The International Monetary System
Chapter 10
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The Gold Standard
Roots in old mercantile trade.
Inconvenient to ship gold, changed to paper
- redeemable for gold.
Want to achieve ‘balance-of-trade equilibrium
Japan
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USA
10-1
Between the Wars
Post WWI, war heavy expenditures affected
the value of dollars against gold
US raised dollars to gold from
$20.67 to $35 per ounce.
Dollar worth less?
Other countries followed suit and devalued
their currencies.
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Bretton Woods
In 1944, 44 countries met in New Hampshire
Countries agreed to peg their currencies to US$
which was convertible to gold at $35/oz.
Agreed not to engage in competitive devaluations
for trade purposes and defend their currencies.
Weak currencies could be devalued up to 10%
w/o approval.
IMF and World Bank created.
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Bretton Woods
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IMF
Created to police monetary system by ensuring
maintenance of the fixed-exchange rate.
Promote int’l monetary cooperation and facilitate
growth of int’l trade.
Wanted to avoid prewar problems, so
Created lending facilities to help countries with trade
deficits.
• Persistent borrowings leads to IMF control of a country’s
economic policy.
Created adjustable parities.
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10-5
Principal Duties
Surveillance of exchange rate policies. (No
longer fixed rate exchange.)
Financial assistance (including credits and loans)
Technical assistance (expertise in fiscal/monetary
policy).
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Sources of Funds
182 nations pay into fund according to the
size of their economy.
Funds remain their property.
Borrower repays loan in 1 to 5 years, with
interest.
No nation has ever defaulted; some are
given extensions.
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Membership in the IMF
Open to any country willing to agree to its
rules and regulations.
Must pay a deposit (quota)
Quota size reflects global importance of a
nation’s economy.
Quota determines voting powers.
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Largest Contributors
18.3
20
15
10
5.7
5.7
5.1
5.1
5
US
Germany
Japan
Britain
France
0
US
Germany
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Japan
Britain
France
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Largest Borrowers
$ Billion
25
21
20
15
11
Thailand
Russia
Indonesia
S. Korea
11.6
10
4
5
0
Thailand
Russia
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Indonesia
S. Korea
10-10
(International Bank for Reconstruction and Development)
Created to fund EUROPE’s reconstruction and help
3d world countries.
Overshadowed by Marshall Plan, so bank looked to
3d world.
Looked at public sector projects.
Country borrows money raised
by WB bond sales.
International Development Agency
created to help poorest countries.
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What Happened After
Bretton Woods?
Under BW, US required to deliver 1oz of gold to
any IMF member that gave US Treasury $35.00.
1958 -1971 US ran accumulated deficit of $56
billion.
US gold reserves shrank from $34.8 billion to
$12.2 billion.
Liabilities to foreign central banks increased
from $13.6 billion to $62.2 billion.
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Collapse of the Fixed Exchange
System
August 8, 1971, Nixon left gold standard?
March 19, 1972, Japan and most of Europe
floated their currencies.
Fully collapsed in 1973.
LBJ policies and Vietnam.
Floating currencies considered
to be a temporary fix.
Still going on today.
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US Dollar Movements
Recession Ends
160
150
140
Oil Crisis
Desert Storm
130
120
1990=100
110
100
90
1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994
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Floating Exchange Rates
Jamaica Agreement, 1976.
Floating rates acceptable.
Based primarily on supply/demand.
Managed float involves gov’t
manipulation in currency markets.
Gold abandoned as reserve asset.
IMF quotas increased, now $180B
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Managed Currency Floats
1985: ‘Group of 5’ met at Plaza Hotel in
NY and agreed on ‘right’ level for US
dollar.
G5 became G7 (now G8). Seeks to
stabilize exchange rates.
Difficult due to growth of Fx market.
 Annual volume up from $18 billion in 1979 to
$1.5 trillion today.
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Floating
Monetary policy autonomy
Trade balance adjustments.
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Fixed
Monetary discipline.
Speculation.
Uncertainty.
Trade balance adjustments.
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Exchange Rate Regimes
Pegged Exchange Rates.
Peg own currency to a major currency ($).
Popular among smaller nations.
Evidence of moderation of inflation.
Currency Boards.
Country commits to converting domestic currency on
demand into another currency at a fixed exchange
rate.
Country holds foreign currency reserves equal to
100% of domestic currency issued.
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How IMF Members Determine
Exchange Values
Inflexible
50
45
Somewhat
Flexible
40
Flexible
30
35
25
20
Peg to $
Peg to FFr
Pegged to Other
Currency
Movement Related to
Other Currency
Free Float
15
10
Figure 10.2
5
Managed Float
Other
0
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10-20
Post-Bretton Woods Financial
Crises
Currency crises:
when a speculative attack on a currency’s exchange value
results in a sharp depreciation of the currency’s value or
forces authorities to defend the currency.
Banking crises:
Loss of confidence in the banking system leading to a run on
the banks.
Foreign debt crises:
When a country cannot service its foreign debt obligations.
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Crises Have Common
Underlying Causes
Common causes:
High inflation
Widening current account deficit
Excessive expansion of domestic borrowing
Asset price inflation
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10-22
Incidence of Currency Crises
1975-1997
Number of Currency Crises per Country
Industrial
97
95
93
91
89
87
85
83
81
79
77
Emerging Market
1975
0.5
0.45
0.4
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0
Figure 10.3a
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Incidence of Banking Crises
1975-1997
Number of Banking Crises per Country
Industrial
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Figure 10.3b
97
95
93
91
89
87
85
83
81
79
77
Emerging Market
75
0.2
0.18
0.16
0.14
0.12
0.1
0.08
0.06
0.04
0.02
0
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Mexican Currency Crises of 1995
Peso pegged to U.S. dollar.
Mexican producer prices rise by 45% without
corresponding exchange rate adjustment.
Investments continued ($64B between 1990 1994.
Speculators began selling pesos and government
lacked foreign currency reserves to defend it.
IMF stepped in.
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Peso Movements
160
140
Index = 100
120
100
80
Mexico
60
40
20
0
94
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95
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Problems in Asian Market
Economies
Cronyism.
Too much money, dependence on
speculative capital inflows.
Lack of transparency in the financial sector.
Currencies tied to strengthening dollar.
Increasing current account deficits.
Weakness in the Japanese economy
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Impact of the Asian Financial Crisis on
US Imports
Appliances
1998
1997
1996
Motor Vehicles
TV & VCR
Toys
Apparel
0
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10
20
30
40
50
60 %
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Devalued Currency
120
Index = 100
100
80
Thailand
Indonesia
S. Korea
60
40
20
1997
1998
0
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Russia
Financial markets loss of confidence in
Russia’s ability to meet national and
international payments.
Led to loss of international reserves and roll
over of treasury bills reaching maturity.
Financial markets unable to determine
‘who’s in charge’.
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Government Actions
Exacerbating the Situation
Defacto devaluation of the ruble.
Unilateral restructuring of rubledenominated public debt.
90-day moratorium on foreign credits
repayment.
Hike in interest rates to defend ruble.
Duma rejects measures designed to alleviate
problems.
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Russia
Russian Rubles to US Dollar
Dec97
Feb98
Apr
Jun
Aug
Oct
Dec
Feb99
Apr
0
5
10
15
20
25
30
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Russia
Real GDP
2
1
0
-1
96
-2
-3
97
98
Percent
-4
-5
-6
-7
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IMF Policy Prescriptions
“One size fits all” prescription for
countries.
Rescue efforts exacerbate the
‘moral hazard’ problem.
Too powerful without
accountability.
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Impact on the Countries
Currency devaluation.
Declining investment.
Rising prices.
Rising unemployment.
Rising poverty.
Rising resentment?
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Investment Impacts
Loss of investment confidence.
Deflation of asset values.
Substantial corporate debt burdens.
Reversal of capital flows
Decline in access to operating cash.
Declines in domestic demand.
Compression of intra regional trade.
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