International Business - The International Monetary System

What are the implications of a depreciated currency?

1. A relatively depreciated currency encourages exports and expenditure switching from imports to domestic goods 2. When currencies depreciate, export competing industries gain at the expense of domestic consumers and nontraded industries 3. Depreciation can have contractionary effects that follows from higher prices

Corporate Government Relations

1. Businesses can influence government policy towards the international monetary system 2. Companies should promote a system that facilitates international growth and development

What 3 things should managers be aware of as a result of the monetary system?

1. Currency Management 2. Business Strategy 3. Corporate-government relations

Business Strategy

1. Exchange rate movements can have a major impact on the competitive position of businesses 2. Need flexibility

What were the provisions of the Jamaican agreement?

1. Floating rates declared acceptable 2. Gold abandoned as a reserve asset 3. Total annual IMF quotas - the amount member countries contribute to the IMF - were increased to $41 billion - today they are about $767 billion

What two multinational monetary institutions did Bretton Woods Establish?

1. IMF 2. World Bank

What caused the collapse of Bretton Woods?

1. Increase in U.S. money supply to finance welfare programs and the Vietnam War led to inflation 2. Other countries increased the value of their currencies relative to the U.S. dollar in response to speculation the dollar would be devalued 3. Because the system relied on an economically well managed U.S., when the U.S. began to print money, run high trade deficits, and experience high inflation, the system was strained to the breaking point 4. U.S. dollar came under Speculative attack

Currency Managment

1. The current system is a managed float government intervention can influence exchange rates 2. Speculation can also create volatile movements in exchange rates

Three types of FX risk

1. Transactional Exposure 2. Translational Exposure 3. Economic (Competitive) Exposure

What are the implications of an appreciated currency?

1. When currencies appreciate, export competing industries lose while domestically- oriented industries gain 2. Domestic consumers/voters also gain as the domestic currency price of imported goods falls, lowering the cost of living

Four Components of Bretton Woods

1. a fixed exchange rate system was established 2. all currencies were fixed to gold, but only the U.S. dollar was directly convertible to gold 3. Devaluations could not to be used for competitive purposes 4. A country could not devalue its currency by more than 10% without IMF approval

What was the Jamaican agreement?

1976 meeting in Jamaica to establish the new exchange rate system

Floating Exchange Rate System

A country allows the foreign exchange market to determine the relative value of a currency

Pegged Exchange Rate System

A country fixes the value of its currency relative to a reference currency

Intermediate/Dirty/Managed Float

A country tries to hold the value of its currency within some range of a reference currency such as the U.S. dollar

How does a peg affect a country's risk premium?

A peg can reduce the country risk premium, leading to lower borrowing costs for government and private sector

How is a peg related to international reserves?

A peg requires international reserves, especially if it come under attack from speculators

How does a peg affect trade?

A peg to trade partners has been shown to promote trade and economic integration (i.e.; Panama)

What are some examples of intermediate or "managed float" countries?

Colombia, India, Indonesia, Peru, Singapore, Costa Rica and China (very managed)

What are intermediate or managed float countries?

Countries that allow their currencies to fluctuate "float" on the daily Forex market within a narrow (+1 or -1) or wide (up to +30 or -30) range

Fixed Exchange Rate System

Exists when countries fix their currencies against each other at some mutually agreed on exchange rate

Transactional Exposure

Exposure that occurs from transactions (sales or purchases) that are in a foreign currency

Translational Exposure

Exposures that arise from translation of account balances recorded in foreign currencies other than the entity's reporting currency

How does a floating rate affect monetary policy?

Floating provides the opportunity to pursue autonomous monetary policy

What system should groups involved in domestic economies favor?

Floating regime that allows government monetary policy to stabilize domestic conditions

Currency Board

Government sets a conversion rate to a foreign currency and guarantees full convertibility through accumulation of reserves (e.g., Hong Kong pegs to the U.S. $)

What are fixed "pegged" exchange rate countries?

Governments establish a fixed price for their currency in terms of another country's currency (global reserve currency = U.S.$) or a "basket" of currencies

How do the central banks of managed float countries manipulate the currency?

Intervene in the currency markets by buying and selling to manage the rate of exchange

Purpose of the IMF

Maintain order in the international monetary system through a combination of discipline and flexibility

How have exchange rates behaved since 1973 compared to between 1945 and 1973?

More volatile and less predictable

Dollarization

Partial or full: eliminate the domestic currency and replace with the U.S. $ (e.g.; Panama, El Salvador) or another currency (e.g., Liechtenstein uses Swiss franc)

Purpose of the World Bank

Promote general economic development

Economic Exposure

Risks that arise when changes in exchange rate impact the competitive dynamics facing a company, for example changing the cost structure of a foreign competitor

What are the implications of liability dollarization?

Sharp depreciation can lead to widespread defaults for dollar borrowers, creating incentives to manage a float

What monetary system should groups involved in foreign trade and investment favor?

Should favor fixed rate systems because exchange rate stability promotes trade and investment

What are "free floating" currency countries?

The currency's value floats in the Forex market; governments allow market forces to determine the exchange rate

International Monetary System

The institutional arrangements that countries adopt to govern exchange rates

How do fixed exchange rate governments maintain their peg?

Through the Forex market and/or monetary policy/open market operations

What are some examples of floating rate countries?

U.S., Canada, UK, EU, Australia, New Zealand, Mexico, Sweden

Foreign Exchange Hedging

Using various methods to minimize or eliminate foreign exchange risk.

Foreign Exchange Risk

When a company deals with a foreign currency or must exchange foreign currency for its home currency, foreign exchange risk is the possibility that the currency will change unfavorably before payment is made or received in that currency.

What is the fixed price of a currency pegged to?

the dollar or a basket of currencies