International Monetary System

Chapter Chapter Preview List the benefits of stable and predictable exchange rates Discuss the law-of-one-price principle Describe purchasing power parity and the factors that affect exchange rates Explain how the gold standard functioned Discuss the experience with Bretton Woods Describe today’s international monetary system

Chapter Currency Values and Business Exchange rates affect activities of both domestic and international firms DevaluationRevaluation import prices lowers raises export prices lowers raises

Chapter Major World Currencies

Chapter Strong Currency: Curse or Cure? Get lean by shaving production costs Reward customers for paying a higher price Diversify into more currency-proof sectors Follow global demand to maintain sales Freezing prices can generate new sales Export strategies in the face of a strong currency

Chapter Stability and Predictability Stable exchange rates Predictable exchange rates Improve accuracy of financial planning Improve accuracy of financial planning Reduce surprises of unexpected rate changes Reduce surprises of unexpected rate changes

Chapter Value of US Dollar

Chapter Law of One Price Identical item must have an identical price in all countries when expressed in a common currency Identical item must have an identical price in all countries when expressed in a common currency Big MacCurrencies Undervalued or overvalued Undervalued or overvalued Limited use in business decisions Limited use in business decisions Fairly good rate predictor Fairly good rate predictor

Chapter Big Mac Index

Chapter Purchasing Power Parity Relative ability of two nations’ currencies to buy the same “basket” of goods in those two nations Considers price levels in adjusting relative currency values Purchasing power of a currency is eroded by inflation

Chapter Inflation: Key Factors Monetary policy directly affects interest rates and money supply Fiscal policy indirectly affects taxes and spending High employment raises wages, which are embodied in consumer prices High rates lower borrowing and spending, which lowers inflation Exchange rates adjust to maintain PPP Money supply Employment Interest rates Adjustment

Chapter Fisher Effect International International Nominal Interest rate = real interest rate + inflation rate Nominal Interest rate = real interest rate + inflation rate Difference in nominal interest rates supported by two nations’ currencies will cause an equal but opposite change in their spot exchange rates Difference in nominal interest rates supported by two nations’ currencies will cause an equal but opposite change in their spot exchange rates Interest Rates

Chapter Evaluating PPP Added costs Trade barriers Business confidence, psychology

Chapter Forecasting Exchange Rates Efficient (inefficient) market views Prices reflect (don’t reflect) all public information Forecasting techniques Fundamental analysis Technical analysis

Chapter Gold Standard International monetary system that linked nations’ currencies to specific values of gold Restricted monetary policies Reduced exchange-rate risk Corrected trade imbalances Ended by “competitive devaluation” In place from 1700s to 1939 In place from 1700s to 1939

Chapter Bretton Woods Agreement International monetary system based on value of US dollar (1944 to 1973) Built-in flexibility Fixed exchange rates World Bank and IMF Ended by weak US dollar

Chapter Jamaica Agreement Formalized the system of floating exchange rates as the new international monetary system (1976) Managed float system Currencies float with government intervention Free float system Currencies float without government intervention

Chapter The System Today Managed float system Pegged exchange rates Currency board European monetary system

Chapter Recent Financial Crises  Developing nations’ debt crisis  Mexico  Southeast Asia  Russia  Argentina

Chapter Chapter Summary This chapter presents factors that help determine exchange rates and how exchange rates can be forecasted. It discusses the mechanisms designed to manage exchange rates, including the international monetary system and the European monetary system. The law of one price stipulates that an identical product must have an identical price in all countries when price is expressed in the same currency. Purchasing power parity is the relative ability of two countries’ currencies to buy the same “basket” of goods in those two countries. The efficient market view of forecasting exchange rates states that prices of financial instruments reflect all publicly available information at any given time. The inefficient market view holds that prices of financial instruments do not reflect all publicly available information. The gold standard was a monetary system that pegged currencies to gold and guaranteed convertibility to gold. The Bretton Woods system of fixed exchange rates was established in Today, the international monetary system remains in large part a managed-float system whereby most nations’ currencies float against one another with government intervention to realign exchange rates when necessary.

International Monetary System