International Monetary System

International Monetary System

PRESENTED BY: Arun Chhikara Gaurav Sharma Gaurav Khurana Prashant Singh Shadab Khan

International Monetary System Preface

Increased Volatility of currency affects the earnings of MNCs, Banks and Cross Border investors 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 MNCs

International Monetary System INTERNATIONAL 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

Free Float

International Monetary System

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 System Managed float

Intervention by Governments 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 System Target 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 System Fixed 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 MNCs which provide both risk & opportunities to them

International Monetary System The 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 System Brief 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 System The 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 System The 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 System Bretton 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 System Bretton woods The fine print

USD became the key currency & each Government pledged to maintain a fixed, or pegged exchange rate vis--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 System Bretton 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 System Fall 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 System Post Bretton woods

Smithsonian agreement of 1971 US devalued to 38 $ / Oz of gold & other countries were revalued on agreed amounts vis--vis the dollar By 1973 The world officially turned to floating exchange rates

Role of International Monetary Fund International Monetary

System

The 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 System

It 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 IMFs 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

Role of World bank

International Monetary System

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

Floating Rate system - 1973

International Monetary System

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 System Assessment 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 System Jamaica Agreement 1976

Floating rates declared acceptable Gold abandoned as reserve asset; I. IMF returned gold reserves to members at current prices II. Proceeds placed in trust fund to help poor nations III. IMF quotas member country contributions increased; membership now 182 countries IV. Less-develop, non-oil exporting countries given more access to IMF IMF continued its role of helping countries cope with macroeconomic and exchange rate problems

International Monetary System Major events after 1973

OPEC 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 1980s. Dollar Crisis (1977-78) 1. U.S. B-O-P difficulties 2. Result of inconsistent monetary policy in U.S. 3. Dollar value falls as confidence shrinks.

International Monetary System The Rising Dollar (1980-85)

1. U.S. inflation subsides as the Fed raises interest rates 2. 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. II. III. . 1988 US$ stabilized Post-1991 Confidence resulted in stronger dollar 1993-1995 Dollar value falls

International Monetary System Financial Crisis 2007-12

Global 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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