Deck 11: The International Monetary System

Question 1

Why did the gold standard collapse? Is there a case for returning to some type of gold standard? What is it?

Answer 1

Under the gold standard, all currencies were backed by gold. Currencies were valued based on the amount of gold the currency could be exchanged for. The massive cost of World War one forced many major nations to print money. In order to avoid a collapse in the value of their currency, said countries unlinked their currencies from gold. After the war, Britain tried to return to the same gold to currency ratio. Due to limited supplies of gold and large amounts of circulating currency, this required either a massive decrease in the amount of circulating currency or a massive expense in gold to speculators who converted pounds into gold in anticipation of the end of currency conversion to gold. The decrease in the amount of currency caused deflation. Britain's exports grew less competitive and unemployment spiked. Britain did not desire to spend all her gold reserves supporting the conversion rate and dropped off the gold standard. This improved Britain's economic position. The US then decided to decrease the amount of gold a dollar could buy. This made US exports more competitive, and other countries copied the US. Soon everyone bought gold rather than holding to currencies in anticipation of more currency devaluations. This speculation put most nation's in the same situation Britain was in, and they dropped the gold standard too.
Yes.
The main argument for the gold standard is the existence of a balance-of-trade-equilibrium. If there is ever a difference between exports and imports, there will be a flow of gold from the country that is importing too much to the country that is exporting too much. As currencies are backed by gold, there will be inflation in the exporter and deflation in the importer. This will soon cause exports to equal imports. No currency manipulations by modern day China, Japan, (or depression era US) would be possible. Countries currently economically dominant will stay dominant at the expense of countries that are currently experiencing economic growth.

Question 2

The International Monetary System
Use the globalEDGE Resource Desk (http://globaledge.msu.edu/Reference-Desk) to complete the following exercises:
The International Capital Markets division of the International Monetary Fund (IMF) publishes the Global Financial Stability Report, a semi-annual report that provides an assessment of global financial markets. Find the Global Financial Stability Map in the most recent report. Provide a description of the indicators used to construct the map, and briefly summarize what the most current map illustrates in terms of changes in financial stability risks.

Answer 2

The Global Financial Stability Map for 2013 shows the difference between the pictures in April 2013 to October 2013.
This map is plotted on four risks and under two sets of conditions. The risks are:
1) Macroeconomic Risks
2) Emerging Markets Risks
3) Credit Risks
4) Market and Liquidity Risks
And the conditions are:
5) Risk Appetite
6) Monetary and Financial.
During this period the trend has been:
1) Macroeconomic Risks - Overall the risk level has remained the same. However the Sovereign Risk and Economic Activity show a negative trend while the Inflation Variability shows a positive movement.
2) Emerging Markets Risks - Overall the trend is negative. This is because the fundamentals, liquidity, inflation and the corporate sector are all showing a declining trend.
3) Credit Risks - Overall the risk level remained the same. The European banking sector along with households and the corporate sector showed a negative trend while the non-European banking sector showed a positive outlook.
4) Market and Liquidity Risks - Overall trend is negative, with liquidity and funding, volatility, equity valuations and market positioning all pointing downwards
5) Risk Appetite - This has increased for institutional allocations. This as decreased for relative assets returns and has shown a similar downward trend in investor surveys and emerging markets.
6) Monetary and Financial - The overall position is the same. There are tighter monetary conditions as well as unfavorable conditions in both emerging and advanced markets. The only positive is the easier lending conditions and the quantitative easing balance sheet expansion.

Question 3

What are the implications of the volatile exchange rates we have seen since 1973 for the risks confronting international businesses?

Answer 3

The volatile nature of the exchange rates since 1973, have seen businesses taking a few steps to try and mitigate these risks. These include:
1) Using the currency forward market and currency swaps to mitigate the short-term fluctuation risks. Unfortunately these tools cannot be used beyond a few months or at the most one year.
2) Dispersing the production so that the currency volatility effects are minimized. Ideally situating majority of one's production in one's largest market would be an ideal scenario. Where this is not possible, getting one's inputs priced in the final selling currencies is another step in that direction.
For example the commercial aircraft market prices all its aircraft in US dollars. Even Airbus a complete European company has to do the same although most of its costs are in euro. To offset this Airbus has started to buy from US manufacturers. It also has asked its suppliers from the euro zone to quote in dollars. This way it is shifting the exchange fluctuation risks down to its suppliers.
3) Another way of reducing economic exposure and increasing flexibility is contract manufacturing. Unfortunately this is possible only in certain low-tech industries like garment manufacturing. Here there is very low capital cost to set up manufacturing, and hence it can be shifted from country to country.
4) The last method which is often used in various countries where businesses which are essential for the country's economic growth can influence government policy. They can get the exchange rates manipulated to suit them by using government intervention in the markets.

Question 4

Could the Latvian government have headed off the 2008 crisis? What policy actions could it have taken to do this? What might the economic and political consequences of those actions have been?

Question 5

What were the attractions of the gold standard?

Question 6

Do you think the standard IMF policy prescriptions of tight monetary policy and reduced government spending are always appropriate for developing nations experiencing a currency crisis? How might the IMF change its approach? What would the implications be for international businesses?

Question 7

Describe the role of the IMF under the Bretton Woods System.

Question 8

Can international businesses influence government policy toward exchange rates? How?

Question 9

Outline the main arguments for a floating exchange rate system.

Question 10

Why did the fixed exchange rate system set up at Bretton Woods collapse?

Question 11

Why do some countries adopt a pegged exchange rate system?

Question 12

Which system do you think makes most sense? Why?

Question 13

What is the difference among a currency crisis, a banking crisis, and a foreign debt crisis?

Question 14

How has the IMF responded to these criticisms?

Question 15

The International Monetary System
Use the globalEDGE Resource Desk (http://globaledge.msu.edu/Reference-Desk) to complete the following exercises:
Latvia has been a member state of the European Union (EU) since 2004. This means that the country adheres to the European System of Accounts 1995 (ESA95)-a classification system that ensures the comparability of national statistics in the EU. To gain a better sense of how this system of accounts functions, visit the Bank of Latvia website, and provide an overview of the ESA95 sectors in Latvia. What do you notice about this classification system? What are the particular sectors of the Latvian economy?

Question 16

What do you think the short-term consequences of the IMF policies will be for Latvia? What might the long-term consequences be?

Question 17

If the IMF had not stepped in with support, what do you think might have occurred?

Question 18

Debate the relative merits of fixed and floating exchange rate regimes. From the perspective of an international business, what are the most important criteria in a choice between the systems? Which system is the more desirable for an international business?

Question 19

What opportunities might current IMF lending policies to developing nations create for international businesses? What threats might they create?

Question 20

What was the goal of the Jamaica Agreement?

Question 21

What is the role of dispersed production systems and contract manufacturing in managing volatile exchange rates?

Question 22

Imagine that Canada, the United States, and Mexico decide to adopt a fixed exchange rate system. What would be the likely consequences of such a system for (a) international businesses and (b) the flow of trade and investment among the three countries?

Question 23

Why did the gold standard collapse?

Question 24

Why did the U.S. dollar rise against other major currencies between 1980 and 1985, and again in the late 1990s, despite the fact that the United States was running a large and expanding trade surplus?

Question 25

Describe the role of the World Bank.

Question 26

Reread the Country Focus on the U.S. dollar, oil prices, and recycling petrodollars, then answer the following questions:
a. What will happen to the value of the U.S. dollar if oil producers decide to invest most of their earnings from oil sales in domestic infrastructure projects?
b. What factors determine the relative attractiveness of dollar-, euro-, and yen- denominated assets to oil producers flush with petrodollars? What might lead them to direct more funds towards non-dollar-denominated assets?
c. What will happen to the value of the U.S. dollar if OPEC members decide to invest more of their petrodollars toward non-dollar assets, such as euro-denominated stocks and bonds?
d. In addition to oil producers, China is also accumulating a large stock of dollars, currently estimated to total $1.4 trillion. What would happen to the value of the dollar if China and oil-producing nations all shifted out of dollar-denominated assets at the same time? What would be the consequence for the U.S. economy?

Question 27

Outline the main arguments for a fixed exchange rate system.

Question 28

Why has the dollar been relatively weak since 2000?

Question 29

What are the strengths of a currency board arrangement? What are the weaknesses?

Question 30

What kind of crisis was Latvia experiencing in 2008: a currency crisis, banking crisis, or debt crisis?

Question 31

What are the main criticisms of the IMF's standard approach to financial crises?