INTERNATIONAL FINANCIAL MANAGEMENT

BARATH VAID.S VAISHNAVI.A SWEATHA.R

Fixed exchange-rate system

Gold as a medium of exchange The value of the monetary unit of a country was fixed in terms of specified quantity and fineness of Gold. A policy of converting gold into paper currency and paper currency into gold, by buying and selling gold at specific prices

 The circulation of the money was backed by its gold reserves at a specified ratio. The stock of money in a country would increase or decrease with the changes in the gold reserves. The exchange rates between any two currencies was determined by the ratio of the price of a unit of gold, in terms of the respective units of each currency.

Mint Parity or Gold Parity

When the value of the monetary unit of each country is fixed in terms of Gold, the exchange rates is automatically fixed by the Mint Parity or Gold Parity Exchange rate may differ from the mint parity, leading to arbitrage process When the arbitrage gets exhausted, the exchange rates automatically will get inline with the Mint Parity.

Price-specie automatic adjustment mechanism

The automatic adjustment mechanism under the gold standard is the price specie flow mechanism, which operates so as to

correct any balance of payments

disequilibria and adjust to changes. Richard Cantillon emphasized that nations could not continuously accumulate gold by

exporting more than their imports.

Deficit nation: Lower money supply Lower internal prices More exports, less imports Elimination of deficit Surplus nation: Higher money supply Higher internal prices Less exports, more imports Elimination of surplus

Quantity Theory of Money

Favorable balance of payments receive gold from other countries, due to excess foreign exchange receipts over payments. A country in deficit will have an outflow of gold on excess foreign exchange payments over receipts. Increase in inflow of gold increases the monetary reserves in the country, which in turn increases the money supply.

Increase in money supply , increase in demand and rise in prices of goods and services Higher prices would make goods and services expensive in the international market Result in fall in exports leading to a balance of payments deficit

Favorable balance of payments caused by a surplus in the countrys balance of trade would be automatically corrected

Timeline of the fixed exchange rate system 18801914 April 1925 October 1929 September 1931 Timeline of the fixed exchange rate system Classical gold standard period United Kingdom returns to gold standard United States stock market crashes United Kingdom abandons gold standard

July 1944
March 1947 August 1971

Bretton Woods conference

International Monetary Fund comes into being United States suspends convertibility of dollar into gold Bretton Woods system collapses

December 1971
March 1972 March 1973 April 1978 September 1985 September 1992

Smithsonian Agreement
European snake with 2.25% band of fluctuation allowed Managed float regime comes into being Jamaica Accords take effect Plaza accord United Kingdom and Italy abandon Exchange Rate Mechanism (ERM)

The gold exchange standard

Set up after World War II, prevailed between 1920 and the early 1930s. A gold exchange standard is a mixture of a reserve currency standard and a gold standard. Unlike the gold standard, the central bank of the reserve country does not exchange gold for currency with the general public, only with other central banks.

Weakness of fixed rate system

The need for a fixed exchange rate regime is challenged by the emergence of derivatives and financial tools, which allow rms to hedge exchange rate uctuations The announced exchange rate may not coincide with the market equilibrium exchange rate, thus leading to excess demand or excess supply The central bank needs to hold stocks of both foreign and domestic currencies at all times in order to adjust and maintain exchange rates and absorb the excess demand or supply

 Fixed exchange rate does not allow for automatic correction of imbalances in the nation's balance of payments since the currency cannot appreciate/depreciate as dictated by the market It fails to identify the degree of comparative advantage or disadvantage of the nation and may lead to inefficient allocation of resources throughout the world There exists the possibility of policy delays and mistakes in achieving external balance The cost of government intervention is imposed upon the foreign exchange market.

BRETTONWOODS SYSTEM
Existence from 1944 Attended by 730 delegates from 44 nations in Bretton Woods, U.S. Setting up a system of rules, institutions, and procedures to regulate the international monetary system. International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD) were established.

BRETTONWOODS SYSTEM
Obligation for the countries to adopt a monetary policy. Maintained exchange rate, tying its currency to U.S Dollar. IMF Designed to monitor exchange rates and lend reserve currencies to nations with trade deficits. IBRD To provide underdeveloped nations with needed capital

NIXON SHOCK (U.S)

In 1970s cost of Vietnam war and increased domestic spending accelerated inflation. Balance of payments deficit faced. Money supply increased by 10%. West Germany leaving the BW system. Devaluation of the dollar, to protect the dollar against foreign price-gougers.

NIXON SHOCK (U.S)

President Nixon imposed a 90-day wage and price freeze, a 10 percent import surcharge and the "closed the gold window, to stabilise economy. In August 1971, U.S. President Richard Nixon announced the "temporary" suspension of the dollar's convertibility into gold. By 1976, worlds major currencies were floating. Oil crises owing countries to quit the fixed rate system.

FLOATING EXCHANGE RATE SYSTEM

Since the collapse of the Bretton Woods system, IMF members were free to choose any form of exchange arrangement they wished. Type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the forex market.

OTHER EXCHANGE RATE SYSTEMS

MANAGED FLOAT The government or the country's central bank occasionally intervenes to change the direction of the value of the country's currency. To act as a buffer against an external economic shock before its effects become truly disruptive to the domestic economy.

OTHER EXCHANGE RATE SYSTEMS

CRAWING PEG
A currency with a fixed exchange rate is allowed to fluctuate within a band of rates.

The par value of the stated currency is also adjusted frequently due to market factors such as inflation.
This gradual shift of the currency's par value is done as an alternative to a sudden and significant devaluation of the currency.

OTHER EXCHANGE RATE SYSTEMS

FIXED RATES WITH WIDER BANDS

Reduce magnitude and frequency of government interventions. Discourage speculations. Allow rate fluctuations to adjust among themselves.