Chapter

10

The International
Monetary system

10-2

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

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10-3

International monetary system (IMF)

Some countries use other institutional arrangements to

fix their currencys value
Pegged exchange rate

Dirty float

Value fixed relative to a reference currency

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
Precursor to the EU

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10-4

The gold standard

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Roots in old mercantile

trade.
Inconvenient to ship
gold, changed to paperredeemable for gold.
Want to achieve
balance-of-trade
equilibrium

ad
Tr

Japan

USA

Go
ld

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10-5

Between the wars

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

US raised dollar price of gold from $20.67 to $35 per ounce

Dollar worth less? - But can buy more

US tatctic to increase exports and prop up economy

Other countries followed suit and devalued their currencies

People lost confidence the in stability of the system - countries reduce their
values - major devaluation occurred

Have currency, change into gold imedietly

Put pressure on gold reserves.

1939 Gold Reserve Droped

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10-6

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

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10-7

Role of the IMF

Created to police monetary system by ensuring

maintenance of the fixed-exchange rate
Promote intl monetary cooperation and facilitate
growth of intl 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

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10-8

Role of the IMF

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 countrys economic policy

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10-9

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

August 8, 1971, Nixon announces dollar no longer

convertible into gold.

High inflation, ($ in pockets) and high spending on imports

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

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10-10

The floating exchange rate

Jamaica Agreement - 1976

Floating rates acceptable

Gold abandoned as reserve asset

IMF continues role of helping countries cope

with macroeconomic and exchange rate
problems

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10-11

Fixed versus floating exchange rates

Floating:

Monetary policy
autonomy
Restores control to
government

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Fixed:
Monetary discipline
Limits speculators
Uncertainty
Predictable rate movements

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10-12

Crisis management by the IMF

Role has expanded to meet crisis

Currency crisis

Banking crisis

when a speculative attack on a currencys exchange

value results in a sharp depreciation of the currencys
value or forces authorities to defend the currency
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

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10-13

Russian Ruble crisis

Financial markets loss of confidence in

Russias 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 whos

in charge

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10-14

Russian Ruble crisis

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

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10-15

Decline of the Ruble

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10-16

The Asian crisis

Mid 1997 several key Thai financial institutions

were on the verge of default

Thailand asks IMF for help

Result of speculative overbuilding

Excess investment
17.2 billion in loans, given with restrictive conditions

Following devaluation of Thai baht speculation hit

other Asian currencies

Malaysia
Singapore
Indonesia
Korea

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10-17

Problems in Asian Market Economies

Cronyism.
Too much money, dependence on speculative
capital inflows.
Lack of transparency in the financial sector.

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