© McGraw Hill Companies, Inc., 2000 The International Monetary System Chapter 10.

© McGraw Hill Companies, Inc., 2000

The International Monetary System Chapter 10

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

Japan USA

Trade

Gold© McGraw Hill Companies, Inc., 2000

10-1


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.

10-2

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.

© McGraw Hill Companies, Inc., 2000 10-3

Bretton Woods

© McGraw Hill Companies, Inc., 200010-4

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 prewar problems, so

Created lending facilities to help countries with trade deficits.

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

Created adjustable parities.© McGraw Hill Companies, Inc., 2000 10-5

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).


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.


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.


Largest Contributors

18.3

5.7 5.7 5.1 5.1

0

5

10

15

20

US Germany Japan Britain France

USGermanyJapanBritainFrance


Largest Borrowers

4

11 11.6

21

0

5

10

15

20

25

Thailand Russia Indonesia S. Korea

ThailandRussiaIndonesiaS. Korea


$ Billion

(International Bank for Reconstruction and Development)

Created to fund EUROPE’s reconstruction and help 3d world countries.

Overshadowed by Marshall Plan, so bank looked to 3d world.

Looked at public sector projects. Country borrows money raised by

WB bond sales. International Development Agency created to

help poorest countries.

© McGraw Hill Companies, Inc., 200010-11

What Happened After Bretton Woods?

Under BW, US required to deliver 1oz of gold to any IMF member that gave US Treasury $35.00.

1958 -1971 US ran accumulated deficit of $56 billion.

US gold reserves shrank from $34.8 billion to $12.2 billion.

Liabilities to foreign central banks increased from $13.6 billion to $62.2 billion.


Collapse of the Fixed Exchange System

August 8, 1971, Nixon left gold standard? March 19, 1972, Japan and most of Europe

floated their currencies. Fully collapsed in 1973.

LBJ policies and Vietnam.

Floating currencies considered to be a temporary fix. Still going on today.


US Dollar Movements

90

100

110

120

130

140

150

160

1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994

1990=100

Oil CrisisDesert Storm

Recession Ends


Floating Exchange Rates

Jamaica Agreement, 1976. Floating rates acceptable.

Based primarily on supply/demand. Managed float involves gov’t

manipulation in currency markets.

Gold abandoned as reserve asset. IMF quotas increased, now $180B


10-15

Managed Currency Floats

1985: ‘Group of 5’ met at Plaza Hotel in NY and agreed on ‘right’ level for US dollar.

G5 became G7 (now G8). Seeks to stabilize exchange rates.

Difficult due to growth of Fx market. Annual volume up from $18 billion in 1979 to

$1.5 trillion today.


Floating

Monetary policy autonomy Trade balance adjustments.


10-17

Fixed

Monetary discipline. Speculation. Uncertainty. Trade balance adjustments.



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.

10-19


How IMF Members Determine Exchange Values

0

5

10

15

20

25

30

35

40

45

50 Peg to $

Peg to FFr

Pegged to OtherCurrencyMovement Related toOther CurrencyFree Float

Managed Float

Other

Inflexible

Somewhat Flexible

Flexible

10-20

Figure 10.2


Post-Bretton Woods Financial Crises

Currency crises: 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 crises: Loss of confidence in the banking system leading to a run on

the banks.

Foreign debt crises: When a country cannot service its foreign debt obligations.

10-21


Crises Have Common Underlying Causes

Common causes: High inflation Widening current account deficit Excessive expansion of domestic borrowing Asset price inflation

10-22


Incidence of Currency Crises1975-1997

00.050.1

0.150.2

0.250.3

0.350.4

0.450.5

1975 77 79 81 83 85 87 89 91 93 95 97

Industrial

Emerging Market

Number of Currency Crises per Country

10-23Figure 10.3a


Incidence of Banking Crises 1975-1997

0

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.16

0.18

0.2

75 77 79 81 83 85 87 89 91 93 95 97

Industrial

Emerging Market

Number of Banking Crises per Country

10-24Figure 10.3b


Mexican Currency Crises 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.

10-25


Peso Movements

0

20

40

60

80

100

120

140

160

Inde

x =

100

Mexico

10-26

94 95


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

10-27


0 10 20 30 40 50 60

Apparel

Toys

TV & VCR

Motor Vehicles

Appliances199819971996

%

Impact of the Asian Financial Crisis onUS Imports

10-28


Devalued Currency

0

20

40

60

80

100

120

Inde

x =

100

ThailandIndonesiaS. Korea

1997 1998

10-29


Russia

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’.

10-30


Government ActionsExacerbating 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.

10-31


Russia

0

5

10

15

20

25

30

Dec-97

Feb-98 Apr Jun Aug Oct Dec

Feb-99 Apr

Russian Rubles to US Dollar

10-32


RussiaReal GDP

-7

-6

-5

-4

-3

-2

-1

0

1

2

96 97 98

Percent

10-33

IMF Policy Prescriptions

“One size fits all” prescription for countries. Rescue efforts exacerbate the ‘moral

hazard’ problem. Too powerful without accountability.



Impact on the Countries

Currency devaluation. Declining investment. Rising prices. Rising unemployment. Rising poverty. Rising resentment?

10-35


Investment Impacts Loss of investment confidence. Deflation of asset values. Substantial corporate debt burdens. Reversal of capital flows

Decline in access to operating cash.

Declines in domestic demand. Compression of intra regional trade.

10-36

© McGraw Hill Companies, Inc., 2000 The International Monetary System Chapter 10.

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Transcript of © McGraw Hill Companies, Inc., 2000 The International Monetary System Chapter 10.