McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter 15 The International Monetary Fund

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter Outline BEFORE THE IMF AND ITS BIRTH FOREIGN EXCHANGE MARKETS TODAY’S IMF THE ASIAN FINANCIAL CRISIS

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. The IMF's Role The International Monetary Fund (IMF) is –a location to which member nations can go for expert economic advice. –designed to foster trade among its member. –the lender for member nations in short-term economic difficulty. –not a lender for development purposes. (This is the function of the World Bank.)

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. The IMF’s Birth After World War II the IMF was developed (with the United Nations, the World Bank and the Global Agreement on Tariffs and Trade) to foster economic growth. It was the brainchild of John Maynard Keynes.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Trade Requires Currency Trade between countries is beneficial. International trade requires that the currency of the trading partners be exchanged. The market where people come to trade currencies is called the foreign exchange market. –E.g. the production and export of a radio can require several currency transactions.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Foreign Exchange Markets The demand for a currency (say the dollar) is also the supply of the other currency (say the yen). The supply for a currency (say the dollar) is also the demand of the other currency (say the yen).

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Modeling Foreign Exchange A curve which represents the willingness of those who have Yen to trade them for dollars A curve which represents the willingness of those who have dollars to trade them for Yen Quantity of yen Price of yen in dollars equilibrium exchange rate

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Who is the IMF and Where Does the Money Come From 182 nations The money that is loaned comes from quotas that are expressed in Special Drawing Rights (SDRs) –a made up currency of the IMF that is comprised of a weighted average of the four major currencies of the world (dollar, yen, pound and Euro.) 75% of the quota can be paid in the countries own currency, 25% must be paid in a hard currency –currencies easily converted to U.S. Dollars or gold

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. How Decisions are Made Voting is not one country one vote It is roughly 100,000 SDRs of quota one vote. This gives the US and Europe an important vote.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. What the IMF Does The IMF makes short term loans to countries in economic distress. If a nation requires a short term infusion of hard currency to make it so that trade can continue, the IMF makes the loan. A country can get its 25% hard currency contribution loaned back to it easily.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. The Asian Financial Crisis: The Cause Part I Large investments in Asia from the Europe and Japan. Banks in Asia did not hedge (taking an investment position so that changes in prices or exchange rates do not alter the advisability of a business decision) their foreign exchange position. These banks borrowed hard currency and loaned out local currency.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. The Asian Financial Crisis: The Cause Part II Thailand exchange rate with the dollar was not at a sustainable level. –The Thai government attempted to maintain the currencies value by buying it with hard currency. –Their hard currency ran out and they were forced to devalue it. Because of the devaluation, banks were unable to pay back the loans in hard currency. Capital fled Asia as more nations were unable to sustain their exchange rates.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. The IMF to the Rescue? The IMF loaned the Asian nations large sums of hard currency with conditions. –The conditions were that they tighten their banking policies and credit to their banks. –This prevented stable companies in Asia from getting lines of credit and threatened their stability.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. The IMF to the Rescue! Had the IMF not made the original loans the problem probably would have been worse. Asian currencies dropped by 50% relative to hard currencies within a few weeks. This could have been worse.