InternationalMonetary System
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
10
10 - 2Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Currency Values and BusinessCurrency Values and Business
Exchange rates affect activities of both domestic and international firms
Devaluation Revaluation
Export prices
Import prices
10 - 3Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Major World CurrenciesMajor World Currencies
Source: Based on Economic Report of the President, Table B110, multiple years
10 - 4Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Stability and PredictabilityStability and Predictability
Stable exchange rates• Improve accuracy of forecasts and financial planning
Predictable exchange rates
• Reduce surprises of unexpected rate changes
10 - 5Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Value of U.S. DollarValue of U.S. Dollar
Source: Based on Economic Report of the President, Table B110, multiple years
10 - 6Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Buying Power ExampleBuying Power Example
Cost in New York… $60 Purchasing Power
Cost in Japan… $80
Cost in Mexico… $30
10 - 7Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Law of One PriceLaw of One Price
Identical item must have an identical price in all countries when
price is expressed in a common currency
10 - 8Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Big Mac IndexBig Mac Index
Uses law of one priceand cost of a Big MacUses law of one priceand cost of a Big Mac
Fairly good predictorof long-term rates
Fairly good predictorof long-term rates
Estimates undervaluedand overvalued currencies
Estimates undervaluedand overvalued currencies
10 - 9Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Purchasing Power ParityPurchasing Power Parity
Relative ability of two nations’ currenciesRelative ability of two nations’ currenciesto buy the same “basket” of goods into buy the same “basket” of goods in
those two nationsthose two nations
Focuses squarely onFocuses squarely onlocal purchasing powerlocal purchasing power
of a currencyof a currency
Considers priceConsiders pricelevels in adjustinglevels in adjusting
relative currency valuesrelative currency values
10 - 10Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Effects of InflationEffects of Inflation
Inflation erodes a currency’s purchasing power!
10 - 11Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Inflation: Key FactorsInflation: Key Factors
• Monetary policy directly affects interest rates and money supply
• Fiscal policy indirectly affects taxes and spending
• High employment raises wages, which are embodied in consumer prices
• High interest rates lower borrowing and
spending, which lowers inflation
• Exchange rates adjust to maintain PPP
Money supply
Employment
Interest rates
Adjustment
10 - 12Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Fisher Effect
InternationalFisher Effect
Nominal interest rate =real rate + inflation rate
Difference in nominal interest ratessupported by two nations’ currencies
will cause an equal but oppositechange in their spot exchange rates
Interest RatesInterest Rates
10 - 13Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Evaluating PPPEvaluating PPP
Addedcosts
Tradebarriers
Businessconfidence & psychology
10 - 14Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Two Market ViewsTwo Market Views
Efficient market view• Forward exchange rates best predict future rates
Inefficient market view• Additional information can improve rate forecasts
10 - 15Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Techniques of ForecastingTechniques of Forecasting
Fundamental analysis• Statistical modeling
Technical analysis• Chart currency trends
Forecasting difficulties• Flawed data• Human error
10 - 16Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Adjusting to Currency SwingsAdjusting to Currency Swings
Strong currency: Prune operations
Adapt products
Source abroad
Freeze prices
Export strategies in the face of currency swings
Weak currency: Source domestically
Grow at home
Push exports
Reduce expenses
10 - 17Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Gold Standard: Early YearsGold Standard: Early Years
Monetary system from the 1700s to 1939 that linked national currencies to specific values of gold
Restricted monetary policiesRestricted monetary policies
Reduced exchange-rate riskReduced exchange-rate risk
Corrected trade imbalancesCorrected trade imbalances
10 - 18Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Gold Standard CollapseGold Standard Collapse
Printing excessive money caused high inflation
British pound returns at its pre-inflation level
U.S. dollar returns at its lower (devalued) level
Competitive devaluations force system to collapse
10 - 19Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Fixed exchange rates
Fixed exchange rates
Built-in flexibilityBuilt-in flexibility
International Monetary FundInternational
Monetary FundWorld Bank (IBRD)World Bank (IBRD)
Bretton Woods AgreementBretton Woods Agreement
International monetary system based onvalue of U.S. dollar (1944 to 1973)
10 - 20Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
End of Bretton WoodsEnd of Bretton Woods
Nations demand gold in return for their paper U.S. dollars
Nations raise their currency values relative to dollars
Persistently weak dollar forces nations to leave the system
Most currencies begin to float freely against the dollar
10 - 21Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Jamaica AgreementJamaica Agreement
Formalized the managed float system of exchangerates as the new international monetary system
Free float system
Currencies float withoutgovernment intervention
Free float system
Currencies float withoutgovernment intervention
Managed float system
Currencies float withgovernment intervention
Managed float system
Currencies float withgovernment intervention
10 - 22Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
The System TodayThe System Today
Managed float system
Pegged exchange rates
Currency board
European monetary system
10 - 23Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Financial CrisesFinancial Crises
Developing nations
Mexico
Southeast Asia
Russia
Argentina
10 - 24Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Europe’s DebtEurope’s Debt
Debt levels spiraled out of control in some European nations recently. In 2010, the IMF and EU organized a bailout for Greece, but the austerity measures it imposed angered the people.