International Monetary Systems
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Transcript of International Monetary Systems
International Monetary SystemInternational Monetary
System
PRESENTED BY:Arun Chhikara
Gaurav SharmaGaurav KhuranaPrashant SinghShadab Khan
International Monetary SystemPreface Increased Volatility of currency affects the earnings of MNC’s,
Banks and Cross Border investor’s
There are large and unexpected fluctuations in the value of currency hence a setup called Bretton Woods was formed in 1944 to reduce this riskiness of international business
The main feature of Bretton Woods was the relatively fixed exchange rate of individual currency in the terms of USD $ and convertibility of $ into gold
In 1971 Bretton Woods fell prey to international financial turmoil and was replaced by the present regime of rapidly fluctuating exchange rates which resulted in both problems and opportunities for MNC’s
International Monetary SystemINTERNATIONAL MONETARY SYSTEM
The International Monetary System refers to set of policies, institutions, practices, regulations & mechanism that determine the rate at which one currency would be exchange for another.
There are primarily 5 market mechanisms to establish exchange rate with each having its share of merits & demerits –
•Free float •Managed float•Target zone arrangement•Fixed rate system•Hybrid system
International Monetary System All countries like to have economic stability & prefer a stable
exchange rate, however fixing exchange rate often leads to currency crises if the monetary policy is inconsistent with it
Countries are less vulnerable to economic shocks if they allow their currency to float freely but that may exhibit excessive volatility which hurts trade & economic growth
The trade off between different mechanism depend upon the importance of the underlying benefits & trade offs associated with them
International Monetary SystemFree Float
Free market exchange rates are determined by interaction of currency supply & demand which is in turn influenced by price level changes interest differential & economic growth
The exchange rate fluctuates randomly as market participants arises & react to new information, for example – Government policies or acts of God & nature
This is also called clean float as the exchange rates are free flowing without any manipulation
International Monetary SystemManaged float Intervention by Government’s in the foreign change market in
order to reduce economic uncertainty associated with free/ clean float
This is triggered by the fear that a sudden change in the currency appreciates or inflation of it depreciates
Central banks of countries intervene to smooth as out exchange rate fluctuations & determine the rate that is why it is called Managed/ dirty float
Crawling peg – unofficial pegging
International Monetary SystemTarget zone arrangement
Under this system, countries adjust their national economic policies to maintain there exchange rates within a specific margin
Members of the arrangement adjust their national economic policies to maintain the target range
International Monetary SystemFixed rate Bretton wood was also a fixed rate mechanism, in this type of
regime, Governments are committed to maintain a target exchange rate
Central banks buy/ sell currency actively if the exchange rate is threatened
For this system to work, all member nations must accept the groups joint inflation rate as its own.
These controls are major source of imperfection for MNC’s which provide both risk & opportunities to them
International Monetary SystemThe current hybrid system The currency system is the one where major currencies float on a
managed basis, some currencies are freely floating while other currencies follow various types of pegged exchange rates
Examples – another currency as legal tender – Equador, el Salvador (US dollar) – pegged against a single currency, Malaysia, Maldives, Nepal, Iraq, Jordan
International Monetary SystemBrief history of International monetary system Why Gold – Gold has a certain desirable properties like durability,
ease of storage, easy recognition, standardization
Short term changes in its stock are limited by high production cost, making it expensive to manipulate
It ensures price stability in long run
This is the reason why most currencies fairly recent recently followed gold standard which defined their exchange rates
International Monetary SystemThe Gold standard The gold standard essentially involved a commitment by the
participating countries to fix the price of their currencies in terms of a specific amount of gold
The price was maintained by buying/ selling gold at that price
The value of gold relative to other goods does not change much over long period of time, that helps in maintaining monetary discipline & ensures long run price stability
Concept of fat money – gold standard
International Monetary SystemThe gold standard from 1925 - 1944
The gold standard broke down during World War I, and was briefly re-instated between 1925-31 as gold exchange standard
Under this system, only US & Britain were allowed to hold gold reserves while other could hold both gold, dollars &/ or pound reserves
1931 – Britain departed from Gold standard due to high influx of gold & capital, this led to devaluation of many currencies which in turn led to trade wars, some economists even blame the protectionist regimes of triggering the great depression
International Monetary SystemBretton woods (1946 – 1971 ) To avoid destructive monetary economic policies to be formulated
allied nations agreed to form a new postwar system
The conference held in New hampshire also created institutions, IMF & World Bank to promote international financial stability
World bank had the primary function of lending to nations devastated by the world war
The IMF had agenda to foster global growth and economic stability
International Monetary SystemBretton woods – The fine print USD became the key currency & each Government pledged to
maintain a fixed, or pegged exchange rate vis-à-vis the dollar or gold
1 ounce of gold = $ 35 1 ounce of gold = 140 mark (German) so 4 mark = $ 1 Exchange rates were allowed to fluctuate by 1% above or below
initial base price.
The fixed exchange rates were maintained by official intervention by central banks in the form of sale & purchase of dollars with the IMF providing the foreign exchange
International Monetary SystemBretton woods (continued) Technical aspects of the system had practical implications on the
participating countries
Stability of exchange rates removed a great deal of uncertainty from international trade & investment transactions
It also imposed a great deal of discipline on the participating nations economic policies
International Monetary SystemFall of Bretton woods
The Bretton wood system was fixed rate, only in name, out of 21 major industrialized countries Only the US & Japan held to their par value during 1946-71. Out of 21, 12 devalued their currencies more than 30% against the dollar
The death blow for the system came from President Nixon, who was alarmed at high inflation rate & he devalued the dollar to deal with the emerging trade deficit
International Monetary SystemPost Bretton woods
Smithsonian agreement of 1971 – US devalued to 38 $ / Oz of gold & other countries were revalued on agreed amounts vis-à-vis the dollar
By 1973 – The world officially turned to floating exchange rates
International Monetary SystemRole of International Monetary FundThe IMF works to foster global growth and economic stability. It provides policy advice and financing to members in economic difficulties and also works with developing nations to help them achieve macroeconomic stability and reduce poverty.
Its main works are –
•policy advice to governments and central banks based on analysis of economic trends and cross-country experiences
•research, statistics, forecasts, and analysis based on tracking of global, regional, and individual economies and markets
•loans to help countries overcome economic difficulties
•concessional loans to help fight poverty in developing countries
International Monetary SystemIt is having 188 member countries till date
Special Drawing Right (SDR)
The IMF supplemented its foreign exchange by creating a new reserve asset, (named SDR).
It serves as the IMF’s unit of account
It is a weighted average of the currencies of five nations (US, Germany, France, Japan & Great Britain)
The weights, which are based on the relative importance of each country in international trade are updated periodically
International Monetary SystemRole of World bank
The world bank is an internationally supported bank that provides financial and technical assistance to developing countries for development programs (e.g. bridges, roads, schools)with the stated goal of reducing poverty.
Role of Bank of International Settlements•Acts as the “Central Bank“ for Industrial Countries’ Central Bank
•Helps in managing FOREIGN EXCHANGE RESERVES
•BIS also holds deposits of Central Banks
International Monetary SystemFloating Rate system - 1973 Proponents of the new system said that this system would reduce
economic volatility & facilitate free trade, floating exchange rates would offset the differences in inflation rate
High inflation countries would have their currencies depreciate, allowing their firms to stay competitive without having to act wages & unemployment
International Monetary SystemAssessment of Floating Rate system
Currency volatility has increased – The experience till date from the system has been disappointing. The dollars ups & down has little to do with inflation & a lot to do with expectations of future government policies & economic conditions
The instability reflects the non monetary shocks to the world economy, such as changing oil prices & competitiveness amongst countries
International Monetary SystemJamaica Agreement 1976
Floating rates declared acceptable
Gold abandoned as reserve asset; I. IMF returned gold reserves to members at current pricesII. Proceeds placed in trust fund to help poor nationsIII. IMF quotas – member country contributions – increased;
membership now 182 countriesIV. Less-develop, non-oil exporting countries given more
access to IMFIMF continued its role of helping countries cope with
macroeconomic and exchange rate problems
International Monetary SystemMajor events after 1973OPEC and the Oil Crisis (1973-74)
1. OPEC raised oil prices four fold 2. Exchange rate turmoil resulted 3. Caused OPEC nations to earn large surplus B-O-P. Surpluses recycled to debtor nations which set up debt crisis of 1980’s.
Dollar Crisis (1977-78)
1. U.S. B-O-P difficulties2. Result of inconsistent monetary policy in U.S.3. Dollar value falls as confidence shrinks.
International Monetary SystemThe Rising Dollar (1980-85)
1. U.S. inflation subsides as the Fed raises interest rates2. Rising rates attracts global capital to U.S.3. Result: Dollar value rises.
The Sinking Dollar:(1985-87)
1. Dollar revaluated slowly downward;2. Plaza Agreement (1985) G-5 agree to depress US $ further.3. Louvre Agreement (1987) G-7 agree to support the falling US $
Recent History (1988-2005)
I. 1988 US$ stabilizedII. Post-1991 Confidence resulted in stronger dollarIII. 1993-1995 Dollar value falls.
International Monetary SystemFinancial Crisis 2007-12Global Financial crisis: Worst Financial Crisis since the Great
Depression (1930)EVENTS• Subprime lending• Growth of the housing bubble• Easy credit conditions• Weak and fraudulent underwriting practices• Deregulation• Increased debt burden or over-leveraging• Incorrect pricing of risk• Boom and collapse of the shadow banking system• EURO Zone crisis• Commodities boom•Currency volatility
International Monetary System
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