1. MONETARYMONETARY
SYSTEMSYSTEM

3. Monetary SystemMonetary 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

4. International Monetary SystemInternational 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)

6. Evolution of the InternationalEvolution of the International
Monetary SystemMonetary 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

7. Bretton Woods (1944 - 1973)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

8. The Role of the IMFThe 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

9. The Role of the World BankThe 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

10. Collapse of Bretton WoodsCollapse 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

11. Jamaica Agreement 1976Jamaica Agreement 1976
Floating rates 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

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

13. Recent Activities and the IMFRecent 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?

14. Managerial ImplicationsManagerial 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