1. © McGraw Hill Companies, Inc., 2000 The International Monetary System Chapter 10

2. The Gold Standard  Roots in old mercantile trade.  Inconvenient to ship gold, changed to paper - redeemable for gold.  Want to achieve ‘balance-of-trade equilibrium Japan USA Trade Gold © McGraw Hill Companies, Inc., 2000 10-1

3. © McGraw Hill Companies, Inc., 2000 Between the Wars  Post WWI, war heavy expenditures affected the value of dollars against gold  US raised dollars to gold from $20.67 to $35 per ounce.  Dollar worth less?  Other countries followed suit and devalued their currencies. 10-2

4. 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. © McGraw Hill Companies, Inc., 2000 10-3

5. Bretton Woods © McGraw Hill Companies, Inc., 2000 10-4

6. IMF  Created to police monetary system by ensuring maintenance of the fixed-exchange rate.  Promote int’l monetary cooperation and facilitate growth of int’l trade.  Wanted to avoid prewar problems, so  Created lending facilities to help countries with trade deficits. Persistent borrowings leads to IMF control of a country’s economic policy.  Created adjustable parities. © McGraw Hill Companies, Inc., 2000 10-5

7. Principal Duties  Surveillance of exchange rate policies. (No longer fixed rate exchange.)  Financial assistance (including credits and loans)  Technical assistance (expertise in fiscal/monetary policy). © McGraw Hill Companies, Inc., 2000 10-6

8. Sources of Funds  182 nations pay into fund according to the size of their economy.  Funds remain their property.  Borrower repays loan in 1 to 5 years, with interest.  No nation has ever defaulted; some are given extensions. © McGraw Hill Companies, Inc., 2000 10-7

9. Membership in the IMF  Open to any country willing to agree to its rules and regulations.  Must pay a deposit (quota)  Quota size reflects global importance of a nation’s economy.  Quota determines voting powers. © McGraw Hill Companies, Inc., 2000 10-8

10. Largest Contributors © McGraw Hill Companies, Inc., 2000 10-9

11. Largest Borrowers © McGraw Hill Companies, Inc., 2000 10-10 $ Billion

12. (International Bank for Reconstruction and Development)  Created to fund EUROPE’s reconstruction and help 3d world countries.  Overshadowed by Marshall Plan, so bank looked to 3d world.  Looked at public sector projects.  Country borrows money raised by WB bond sales.  International Development Agency created to help poorest countries. © McGraw Hill Companies, Inc., 2000 10-11

13. What Happened After Bretton Woods?  Under BW, US required to deliver 1oz of gold to any IMF member that gave US Treasury $35.00.  1958 -1971 US ran accumulated deficit of $56 billion.  US gold reserves shrank from $34.8 billion to $12.2 billion.  Liabilities to foreign central banks increased from $13.6 billion to $62.2 billion. © McGraw Hill Companies, Inc., 2000 10-12

14. Collapse of the Fixed Exchange System  August 8, 1971, Nixon left gold standard?  March 19, 1972, Japan and most of Europe floated their currencies.  Fully collapsed in 1973.  LBJ policies and Vietnam.  Floating currencies considered to be a temporary fix.  Still going on today. © McGraw Hill Companies, Inc., 2000 10-13

15. US Dollar Movements 1990=100 Oil Crisis Desert Storm Recession Ends © McGraw Hill Companies, Inc., 2000 10-14

16. Floating Exchange Rates  Jamaica Agreement, 1976.  Floating rates acceptable.  Based primarily on supply/demand.  Managed float involves gov’t manipulation in currency markets.  Gold abandoned as reserve asset.  IMF quotas increased, now $180B © McGraw Hill Companies, Inc., 2000 10-15

17. Managed Currency Floats  1985: ‘Group of 5’ met at Plaza Hotel in NY and agreed on ‘right’ level for US dollar.  G5 became G7 (now G8). Seeks to stabilize exchange rates.  Difficult due to growth of Fx market.  Annual volume up from $18 billion in 1979 to $1.5 trillion today. © McGraw Hill Companies, Inc., 2000 10-16

18. Floating  Monetary policy autonomy  Trade balance adjustments. © McGraw Hill Companies, Inc., 2000 10-17

19. Fixed  Monetary discipline.  Speculation.  Uncertainty.  Trade balance adjustments. © McGraw Hill Companies, Inc., 2000 10-18

20. © McGraw Hill Companies, Inc., 2000 Exchange Rate Regimes  Pegged Exchange Rates.  Peg own currency to a major currency ($).  Popular among smaller nations.  Evidence of moderation of inflation.  Currency Boards.  Country commits to converting domestic currency on demand into another currency at a fixed exchange rate.  Country holds foreign currency reserves equal to 100% of domestic currency issued. 10-19

21. © McGraw Hill Companies, Inc., 2000 How IMF Members Determine Exchange Values Inflexible Somewhat Flexible Flexible 10-20 Figure 10.2

22. © McGraw Hill Companies, Inc., 2000 Post-Bretton Woods Financial Crises  Currency crises:  when a speculative attack on a currency’s exchange value results in a sharp depreciation of the currency’s value or forces authorities to defend the currency.  Banking crises:  Loss of confidence in the banking system leading to a run on the banks.  Foreign debt crises:  When a country cannot service its foreign debt obligations. 10-21

23. © McGraw Hill Companies, Inc., 2000 Crises Have Common Underlying Causes  Common causes:  High inflation  Widening current account deficit  Excessive expansion of domestic borrowing  Asset price inflation 10-22

24. © McGraw Hill Companies, Inc., 2000 Incidence of Currency Crises 1975-1997 Number of Currency Crises per Country 10-23 Figure 10.3a

25. © McGraw Hill Companies, Inc., 2000 Incidence of Banking Crises 1975-1997 Number of Banking Crises per Country 10-24 Figure 10.3b

26. © McGraw Hill Companies, Inc., 2000 Mexican Currency Crises of 1995  Peso pegged to U.S. dollar.  Mexican producer prices rise by 45% without corresponding exchange rate adjustment.  Investments continued ($64B between 1990 - 1994.  Speculators began selling pesos and government lacked foreign currency reserves to defend it.  IMF stepped in. 10-25

27. © McGraw Hill Companies, Inc., 2000 Peso Movements 10-26 9495

28. © McGraw Hill Companies, Inc., 2000 Problems in Asian Market Economies  Cronyism.  Too much money, dependence on speculative capital inflows.  Lack of transparency in the financial sector.  Currencies tied to strengthening dollar.  Increasing current account deficits.  Weakness in the Japanese economy 10-27

29. © McGraw Hill Companies, Inc., 2000 10-28

30. © McGraw Hill Companies, Inc., 2000 Devalued Currency 1997 1998 10-29

31. © McGraw Hill Companies, Inc., 2000 Russia  Financial markets loss of confidence in Russia’s 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 ‘who’s in charge’. 10-30

32. © McGraw Hill Companies, Inc., 2000 Government Actions Exacerbating the Situation  Defacto devaluation of the ruble.  Unilateral restructuring of ruble- denominated public debt.  90-day moratorium on foreign credits repayment.  Hike in interest rates to defend ruble.  Duma rejects measures designed to alleviate problems. 10-31

33. © McGraw Hill Companies, Inc., 2000 Russia Russian Rubles to US Dollar 10-32

34. © McGraw Hill Companies, Inc., 2000 Russia Real GDP 10-33

35. IMF Policy Prescriptions  “One size fits all” prescription for countries.  Rescue efforts exacerbate the ‘moral hazard’ problem.  Too powerful without accountability. © McGraw Hill Companies, Inc., 2000 10-34

36. © McGraw Hill Companies, Inc., 2000 Impact on the Countries  Currency devaluation.  Declining investment.  Rising prices.  Rising unemployment.  Rising poverty.  Rising resentment? 10-35

37. © McGraw Hill Companies, Inc., 2000 Investment Impacts  Loss of investment confidence.  Deflation of asset values.  Substantial corporate debt burdens.  Reversal of capital flows  Decline in access to operating cash.  Declines in domestic demand.  Compression of intra regional trade. 10-36