The International Monetary System

Chapter 10

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 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

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10-1
 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.
© McGraw Hill Companies, Inc., 2000 10-2
 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.
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 Bretton Woods

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10-4
 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
 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).

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 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.
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10-7
 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.

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10-8
 Largest Contributors
18.3
20

15

10 5.7 5.7 5.1 5.1 US

Germany
Japan
5
Britain
France
0
US Germany Japan Britain France

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

 Largest Borrowers
$ Billion
25
21
20

15 Thailand
11 11.6
Russia
10 Indonesia
4 S. Korea
5

0
Thailand Russia Indonesia S. Korea

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

 (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.
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10-11
 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
 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
 US Dollar Movements
Recession Ends
160
150
Desert Storm
140 Oil Crisis
130
1990=100
120
110

100
90
1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994

© McGraw Hill Companies, Inc., 2000 10-14

 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
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10-15
 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
 Floating

Monetary policy autonomy

Trade balance adjustments.

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10-17
 Fixed

Monetary discipline.
Speculation.
Uncertainty.
Trade balance adjustments.

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10-18
 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.
© McGraw Hill Companies, Inc., 2000 10-19
 How IMF Members Determine
Exchange Values
50 Peg to $
Inflexible
45
Somewhat Peg to FFr
40
Flexible
35 Pegged to Other
Flexible 30 Currency
Movement Related to
25
Other Currency
20 Free Float
15
10 Managed Float
Figure 10.2 5
Other
0

© McGraw Hill Companies, Inc., 2000 10-20

 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.

© McGraw Hill Companies, Inc., 2000 10-21

 Crises Have Common
Underlying Causes

Common causes:
High inflation
Widening current account deficit
Excessive expansion of domestic borrowing
Asset price inflation

© McGraw Hill Companies, Inc., 2000 10-22

 Incidence of Currency Crises
1975-1997
Number of Currency Crises per Country
0.5
0.45
0.4
0.35 Industrial
0.3 Emerging Market
0.25
0.2
0.15
0.1
0.05
0
77

79

81

83

85

87

89

91

93

95

97
1975

Figure 10.3a
© McGraw Hill Companies, Inc., 2000 10-23
 Incidence of Banking Crises
1975-1997
Number of Banking Crises per Country
0.2
0.18 Industrial
0.16 Emerging Market
0.14
0.12
0.1
0.08
0.06
0.04
0.02
0
75

77

79

81

83

85

87

89

91

93

95

97
Figure 10.3b
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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.
© McGraw Hill Companies, Inc., 2000 10-25
 Peso Movements
160
140
120
Index = 100

100
80 Mexico
60
40
20
0
94 95

© McGraw Hill Companies, Inc., 2000 10-26

 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
© McGraw Hill Companies, Inc., 2000 10-27
Impact of the Asian Financial Crisis on
US Imports

Appliances
1998
Motor Vehicles 1997
1996
TV & VCR

Toys

Apparel

0 10 20 30 40 50 60 %

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

 Devalued Currency
120

100

80
Index = 100

Thailand
60 Indonesia
S. Korea
40

20
1997 1998
0

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

 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’.

© McGraw Hill Companies, Inc., 2000 10-30

 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.
© McGraw Hill Companies, Inc., 2000 10-31
 Russia
Russian Rubles to US Dollar
Dec- Feb- Feb-
97 98 Apr Jun Aug Oct Dec 99 Apr
0

10

15

20

25

30

© McGraw Hill Companies, Inc., 2000 10-32

 Russia
Real GDP

2
1
0
-1 96 97 98
-2
Percent
-3
-4
-5
-6
-7

© McGraw Hill Companies, Inc., 2000 10-33

 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

 Impact on the Countries
Currency devaluation.
Declining investment.
Rising prices.
Rising unemployment.
Rising poverty.
Rising resentment?

© McGraw Hill Companies, Inc., 2000 10-35

 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.

© McGraw Hill Companies, Inc., 2000 10-36