Bisnis Internasional

Hafiza Adlina, MBA

 The International Monetary System
• The international monetary system refers to the institutional arrangements that govern exchange rates. In Chapter 10 we assumed the foreign
exchange market was the primary institution for determining exchange rates, and the impersonal market forces of demand and supply determined
the relative value of any two currencies (i.e., their exchange rate). Furthermore, we explained that the demand and supply of currencies is influenced
by their respective countries' relative inflation rates and interest rates. When the foreign exchange market determines the relative value of a currency,
we say that the country is adhering to a floating exchange rate regime. Four of the world's major trading currencies-the U.S. dollar, the European
Union's euro, the Japanese yen, and the British pound-are all free to float against each other. Thus, their exchange rates are determined by market
forces and fluctuate against each other day to day, if not minute to minute. However, the exchange rates of many currencies are not determined by
the free play of market forces; other institutional arrangements are adopted.
• Many of the world's developing nations peg their currencies, primarily to the dollar or the euro. A pegged exchange rate means the value of the
currency is fixed relative to a reference currency, such as the U.S. dollar, and then the exchange rate between that currency and other currencies is
determined by the reference currency exchange rate. Similarly, many of the states around the Gulf of Arabia have long pegged their currencies to the
dollar.
• Other countries, while not adopting a formal pegged rate, try to hold the value of their currency within some range against an important reference
currency such as the U.S. dollar, or a "basket" of currencies. This is often referred to as a dirty float. It is a float because in theory, the value of the
currency is determined by market forces, but it is a dirty float (as opposed to a clean float) because the central bank of a country will intervene in the
foreign exchange market to try to maintain the value of its currency if it depreciates too rapidly against an important reference currency. This has been
the policy adopted by the Chinese since July 2005. The value of the Chinese currency, the yuan, has been linked to a basket of other currencies,
including the dollar, yen, and euro, and it is allowed to vary in value against individual currencies, but only within tight limits. As discussed in Chapter
5, some believe the Chinese are deliberately holding down the value of their currency to promote exports.
• Still other countries have operated with a fixed exchange rate, in which the values of a set of currencies are fixed against each other at some mutually
agreed on ex, change rate. Before the introduction of the euro in 1999, several member states of the European Union operated with fixed exchange
rates within the context of the European Monetary System (EMS). For a quarter of a century after World War II, the world's major industrial nations
participated in a fixed exchange rate system. Although this system collapsed in 1973, some still argue that the world should attempt to reestablish it.
The Gold Standard

• The gold standard had its origin in the use of gold coins as a medium of exchange,
unit of account, and store of value-a practice that dates to ancient times. When
international trade was limited in volume, payment for goods purchased from
another country was typically made in gold or silver. However, as the volume of
international trade ex panded in the wake of the Industrial Revolution a more
convenient means of financing international trade was needed. Shipping large
quantities of gold and silver around the world to finance international trade seemed
impractical. The solution adopted was to arrange for payment in paper currency and
for governments to agree to convert the paper currency into gold on demand at a
fixed rate.
Strength of The Gold Standard

• The great strength claimed for the gold standard was that it contained a powerful mechanism for achieving balance-of-trade
equilibrium by all countries. A country is said to be in balance-of-trade equilibrium when the income its residents earn from
exports is equal to the money its residents pay to other countries for imports (the current account of its balance of payments is in
balance). Suppose there are only two countries in the world, Japan and the United States. Imagine Japan's trade balance is in
surplus because it exports more to the United States than it imports from the United States. Japanese ex porters are paid in U.S.
dollars, which they exchange for Japanese yen at a Japanese bank. The Japanese bank submits the dollars to the U.S. government
and demands payment of gold in return. (This is a simplification of what would occur, but it will make our point.)
• Under the gold standard, when Japan has a trade surplus, there will be a net flow of gold from the United States to Japan. These
gold flows automatically reduce the U.S. money supply and swell Japan's money supply. As we saw in Chapter 9, there is a close
connection between money supply growth and price inflation. An increase in money supply will raise prices in Japan, while a
decrease in the U.S. money supply will push U.S. prices downward. The rise in the price of Japanese goods will decrease demand
for these goods, while the fall in the price of U.S. goods will increase demand for these goods. Thus, Japan will start to buy more
from the United States, and the United States will buy less from Japan, until a balance-of-trade equilibrium is achieved.
• This adjustment mechanism seems so simple and attractive that even today, almost 70 years after the final collapse of the gold
standard, some people believe the world should return to a gold standard.
 • The IMF Articles of Agreement were
heavily influenced by the worldwide
financial col lapse, competitive
devaluations, trade wars, high
unemployment, hyperinflation in
The Role of Germany and elsewhere, and
general economic disintegration that

IMF occurred between the two world

wars. The aim of the Bretton Woods
agreement, of which the IMF was
the main custodian, was to try to
avoid a repetition of that chaos
through a combination of discipline
and flexibility.
The Role of The World Bank

• The official name for the World Bank is the International Bank for Reconstruction and Development (IBRD). When the Bretton Woods
participants established the World Bank, the need to reconstruct the war-tom economies of Europe was foremost in their minds. The bank's
initial mission was to help finance the building of Europe's economy by providing low-interest loans. As it turned out, the World Bank was
overshadowed in this role by the Marshall Plan, under which the United States lent money directly to European nations to help them rebuild.
So the bank turned its attention to development and began lending money to Third World nations. In the 1950s, the bank concentrated on
public-sector projects. Power stations, road building, and other transportation investments were much in favor. During the 1960s, the bank
also began to lend heavily in support of agriculture, education, population control, and urban development.
• The bank lends money under two schemes. Under the IBRD scheme, money is raised through bond sales in the international capital market.
Borrowers pay what the bank calls a market rate of interest-the bank's cost of funds plus a margin for expenses. This "market" rate is lower
than commercial banks' market rate. Under the IBRD scheme, the bank offers low-interest loans to risky customers whose credit rating is
often poor, such as the governments of underdeveloped nations.
• A second scheme is overseen by the International Development Association (IDA), an arm of the bank created in 1960. Resources to fund IDA
loans are raised through subscriptions from wealthy members such as the United States, Japan, and Germany. IDA loans go only to the
poorest countries. Borrowers have 50 years to repay at an interest rate of 1 percent a year. The world's poorest nations receive grants and
interest-free loans.
The Collapse of the Fixed Exchange Rate
System

• The system of fixed exchange rates established at Bretton Woods worked well until the late 1960s, when it began to show signs of strain. The
system finally collapsed in 1973, and since then we have had a managed-float system. To understand why the system col lapsed, one must
appreciate the special role of the U.S. dollar in the system. As the only currency that could be converted into gold, and as the currency that
served as the refer ence point for all others, the dollar occupied a central place in the system. Any pressure on the dollar to devalue could wreak
havoc with the system, and that is what occurred.
• Most economists trace the breakup of the fixed exchange rate system to the U.S. macroeconomic policy package of 1965-1968.4 To finance both
the Vietnam conflict and his welfare programs, President Lyndon Johnson backed an increase in U.S. government spending that was not financed
by an increase in taxes. Instead, it was financed by an increase in the money supply, which led to a rise in price inflation from less than 4 per cent
in 1966 to close to 9 percent by 1968. At the same time, the rise in government spending had stimulated the economy. With more money in
their pockets, people spent more-particularly on imports-and the U.S. trade balance began to deteriorate.
• The increase in inflation and the worsening of the U.S. foreign trade position gave rise to speculation in the foreign exchange market that the
dollar would be devalued. Things came to a head in the spring of 1971 when U.S. trade figures showed that for the first time since 1945, the
United States was importing more than it was exporting. This set off massive purchases of German deutsche marks in the foreign exchange
market by speculators who guessed that the mark would be revalued against the dollar. On a single day, May 4, 1971, the Bundesbank
(Germany's central bank) had to buy $1 billion to hold the dollar/deutsche mark exchange rate at its fixed exchange rate given the great demand
for deutsche marks. On the morning of May 5, the Bundesbank purchased an other $1 billion during the first hour of foreign exchange trading!
At that point, the Bundesbank faced the inevitable and allowed its currency to float.
The Floating Exchange Rate Regime

• The floating exchange rate regime that followed the collapse of the fixed
exchange rate system was formalized in January 1976 when IMF members met
in Jamaica and agreed to the rules for the international monetary system that
are in place today.
The Jamaica Agreement

The Jamaica meeting revised the IMF's Articles of Agreement to reflect the new reality of floating exchange
rates. The main elements of the Jamaica agreement include the following:
• Floating rates were declared acceptable. IMF members were permitted to enter the foreign exchange market
to even out "unwarranted" speculative fluctuations.
• Gold was abandoned as a reserve asset. The IMF returned its gold reserves to members at the current
market price, placing the proceeds in a trust fund to help poor nations. IMF members were permitted to sell
their own gold reserves at the market price.
• Total annual IMF quotas-the amount member countries contribute to the IMF-were increased to $41 billion.
(Since then they have been increased to $300 billion while the membership of the IMF has been expanded
to include 184 countries. In 2009, the IMF was seeking to increase its funding to help with the global
financial crisis). Non-oil-exporting, less developed countries were given greater access to IMF funds.
Exchange Rates Since 1973

Since March 1973, exchange rates have become much more volatile and less predictable than they were between 1945 and 1973.5 This volatility has been partly due to a
number of unexpected shocks to the world monetary system, including:

• The oil crisis in 1971, when the Organization of Petroleum Exporting Countries (OPEC) quadrupled the price of oil. The harmful effect of this on the U.S. inflation rate
and trade position resulted in a further decline in the value of the dollar.
• The loss of confidence in the dollar that followed a sharp rise in the U.S.

• inflation rate in 1977-1978.

The oil crisis of 1979, when OPEC once again increased the price of oil

• dramatically-this time it was doubled.

• The unexpected rise in the dollar between 1980 and 1985, despite a deteriorating balance-of-payments picture.
The rapid fall of the U.S. dollar against the Japanese yen and German deutsche mark between 1985 and 1987, and against the yen between 1993 and 1995. The partial
collapse of the European Monetary System in 1992.

• The 1997 Asian currency crisis, when the Asian currencies of several countries, including South Korea, Indonesia, Malaysia, and Thailand, lost between
50 percent and 80 percent of their value against the U.S. dollar in a few months. The decline in the value of the U.S. dollar from 2001 to 2009.
 • The breakdown of the Bretton Woods
system has not stopped the debate about
Fixed versus the relative merits of fixed versus floating
exchange rate regimes. Disappointment

Floating with the system of floating rates in recent

years has led to renewed debate about the
merits of fixed exchange rates. This section
Exchange reviews the arguments for fixed and floating
exchange rate regimes.9 We will discuss the

Rates
case for floating rates before studying why
many commentators are disappointed with
the experience under floating exchange
rates and yearn for a system of fixed rates.
Points

• The gold standard is a monetary standard that pegs currencies to gold and guarantees convertibility to gold. It
was thought that the gold standard contained an automatic mechanism that contributed to the simultaneous
achievement of a balance-of-payments equilibrium by all countries. The gold standard broke down during the
1930s as countries
• The Bretton Woods system of fixed exchange rates was established in 1944. The U.S. dollar was the central
currency of this system; the value of every other currency was pegged to its value. Significant exchange rate
devaluations were al lowed only with the permission of the IMF. The role of the IMF was to maintain order in
the international monetary system (i) to avoid a repeti tion of the competitive devaluations of the 1930s and
(ii) to control price inflation by imposing monetary discipline on countries.
• The fixed exchange rate system collapsed in 1973, primarily due to speculative pressure on the dollar following
a rise in U.S. inflation and a growing U.S. balance-of-trade deficit engaged in competitive devaluations.
Points
• Since 1973 the world has operated with a float ing exchange rate regime, and exchange rates have become
more volatile and far less predict able. Volatile exchange rate movements have helped reopen the debate
over the merits of fixed and floating systems.
• The case for a floating exchange rate regime claims (i) such a system gives countries autonomy regarding
their monetary policy and (ii) floating exchange rates facilitate smooth adjustment of trade imbalances.
• The case for a fixed exchange rate regime claims (i) the need to maintain a fixed exchange rate imposes
monetary discipline on a country, (ii) floating exchange rate regimes are vulnerable to speculative pressure,
(iii) the uncertainty that accompanies floating exchange rates dampens the growth of international trade
and investment, and (iv) far from correcting trade imbalances, depreciating a currency on the foreign
exchange market tends to cause price inflation.
Points
• In today's international monetary system, some countries have adopted floating exchange rates, some have pegged their currency to
another currency such as the U.S. dollar, and some have pegged their currency to a basket of other currencies, allowing their currency to
fluctuate within a zone around the basket.
• In the post-Bretton Woods era, the IMF has continued to play an important role in helping countries navigate their way through financial
crises by lending significant capital to embattled governments and by requiring them to adopt certain macroeconomic policies
• An important debate is occurring over the appropriateness of IMF-mandated macroeconomic policies. Critics charge that the IMF often im-
poses inappropriate conditions on developing nations that are the recipients of its loans.
• The present managed-float system of exchange rate determination has increased the importance of currency management in international
businesses.
• The volatility of exchange rates under the present managed-float system creates both opportunities and threats. One way of responding to
this volatility is for companies to build strategic flexibility and limit their economic exposure by dispersing production to different locations
around the globe by contracting out manufacturing (in the case of low-value-added manufacturing) and other means.