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10. Chapter. The International Monetary system. Large and inefficient state sector heavy subsidies Government debt risen to 60% of gross domestic product Rampant inflation IMF focus Reduce inflation Stabilize value o f currency Privatization Reduction of subsidies Government reforms

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chapter

10

Chapter

The International Monetary system

turkeys 18 th imf program
Large and inefficient state sector heavy subsidies

Government debt risen to 60% of gross domestic product

Rampant inflation

IMF focus

Reduce inflation

Stabilize value o f currency

Privatization

Reduction of subsidies

Government reforms

Reasons for failure

Turkeys 18th IMF program
international monetary system imf
The institutional arrangements that countries adopt to govern exchange rates

Dollar, Euro, Yen and Pound “float” against each other

Floating exchange rate:

Foreign exchange market determines the relative value of a currency

International monetary system (IMF)
international monetary system imf1
Some countries use other institutional arrangements to fix their currency’s value

Pegged exchange rate

Value fixed relative to a reference currency

Dirty float

Hold value within range of a reference currency

Fixed exchange rate

Set of currencies are fixed against each other at some mutually agreed upon exchange rate

International monetary system (IMF)
the gold standard
The gold standard
  • Roots in old mercantile trade.
  • Inconvenient to ship gold, changed to paper- redeemable for gold.
  • Want to achieve ‘balance-of-trade equilibrium

Trade

USA

Japan

Gold

balance of trade equilibrium
Balance of trade equilibrium

Decreased money supply = price decline.

Trade Surplus

As prices decline, exports

increase and trade goes

into equilibrium.

Increased money supply = price inflation.

Gold

between the wars
Post WWI, war heavy expenditures affected the value of dollars against gold

US raised dollars to gold from $20.67 to $35 per ounce

Dollar worth less?

Other countries followed suit and devalued their currencies

Between the wars
bretton woods
In 1944, 44 countries met in New Hampshire

Countries agreed to peg their currencies to US$ which was convertible to gold at $35/oz.

Agreed not to engage in competitive devaluations for trade purposes and defend their currencies

Weak currencies could be devalued up to 10% w/o approval

IMF and World Bank created

Bretton Woods
role of the imf
Created to police monetary system by ensuring maintenance of the fixed-exchange rate

Promote int’l monetary cooperation and facilitate growth of int’l trade

Wanted to avoid problems following WW1, through

A) Discipline

Maintaining a fixed exchange rate imposes monetary discipline, curtails inflation

Brake on competitive devaluations and stability to the world trade environment

Role of the IMF

,

role of the imf1
B) Flexibility

Lending facility:

Lend foreign currencies to countries having balance-of-payments problems

Adjustable parities:

Allow countries to devalue currencies more than 10% if balance of payments was in “fundamental disequilibrium’

Persistent borrowings leads to IMF control of a country’s economic policy

Role of the IMF
principal duties
Surveillance of exchange rate policies (No longer fixed rate exchange)

Financial assistance (including credits and loans)

Technical assistance (expertise in fiscal/monetary policy)

Principal duties
sources of funds
182 nations pay into fund according to the size of their economy

Funds remain their property

Borrower repays loan in 1 to 5 years, with interest

No nation has ever defaulted; some are given extensions

Sources of funds
membership in the imf
Open to any country willing to agree to its rules and regulations

Must pay a deposit (quota)

Quota size reflects global importance of a nation’s economy

Quota determines voting powers

Membership in the IMF
role of the world bank
Role of the World Bank
  • International Bank for Reconstruction and Development (IBRD)
  • Purpose: To fund Europe’s reconstruction and help 3d world countries.
  • Overshadowed by Marshall Plan,
  • Turns to ‘development’
    • Lending money raised by WB bond sales
      • Agriculture
      • Education
      • Population control
      • Urban development
collapse of the fixed exchange system
Pressure to devalue dollar led to collapse

President Johnson financed both the Great Society and Vietnam by printing money

High inflation and high spending on imports

August 8, 1971, Nixon announces dollar no longer convertible into gold.

Countries agreed to revalue their currencies against the dollar

March 19, 1972, Japan and most of Europe floated their currencies

In 1973. Bretton Woods fails when key currency (dollar) is under speculative attack

Now have a managed-float system

Collapse of the fixed exchange system
the floating exchange rate
Jamaica Agreement - 1976

Floating rates acceptable

Gold abandoned as reserve asset

IMF quotas increased

IMF continues role of helping countries cope with macroeconomic and exchange rate problems

The floating exchange rate
exchange rates since 1973
More volatile:

Oil crisis -1971

Loss of confidence in the dollar - 1977-78

Oil crisis – 1979, OPEC increases price of oil

Unexpected rise in the dollar - 1980-85

Rapid fall of the dollar - 1985-87 and 1993-95

Partial collapse of European Monetary System - 1992

Asian currency crisis - 1997

Exchange rates since 1973
floating exchange rates
Floating exchange rates
  • Trade balance adjustments
  • Monetary policy autonomy
fixed exchange rates
Fixed exchange rates
  • Monetary discipline
  • Speculation
  • Uncertainty
  • Trade balance adjustments
fixed versus floating exchange rates
Floating:

Monetary policy autonomy

Restores control to government

Trade balance adjustments

Adjust currency to correct trade imbalances

Fixed:

Monetary discipline

.Speculation

Limits speculators

Uncertainty

Predictable rate movements

Trade balance adjustments

Argue no link between exchange rates and trade

Link between savings and investment

Fixed versus floating exchange rates
exchange rate regimes
Pegged Exchange Rates.

Peg own currency to a major currency ($).

Popular among smaller nations

Evidence of moderation of inflation

Currency Boards.

Country commits to converting domestic currency on demand into another currency at a fixed exchange rate

Country holds foreign currency reserves equal to 100% of domestic currency issued

Exchange rate regimes
crisis management by the imf
Role has expanded to meet crisis

Currency crisis

when a speculative attack on a currency’s exchange value results in a sharp depreciation of the currency’s value or forces authorities to defend the currency

Banking crisis

Loss of confidence in the banking system leading to a run on the banks

Foreign debt crisis

When a country cannot service its foreign debt obligations

Crisis management by the IMF
crises have common underlying causes
Common causes:

High inflation

Widening current account deficit

Excessive expansion of domestic borrowing

Asset price inflation

Crises have common underlying causes
mexican currency crisis of 1995
Peso pegged to U.S. dollar

Mexican producer prices rise by 45% without corresponding exchange rate adjustment

Investments continued ($64B between 1990 -1994

Speculators began selling pesos and government lacked foreign currency reserves to defend it

IMF stepped in

Mexican currency crisis of 1995
russian ruble crisis
Financial markets loss of confidence in Russia’s ability to meet national and international payments

Led to loss of international reserves and roll over of treasury bills reaching maturity

Financial markets unable to determine ‘who’s in charge’

Russian Ruble crisis
russian ruble crisis1
Persistent decline in value of ruble:

High inflation

Artificial low prices in Communist era

Shortage of goods

Liberalized price controls

Too many rubles chasing too few goods

Growing public-sector debt

Refusal to raise taxes to pay for government

Russian Ruble crisis
government actions exacerbating the situation
Defacto devaluation of the ruble

Unilateral restructuring of ruble-denominated public debt

90-day moratorium on foreign credits repayment

Hike in interest rates to defend ruble

Duma rejects measures designed to alleviate problems.

Government actions: Exacerbating the Situation
the asian crisis
Factors leading to the Asian financial crisis of 1997

The investment boom

Excess capacity

The debt bomb

Expanding imports

The Asian crisis
the asian crisis1
Mid 1997 several key Thai financial institutions were on the verge of default

Result of speculative overbuilding

Excess investment (dollar denominated debt)

Deteriorating balance-of payments position

Thailand asks IMF for help

17.2 billion in loans, given with restrictive conditions

Following devaluation of Thai baht speculation hit other Asian currencies

Malaysia

Singapore

Indonesia

Korea

The Asian crisis
problems in asian market economies
Cronyism.

Too much money, dependence on speculative capital inflows.

Lack of transparency in the financial sector.

Currencies tied to strengthening dollar.

Increasing current account deficits.

Weakness in the Japanese economy

Problems in Asian Market Economies
evaluating the imf policy prescriptions
Inappropriate policies:

“One size fits all’

Moral hazard:

People behave recklessly when they know they will be saved if things go wrong

Foreign lending banks could fail

Foreign lending banks have paid price for rash lending

Lack of Accountability

IMF has grown too powerful

Evaluating the IMF policy prescriptions
impact on the countries
Impact on the countries
  • Currency devaluation
  • Declining investment
  • Rising prices
  • Rising unemployment
  • Rising poverty
  • Rising resentment?
implications for business
Currency management

Business strategy

Forward exchange market (months not years ahead)

Strategic flexibility

Corporate-government relations

Implications for business