Understanding the International Monetary System McGraw-Hill/Irwin International Business, 11/e Copyright © 2008 The McGraw-Hill Companies, Inc. All rights reserved. chapter five

5-3 Learning Objectives Explain the functioning of the gold standard Describe the purposes of the IMF Appreciate the accomplishments of Bretton Woods system and the ensuing developments shaping the world monetary system Describe the purpose of the World Banks Discuss the purpose of the Bank for International Settlements

5-4 Learning Objectives Discuss the floating exchange rate system Describe the development of the euro Explain the role of the Balance of Payments (BOP) Discuss the major BOP accounts Explain the use of Special Drawing Rights (SDRs)

5-5 Gold Standard –The use of gold at an established number of units per currency Bretton Woods –The New Hampshire town where treasury and central bank representatives met near the end of World War II to establish the IMF, the World Bank, and the gold exchange standard

5-6 International Monetary Fund International Monetary Fund (IMF) –Institution that coordinates multilateral monetary rules and their enforcement Triffin paradox –The concept that a national currency that is also a reserve currency will eventually run a deficit, which eventually inspires a lack of confidence in the reserve currency and leads to a financial crisis.

5-7 World Bank –Institution that focuses on funding of development projects Bank for International Settlements –Institution that is the central bank for central bankers

5-8 Currency Exchange Rate Systems Fixed currency exchange rates –Rates that governments agree on and undertake to maintain Floating currency exchanges rates –Rates that are allowed to float against other currencies and are determined by market forces Jamaica Agreement –The 1976 IMF agreement that allows flexible exchange rates among members

5-9 Current Currency Exchange Rate Arrangements Exchange arrangements with no separate legal tender Currency board arrangements Other conventional fixed peg arrangements Pegged exchange rates within horizontal bands

5-10 Current Currency Exchange Rate Arrangements Crawling pegs Exchange rates within crawling bands Managed floating with no preannounced path for the exchange rate Independently floating exchange rates

5-11 Euro Currency of the European Union (started on January 1, 2002) 12 EU members have joined the European Monetary Union (Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxemburg, the Netherlands, Portugal, Spain) The U.K. and Switzerland maintain their currencies. Yet they accept euro in transactions within their countries

5-12 BOP Accounts Table 5.1 Current account –Records a country’s exports and imports in goods and services Goods or merchandise account Services account Unilateral transfers

5-13 BOP Accounts Capital account –Records the net changes in a nation’s international financial assets and liabilities Direct investments Portfolio Investments Short-term capital flows Official Reserves account –Records the assets held by the government; gold, foreign currencies, and accounts in foreign banks; a balance of the country’s foreign currency

5-14 Table 5.1 U.S. International Transactions (millions of dollars)

5-15 Special Drawing Rights Special Drawing Rights (SDR) –An international reserve asset established by the IMF (1970) –The unit of account for the IMF and other international organizations –SDR value based on a basket of 5 currencies: US$ (45%), Euro (29%), Yen (15%), and pound sterling (11%) –SDR is more stable than any other currencies such that it is used in international transactions