Transcript Chapter 10 slides

10
International
Monetary System
Copyright © 2014 Pearson Education, Inc.
Chapter Objectives
• Explain how exchange rates influence the
activities of domestic and international companies
• Identify the factors that help determine exchange
rates and their impact on business
• Describe the primary methods of forecasting
exchange rates
• Discuss the evolution of the current international
monetary system and explain how it operates
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The Euro
• Currency of 17 European nations
• Boosted efficiency and competitiveness
• Later declined with lower expectations
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Currency Values and Business
Exchange rates affect activities of both
domestic and international firms
Devaluation
Revaluation
Export prices
Import prices
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Major World Currencies
Source: Based on Economic Report of the President, Table B110, multiple years
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Stability and Predictability
Stable exchange rates
• Improve accuracy of forecasts
and financial planning
Predictable exchange rates
• Reduce surprises of unexpected rate changes
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Value of U.S. Dollar
Source: Based on Economic Report of the President, Table B110, multiple years
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Buying Power Example
Cost in New York… $60
Purchasing Power
Cost in Japan… $80
Cost in Mexico… $30
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Discussion Question
What are the key
differences between
the concepts of
devaluation and
revaluation?
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Answer to Discussion Question
Devaluation is the intentional
lowering of a currency’s value by a
nation’s government. It lowers the
price of a country’s exports and
increases the price of imports.
Devaluation reduces buying power.
Revaluation is the intentional raising
of a currency’s value by a nation’s
government. It increases the price of
a country’s exports and lowers the
price of imports. Revaluation boosts
buying power.
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Law of One Price
Identical item must
have an identical price
in all countries when
price is expressed in a
common currency
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Big Mac Index
Uses law of one price
and cost of a Big Mac
Estimates undervalued
and overvalued currencies
Fairly good predictor
of long-term rates
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Purchasing Power Parity
Relative ability of two nations’ currencies
to buy the same “basket” of goods in
those two nations
Focuses squarely on
local purchasing power
of a currency
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Considers price
levels in adjusting
relative currency values
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Effects of Inflation
Inflation erodes a currency’s purchasing power!
Source: Desmond Kwande/Getty Images/Newscom
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Inflation: Key Factors
Money supply
• Monetary policy directly affects interest
rates and money supply
• Fiscal policy indirectly affects taxes
and spending
Employment
• High employment raises wages, which
are embodied in consumer prices
Interest rates
• High interest rates lower borrowing and
spending, which lowers inflation
Adjustment
• Exchange rates adjust to maintain PPP
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Interest Rates
Fisher Effect
Nominal interest rate =
real rate + inflation rate
International
Fisher Effect
Difference in nominal interest rates
supported by two nations’ currencies
will cause an equal but opposite
change in their spot exchange rates
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Evaluating PPP
Added
costs
Trade
barriers
Business
confidence &
psychology
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Discussion Question
The principle known as the
__________ can be
interpreted as the exchange
rate between two nations’
currencies that is equal to the
ratio of their price levels.
a. Law of one price
b. International Fisher effect
c. Purchasing power parity
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Answer to Discussion Question
The principle known as the
__________ can be
interpreted as the exchange
rate between two nations’
currencies that is equal to the
ratio of their price levels.
a. Law of one price
b. International Fisher effect
c. Purchasing power parity
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Two Market Views
Efficient market view
• Forward exchange rates best
predict future rates
Inefficient market view
• Additional information can
improve rate forecasts
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Techniques of Forecasting
Fundamental analysis
• Statistical modeling
Technical analysis
• Chart currency trends
Forecasting difficulties
• Flawed data
• Human error
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Gold Standard: Early Years
Monetary system from the 1700s to 1939 that linked
national currencies to specific values of gold
Reduced exchange-rate risk
Restricted monetary policies
Corrected trade imbalances
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Gold 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
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Bretton Woods Agreement
International monetary system based on
value of U.S. dollar (1944 to 1973)
Fixed exchange
rates
Built-in flexibility
World Bank (IBRD)
International
Monetary Fund
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End 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
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Discussion Question
What characteristics
of the gold standard
lead some to call for
its return today?
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Answer to Discussion Question
The gold standard linked nations’ paper
currencies to values of gold and to each other.
This reduced exchange rate risk.
Nations had to convert their paper currency
into gold on demand by currency holders so
paper currency values could not grow faster
than the value of gold reserves. This imposed
strict monetary policies on nations.
A nation experiencing a trade deficit had to
decrease its supply of paper currency, which
lowered domestic prices, which lowered
export prices, which boosted exports until
trade was balanced. This helped correct trade
imbalances for nations.
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Jamaica Agreement
Formalized the managed float system of exchange
rates as the new international monetary system
Managed float system
Currencies float with
government intervention
Free float system
Currencies float without
government intervention
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The System Today
Managed float system
Pegged exchange rates
Currency board
European monetary system
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Adjusting to Currency Swings
Export strategies in the face of currency swings
Strong currency:
Weak currency:
 Prune operations
 Source domestically
 Adapt products
 Grow at home
 Source abroad
 Push exports
 Freeze prices
 Reduce expenses
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Financial Crises

Developing nations

Mexico

Southeast Asia

Russia

Argentina
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Europe’s Debt
Debt levels spiraled
out of control in
some European
nations recently. The
IMF and EU have
organized bailouts
for Greece, but the
austerity measures it
imposed angered
the people.
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Source: Simela Pantzartzi/Newscom
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Future of the International
Monetary System
• Greater IMF transparency
• Better manage risks
• Monitor “hot” money flows
• Private sector involvement
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Discussion Question
A __________ exchange
rate system is one in which
currencies float against one
another, with governments
intervening to stabilize their
currencies at particular
exchange rates.
a. Free float
b. Managed float
c. Jamaica float
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Answer to Discussion Question
A __________ exchange
rate system is one in which
currencies float against one
another, with governments
intervening to stabilize their
currencies at particular
exchange rates.
a. Free float
b. Managed float
c. Jamaica float
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