In this chapter, you will explore what factors determine exchange rates and recent attempts to manage them. You will also: Learn how exchange rates affect all sorts of business activities, examine different methods of forecasting exchange rates, and understand how the international monetary system functions.
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 Copyright © 2014 Pearson Education, Inc 10 - The Euro • Currency of 17 European nations • Boosted efficiency and competitiveness • Later declined with lower expectations Copyright © 2014 Pearson Education, Inc 10 - Currency Values and Business Exchange rates affect activities of both domestic and international firms Devaluation Revaluation Export prices Import prices Copyright © 2014 Pearson Education, Inc 10 - Major World Currencies Source: Based on Economic Report of the President, Table B110, multiple years Copyright © 2014 Pearson Education, Inc 10 - Stability and Predictability Stable exchange rates • Improve accuracy of forecasts and financial planning Predictable exchange rates • Reduce surprises of unexpected rate changes Copyright © 2014 Pearson Education, Inc 10 - Value of U.S. Dollar Source: Based on Economic Report of the President, Table B110, multiple years Copyright © 2014 Pearson Education, Inc 10 - Buying Power Example Cost in New York… $60 Purchasing Power Cost in Japan… $80 Cost in Mexico… $30 Copyright © 2014 Pearson Education, Inc 10 - Discussion Question What are the key differences between the concepts of devaluation and revaluation? Copyright © 2014 Pearson Education, Inc 10 - 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 Copyright © 2014 Pearson Education, Inc 10 - 10 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 Copyright © 2014 Pearson Education, Inc 10 - 22 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 Copyright © 2014 Pearson Education, Inc devaluations force system to collapse 10 - 23 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 Copyright © 2014 Pearson Education, Inc 10 - 24 End of Bretton Woods Nations demand gold in Copyright © 2014 Pearson Education, Inc 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 10 - 25 Discussion Question What characteristics of the gold standard lead some to call for its return today? Copyright © 2014 Pearson Education, Inc 10 - 26 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 Copyright © 2014 Pearson Education, Inc 10 - 27 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 Copyright © 2014 Pearson Education, Inc 10 - 28 The System Today Managed float system Pegged exchange rates Currency board European monetary system Copyright © 2014 Pearson Education, Inc 10 - 29 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 Copyright © 2014 Pearson Education, Inc 10 - 30 Financial Crises Developing nations Mexico Southeast Asia Russia Argentina Copyright © 2014 Pearson Education, Inc 10 - 31 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 Copyright © 2014 Pearson Education, Inc Source: Simela Pantzartzi/Newscom 10 - 32 Future of the International Monetary System • Greater IMF transparency • Better manage risks • Monitor “hot” money flows Private sector Copyright â 2014 Pearson Education, Inc 10 - 33 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 Copyright © 2014 Pearson Education, Inc 10 - 34 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 Copyright © 2014 Pearson Education, Inc 10 - 35 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher Printed in the United States of America Copyright © 2014 Pearson Education, Inc 10 - 36 ... force system to collapse 10 - 23 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. .. 2014 Pearson Education, Inc 10 - 27 Jamaica Agreement Formalized the managed float system of exchange rates as the new international monetary system Managed float system Currencies float with government... Education, Inc 10 - 21 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