International Monetary

System
 Group 2

Putu Shandya Maharani 1506305117

Ida Ayu Artha Widya Sari 1506305143
 Learning objectives

Explain how exchanges rates influence the activities of

domestic and international companies
Identify the factors that help determine exchange rates
and their impact on business
Describe the primary methods of forecasting exchange
rates
Discuss the evolution of the currency international mon
-etary system and explain how it operates
 How Exchange rates influence business activities

Currencys exchange rate affects the

activities of both domestic and international companies. A country with a currency
that is weak (valued low relative to other currencies) will see a decline in the price
of its exports and an increase in the
price of its imports.

Lower prices for the countrys export on world markets can give companies the
opportunity to take market share away from companies whose product prices high
in comparison.
 Affect from Exchange Rate
A companies will improve profits if it sells its products in a country with strong
currency while sourcing from a country with a weak currency

affect the amount of profit a company earn from its international subsidiaries

Translating subsidiaries earnings from a weak host country currency into a strong home
currency reduces the amount of these earnings when stated into home currency. Likewise,
translating earnings into a weak home currency increases stated earnings in the home
currency
The international lowering of the value of a
currency by the nations government is
called devaluation

The international raising of its value by the

nations government, is called revaluation
 Desire for Stability and Predictability

Stable exchange rate improve the accuracy of financial planning and make cash flow
forecasts more precise.

Predictable exchange rate reduce the likelihood that the companies will be caught-off guard
by sudden and unexpected rate changes

They also reduces the need for costly insurance

Rather than purchasing insurance, companies would be better-off spending their money on
more productive activities, such as developing new products or designing more efficient
production methods.
 What factors determine exchange rates?

Law of One Price

Stripulates that an identical products must have an identical price in all countries
when the price is expressed in a common currency.

For example, suppose coal mined within the united states and germany is of
similar quality in each country. Suppose further that a kilogram of coal cost 1.5
in germany and $1 in the United states. Therefor the law of one price calculates
the expected exchange rate between the euro and dollar to be 1.5/$. However
suppose the actual euro/dollar exchange rate as witnessed on currency market is
1.2/$. A kilogram of coal still costs $1 in the United States and 1.5 in germany.
But to pay german coal with dollar denominated after the change in exchange
rate, one must convert not just $1 into euros, but $1.25 (the expected exchange
rate divided by the actual exchange rate, or 1.5/$1.2). thus price of coal is
higher in germany than in the United States
 Whats we learn from law one price

Moreover because the law of one price is being violated in our

example, an
arbitrage opportunity arisesthat is, an opportunity to buy a
product in one
country and sell it in a country where it has greater value.
 Purchasing power parity

Is the relative ability of two

countriescurrencies to
buy the same basket of goods in those
two
countries.

Suppose 650 baht in thailand will buy a bag of

groceries that costs $30 in the United States. The
question is : are thai consumer better off or worse off
than their counterparts in the united states?
Suppose the GNP per capita of each country as
follows:
 Information that we
use

Country Price a bag of GNP/ Capita Exchange rates in 1 GNP in dollars

groceries dollar
Thailand 650 baht 122,277 baht 41.45 baht 2.950 dollars

U.S. 30 dollars 26.980 dollars

We already know that 650 baht will buy in thailand what $30
will buy in the United States. Thus we calculate 650 : 30 = 21.67 baht
per dollar. Whereas the exchange rate on currency market is 41.45 baht/
$, the purchasing power parity rate of the bath is 21.67 baht /$. We can
now recalculate thailands GNP per capita at PPP as follows : 122,277 :
21.67 = 5.643. thai consumers on average are not nearly as affluent as
their counterparts in the United States. But when we consider the goods
and services that they can purchase with their bath-not the amount of
U.S. dollars that they can buy-we see that the GNP per capita at PPP of
$5.643 more accurately portrays the real purchasing power of thai
consumers
Role Of Inflation
Impact of money-supply decisions
because the damaging effects of
inflation, governments try to manage the
supply of and demand for their
currencies. We also called it as
monetary policy For example
selling government securities. Fiscal
policy involves using taxes and
government spending to influence the
money supply indirectly. For example
increase
taxes.
 What is Inflation ?

Inflation is the result of the supply an demand for

a currency. For example when money
Injected in to an economy that is not
producing greater output , it will make people
increasing their consumption. The price of
goods will be higher and consumer have to
spend more to consume.
Role Of Inflation

Impact of unemployment and interest rates

When unemployment rates are low, there is
shortage of
labor and employers pay higher wages to attract
employees.
They then usually raise the prices of their
products, that
causing inflation.
Interest rate affect inflation because they affect
the cost
borrowing money.
One way to cool off inflationary is to raising
interest rate.
 How exchange rates adjust to inflation

Adjustment
is necessary to maintain purchasing power
parity between nations.
The formula : )/
= exchange rate at the beginning at the period
=the inflation rate in country 1
=the inflation rate in country 2

High rates inflation will affecting the purchasing power

parity.
 Role Of Interest Rate

Two types interest rate : real interest rates and nominal interest rate.
Nominal interest rate consist of real interest rate plus an
additional charge for inflation. Bank usually gives nominal interest rate for
the loan. The use of this principle is as compensated for the erosion od
its purchasing power during the loan period
caused by inflation.

Fisher effect principle that the nominal interest rate is the sum of the
interest rate and expected rate of inflation over a specific period.
 The relation between exchange rate and interest rate

To illustrate this relation we refer to the international Fisher

effect- the principle that a difference in nominal interest rates
supported by two countries currencies will cause an equal but
opposite change in their spot exchange rates
Evaluating Purchasing power
parity
purchasing power parity is better at predicting long term
exchange rates, but accurate forecasts of short-term rates are
most beneficial to international managers
There are many possible reasons for the failure of PPP
to predict exchange rate accurately
Impact of added costs
For example transportation costs. Because PPP assume no
transportation costs
Impact of trade barriers
PPP also assume no barriers to international trade. For
example imposed tariff and quota
Impact of business confidence Psychology
FORECASTING EXCHANGE
RATES

Efficient Market View

Inefficient Market View

 Forecasting Techniques

Fundamental analysis
Techniques that uses statistical model based on fundamental economic
indicators to forecast exchange rate. This model include economic variable such
as inflation, interest rates, money supply, tax-rates and government spending
Technical analysis
Techniques that uses charts of post trends in currency prices and other factors to
forecast exchange rates

Dificulties of Forecasting

Highly sophisticated statistical technique in the hands of well-trained analyst

People might miscalculating the importance of economic news becoming available to the
market, placing too much emphasis on some elements and ignoring others.
Evolution of The Inte
rnational Monetary S
ystem
The Gold Standard

An international monetary system in which

nations linked the value of their paper
currencies to specific values of gold. Britain
was the first nation to implement the gold in
early 1700s.
 Advatages of The Gold Standar

1. Reduces the risk in exchange rates.

2. Imposes strict monetary policies.
3. Help correct a nations trade imbalance
 Collapse of The Gold Standar

The gold standard worked fairly well from the 1870s until the start
of World War I

After the war countries started regularly devaluing their currencies

to try to encourage exports

Confidence in the system fell, and people began to demand gold

for their currency putting pressure on countries' gold reserves, and
forcing them to suspend gold convertibility

The Gold Standard ended in 1939

 Bretton Woods Agreement
Agreement (1944) among nations to create a new international monetary
system based on the U.S. dollar.

GOAL

The system design to balance the strict discipline

of the gold standard with the flexibility that
countries needed to deal with temporary domestic
difficulties.
The Bretton Woods Agreement
established two multinational
institutions
1.The World Bank to promote general
economic development
2.The International Monetary Fund (IMF) to
maintain order in the international
monetary system
Special Drawing Right (SDR)
Valuation of SDR

U.S. dollar
9%
10% Euro
British pound
Japanese yen
23% 59%
Collapes of Bretton Woods Agreement
In the 1960s the Bretton Woods
system began to Falter
Problem:
U.S. was experiencing a
trade deficit (imports
were exceeding exports)
and a budget deficit
(expenses were
outstripping revenues)
A Manage Float System Emerges
Manage Float System is exchange rate
system in which currencies float against
one another, with governments
intervening to stabilize their currencies at
particular target exchange rates.
The Jamaica Agreement

At the Jamaica meeting, the IMF's Articles of Agreement were revised to reflect the new reality
of floating exchange rates
Under the Jamaican agreement
floating rates were declared acceptable
gold was abandoned as a reserve asset
Todays Exchange-Rate Agreement

Pegged Exchange-Rate Agreement

Currency Board
European Monetary System
In 1979, European Union (EU) created the European Monetary
System.

Goals:
Established to stabilize
exchange rates, promote
trade among nations, and
keep inflation low through
monetary discipline
Recent Financial Crisis

Developing Nations Debt Crisis

Mexico Peso Crisis
Southeast Asias Currency Crisis
Russias Ruble Crisis
Argentina Peso Crisis
Future of The International Monetary
System

Greater cooperation and

understanding among
the IMF, private sector
banks and debtor are
needed.