&/G? $&BT 8R/S/S


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The N mar,et en#ompasses+

8onversion of pur#hasin" power from one #urren#y to anotherO0an, deposits of forei"n #urren#yO #redit denominated in forei"n#urren#yO forei"n trade finan#in"O tradin" in forei"n #urren#y optionsP futures% and #urren#y swaps

?o #entral mar,et pla#e Worldwide lin,a"e of 0an, #urren#y traders% non-0an, dealers% and

N 0ro,ersQli,e an international 7T8 : over the #ounter; mar,et

6ar"est finan#ial mar,et in the world

$aily tradin" is estimated to 0e =SA1.9 trillion in


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The =.S. has a 1LI share of N tradin" % and >apanhas a 9I share. 2ustralia% on" Mon"% Sin"apore%Switerland and Germany are also lar"e #enters forforei"n e!#han"e tradin"% and there are numerous

smaller #enters in other #ountries. The #enters are hi"hly inte"rated "lo0ally% 4 hours aday% with real-time pri#e information "athered fromnumerous sour#es and distri0uted "lo0ally 0y firmssu#h as Reuters and @oneyline Telerate.

:we0site+http+DDa0out.reuters.#omDprodu#tionDdatatreasuryDO for moneyline Teleratehttp+DDwww.moneyline.#omDa0outDa0outhome.Esp;


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7owe6er8

The introdu#tion of euro eliminated the need fore!#han"e amon" several &uropean #urren#ies and#ontri0uted to a 14I de#line in forei"n e!#han"emar,et turnover 0etween 1993 and


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2nother si"nifi#ant #han"e has 0een the introdu#tionof ele#troni# 0ro,erin" systems. Su#h systemsa##ount for an in#reasin" share of turnover% espe#iallyin the spot mar,et% and there are initiatives to e!pand

su#h systems into other mar,et se"ments.


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The N mar,et is a two-tiered mar,et+

/nter0an, @ar,et :Wholesale; 2##ounts for a0out 3I of N tradin" volumeQmostly

spe#ulative or ar0itra"e transa#tions

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103897054-international-financial-management.pdf

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