international monetary system
TRANSCRIPT
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The International
Monetary System
Part I
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Introduction
The international monetary system refers to
the institutional arrangements that countries
adopt to govern exchange rates
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Introduction
International monetary systems are sets of internationally agreed rules, conventions and supporting institutions that facilitate international trade, cross border investment and generally the reallocation of capital between nation states
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Introduction
It addresses to solve the problems relating to
international trade:
a. Liquidity
b. Adjustment
c. Stability
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The problem of Liquidity
The problem of liquidity existed even in the
domestic transactions through barter
system Barter system was replaced by precious
metals as a medium of exchange and store
of value Gold standard system of international
payments came into existence
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The Gold Standard
The first modern international monetary system was the gold standard
Put in effect in 1850Participants – UK,
France, Germany & USA
USAJapan
Gold
Trade
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Gold Standard- I ( 1876-1913)
● In this system, each currency was linked to a weight of gold
● Under gold standard, each country had to establish the rate at which its currency could be converted to a weight of gold
E.g. $ 20.67/ ounce ; Pound 4.247/ once
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Gold Standard- I ( 1876-1913)
● Most of the countries used to declare par value of their currency in terms of gold
● The problem was every country needed to maintain adequate reserves of gold in order to back its currency
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The Gold Standard
● After World War I, the exchange rates were
allowed to fluctuate
● Since gold was convertible into currencies
of the major developed countries, central
banks of different countries either held gold
or currencies of these developed countries
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The System of Bretton Woods ( 1944-71)
In July, 1944, 44 countries met in Bretton
Woods, New Hampshire, USA – a new
International Monetary System was created
John Maynard Keynes of Britain and Harry
Dexter White of USA were the key movers
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The Bretton Woods Agreement
Creation of International Monetary Fund (IMF)
to promote consultations and collaboration
on international monetary problems and
countries with deficit balance of payments Establish a par value of currency with
approval of IMF Maintain exchange rate for its currency
within one percent of declared par value
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The Bretton Woods Agreement
Each member to pay a quota into IMF pool –
one quarter in gold and the rest in their own
currency The pool to be used for lending Dollar was to be convertible to gold till
international instrument was introduced International Bank for Reconstruction and
Development (IBRD) was created to
rehabilitate war-torn countries and help
developing countries
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The System of Bretton Woods ( 1944-71)
So in effect this was a gold – dollar exchange
standard ( $35/ounce)- known as fixed
exchange rate system or adjustable peg Devaluation could not be resorted arbitrarily When BOP problem became structural i.e.
repetitive, devaluation upto ten percent was
permitted by IMF Thus each currency was tied to dollar directly
or indirectly
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Collapse of the Fixed Exchange System
The system of fixed exchange rates established at Bretton Woods worked well until the late 1960’s Any pressure to devalue the dollar would cause problems throughout the world The trade balance of the USA became highly negative and a very large amount of US dollars was held outside the USA ; it was more than the total gold holdings of the USA
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Collapse of the Fixed Exchange System
During end of sixties, European governments wanted gold in return for the dollar reserves they held On 15th Aug. 1971, President Nixon suspended the system of convertibility of gold and dollar and decided for floating exchange rate system
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The end of the Bretton Woods System (1972–81)
The system dissolved between 1968 and
1973
By March 1973, the major currencies began
to float against each other
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The end of the Bretton Woods System (1972–81)
IMF members have been free to choose any
form of exchange arrangement they wish
(except pegging their currency to gold): Allowing the currency to float freely Pegging it to another currency or a basket
of currencies Adopting the currency of another country,
participating in a currency bloc, or Forming part of a monetary union
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Exchange Systems after 1973
• Exchange Rate systems are classified on the basis of the flexibility that the monetary authorities show towards fluctuations in the exchange rates and are divided into two categories:
1. Systems with a fixed exchange rate ( “fixed peg” or “hard peg”) and
2. Systems with a flexible exchange rate ( “Floating” systems)
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Exchange Systems after 1973
• But as usual, between these two extreme positions there exists also an intermediate range of different systems with limited flexibility, usually referred to as “soft pegs”
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A fixed peg regime
A fixed peg regime exists when the exchange rate of the home currency is fixed to an anchor currency
This is the case with economies having currency boards or with no separate national currency of their own
Countries do not have a separate national currency, either when they have formally dollarized, or when the country is a member of a currency union, for example Euro
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Floating Exchange Rate System
● The collapse of Bretton Woods and Smithsonian Agreements coupled with oil crisis of 1970, the floating exchange rate system was adopted by leading industrialised countries
● Officially approved in April 1978
● Under the system, the exchange rate would be determined by market forces without the intervention of government
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Floating Exchange Rate System
● No country in the world has adopted freely floating exchange rate system
● Floating exchange rate regimes consist of independent floating and managed floating systems
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Independent Floating systems
In Independent Floating systems the exchange rate is market determined and monetary policy usually functions without exchange rate considerations
Foreign exchange interventions are rare and meant to prevent undue fluctuations
But no attempt is undertaken to achieve/maintain a particular rate
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Managed Floating systems
Managed Floating systems usually let the market take its own course but the monetary authorities intervene in the market to “manage” the exchange rate, if needed, to prevent high volatilities and to stimulate growth, without committing to a particular exchange rate level
The monetary authorities do not specify their opinion on “suitable” exchange rate level
The IMF calls this practice a “Managed Floating With No Predetermined Path for the Exchange Rate”
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Intermediate Regimes ( Soft Pegs)
• Intermediate exchange rate regimes consist of an array of differing systems allowing a varying degree of flexibility, such as conventional fixed exchange rate pegs, crawling pegs and exchange rate bands
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Conventional fixed exchange rate pegs
In a Conventional Fixed Peg arrangement a currency is pegged at a fixed rate to a major currency or a basket of currencies, allowing the exchange rate to fluctuate within a narrow margin of ±1 percent around a formal (or de facto) central rate
The monetary authority intervenes in the market, if the fluctuation is outside these limits
(post-crisis Malaysia, fixing Ringgit against US dollar for a rate of RM 3,8 per $1)
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Crawling Peg ( The Dirty Float)
● In this system an attempt is made to combine the advantages of fixed exchange rate with flexibility of floating exchange rate
● It fixes the exchange rate at a given level which is responsive to changes in market conditions i.e. it is allowed to crawl
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Crawling Peg ( The Dirty Float)
In a Crawling Peg arrangement the currency is adjusted periodically “in small amounts at a fixed rate or in response to changes in selective quantitative indicators (past inflation differentials vis-à-vis major trading partners…)
A Crawling Band allows a periodic adjustment of the exchange rate band itself
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Crawling Peg ( The Dirty Float)
● The upper and lower limits are decided for exchange rate depending demand and supply of foreign exchange
● As the exchange rate crosses these limits, fiscal and monetary policies come into play to push the exchange rate within the target zone
● But in this case, these limits are sustained for some time and if it is felt that economic indicators are being disturbed, the monetary authorities let the exchange rate depreciate or appreciate as the case may be
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Trends in Global Exchange Rate Regimes
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Exchange Rate Regimes IMF Members, 2006
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Exchange Rates Since 1973
• Since 1973, exchange rates have become more volatile and less predictable than they were between 1945 and 1973, due to:
Oil crisis -1971 Loss of confidence in the dollar - 1977-78 Oil crisis – 1979, OPEC increases price of oil Unexpected rise in the dollar - 1980-85 Rapid fall of the dollar - 1985-87 and 1993-95 Partial collapse of European Monetary System – 1992 Asian currency crisis - 1997
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Exchange Rates Since 1973
● The merits of each continue to be debated
● There is no agreement as to which system
is better
● Many countries today are disappointed
with the floating exchange rate system
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Implications For Managers
For managers, understanding the international monetary system is important for:
Currency management Business strategy Corporate-government relations
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Currency Management
Managers must recognize that the current international monetary system is a managed float system in which government intervention can help drive the foreign exchange market
Under the present system, speculative buying and selling of currencies can create volatile movements in exchange rates
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Business Strategy
Managers need to recognize that while
exchange rate movements are difficult to
predict, their movement can have a major
impact on the competitive position of
businesses
To contend with this situation, managers
need strategic flexibility e.g. dispersing
production to different locations
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Corporate-Government Relations
Managers need to recognize that
businesses can influence government
policy towards the international monetary
system
Companies should promote an
international monetary system that
facilitates international growth and
development
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Evolution of Indian Exchange Rate system
• 1931 – Rupee pegged to Pound Sterling – parity Rs. 1= shilling 1 and 6 pence
• 1944 – IMF asked nations to peg currency to dollar or gold – chose gold – parity again with sterling –
BP 1 = Rs. 13.33
• 1949 – Pound was devalued 30.5% so was
Rupee but 36.5% in dollar terms
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Evolution of Indian Exchange Rate system
• 1967 – Pound again devalued by 14.3% but India did not – it delinked rupee
from pound and linked it to dollar
• 1971 – Smithsonian Agreement – the international currencies were realigned– India returned to sterling
peg – parity BP = Rs. 18.9677
The fluctuation of (+)/(-) 2.25% was allowed
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Evolution of Indian Exchange Rate system
• Sept. 1975 – the sterling peg was replaced by a basket peg - The fluctuation band widened to
(+)/(-) 5%
• July 1991 – the rupee was devalued twice by 18-20%
• 1991-92 Budget - partial convertibility on current account
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Evolution of Indian Exchange Rate system
• 1992-93 Budget – the rupee was made fully convertible on current account and a liberalized exchange rate management system ( LERMS) was introduced
• Presently, FEDAI announces indicative rates on every business day . RBI has discretion to enter the market to stabilise the exchange rate
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