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

3. 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

4. 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. 5-5 Gold Standard –A fixed exchange system in which fixed exchanges were set among the world currencies in terms of gold. The par value or stated value at which one currency would exchange for another was stated in terms of gold and the US dollar. The US dollar was worth $35 per ounce of gold. All other currencies were stated in terms of the US dollar. This system is called the Bretton Woods agreement. 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

6. 5-6 International Monetary Fund World Bank –Institution that focuses on funding of development projects International Monetary Fund (IMF) –Institution that coordinates multilateral monetary rules and their enforcement Triffin paradox The fact that countries held dollars instead of gold was a problem for the US and led to the Triffin paradox. If a country wanted to convert dollars to gold, then the US had to pay them in gold. There is only so much gold. –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.

7. 5-7 A New System Other currencies could no longer be converted to gold. Nixon separated suspended the convertibility of the US dollar into gold in 1971. There were several attempts to fix the old systems but by 1973, Japan and Europe had allowed their currencies to float which ended the Bretton Woods Agreement.

8. 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 –A “Dirty” float means that governments buy up each other’s currency to allow theirs to remain in a certain relationship with the other currency Jamaica Agreement –The 1976 IMF agreement that allows flexible exchange rates among members and makes sure developing countries had access to International Monetary System Funds

9. 5-9 Current Currency Exchange Rate Arrangements Exchange arrangements with no separate legal tender Currency board arrangements-tying one currency to another Other conventional fixed peg arrangements- currency allowed to vary within a range of 1% Pegged exchange rates within horizontal bands-when the currencies get to out of range (beyond 1%), they move to the next peg

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

11. 5-11 Euro Currency of the European Union 12 EU members have joined the European Monetary Union The Euro is appreciated against the US dollar This makes it easier for Europe to buy our goods One country’s currency against another affects a particular country’s Balance of Payments

12. 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

13. 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

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

15. 5-15 Special Drawing Rights Special Drawing Rights (SDR) –An international reserve asset established by the IMF –The unit of account for the IMF and other international organizations