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CHAPTER 8
THE INTERNATIONAL FINANCE AND MONETARY STRUCTURE
Overview
This chapter combines Chapter 7 (Monetary and Finance Structure ) and Chapter 8 (International
Debt) from the 6th edition. In this 7th edition we emphasize the most important aspects of
finance, money, and debt. Many students (and some instructors) find these three topics to be
difficult. We start by defining some important concepts and ideas related to finance and debt. We
After the Cold War ended in 1990, economic liberal policies enabled large increases in flows of
investments around the world. “Hot money” and international speculation helped trigger major
financial crises in Mexico, Southeast Asia, and Russia. The IMF and Western governments
provided financial assistance to debtor states on condition that they continue to repay creditors
and impose austerity on their societies. As China was becoming a major manufacturer and
exporter, the United States relied on countries such as China, Japan, Germany, and Saudi Arabia
to offset its growing debt and high levels of domestic consumption by purchasing U.S. property
and Treasuries. The heyday of globalization from the late 1990s to 2007 saw high growth rates in
much of the world, but in the United States and Europe growing consumption rested on a
foundation of higher government and consumer debt.
Today’s global political economy is much more integrated than it was twenty-five years ago.
Many states would like a truly multilateral institution to regulate finance and exchange rates and
produce rules for handling debt that reflect the interests of debtors as much as creditors. In
contrast, some countries prefer to let a hegemonic power with a strong economy and currency
maintain a stable international order.
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U.S. president Trump has responded to China’s growing power and large trade surpluses with the
United States with hostile protectionist measures. More than ever, currency fluctuations and
capital mobility can easily negatively affect domestic employment and investment. While there
is evidence that the global financial crisis did weaken confidence in the U.S. dollar briefly, it
Key Terms
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speculation
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hot money
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the gold standard
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the fixed exchange rate system
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the flexible exchange rate system
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the balance of payments
Teaching Tips
• We encourage instructors to assign this chapter after Chapters 6 and 7 on production and
trade, which for many students and instructors are more interesting and easier to understand
than finance and debt.
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• One of the best ways to cover the interrelated subjects in this chapter is to discuss the
chronology of money and finance events provided early in the chapter. The chronology can
• We suggest that instructors cover the historical elements of the chapter up through the “Iron
Lady and the Cowboy” section in a 1.5-hour meeting or in 2 50-minute class meetings. As
you go through the chapter, highlight the terms in bold and others of significance.
Particularly important are the characteristics of each of the exchange rate systems and
differences between them. Stress that the rules of the two most recent systems have usually
reflected the economic and political interests of the United States.
• Take some time to go through the important concept of balance of payments. Distinguish
between the “current” and “capital” accounts and clarify that the balance of trade is only part
of the current account.
• The supplementary materials below contain some diagrams that deal with different aspects of
money and finance issues. If you decide to use them, be aware that students without any
economics background may be put off by them.
• The second half of the chapter focuses on several crises, the most notable being the Asian
financial crisis and the 2007-2008 global financial crisis. Note to students that these crises
have gradually been affecting larger numbers of countries.
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• Ask students how what they have learned in this unit applies to other issues they have already
dealt with. This is a good segue into the next chapter on security, which is heavily impacted
by the economy.
1. No. 4 on the list of class discussion questions at the end of the chapter would make a good
essay question: Write an essay in which you describe how economic liberal ideas and
2. No. 5 on that list would also make a good essay question: Write an essay in which you
explain what specific political and economic factors have contributed to the United States’
3. Briefly outline the main features of the Gold, Fixed-Exchange Rate, and Managed-Exchange
4. How likely is China to be the next hegemon of the global financial system? What does it
have in its favor and what obstacles stand in its way?
5. What criticisms would you make of the way the U.S. government responded to the global
Sample Multiple-Choice Questions
1) Which of the following statements about hard and soft currencies is incorrect?
a) The Canadian dollar is a hard currency.
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2) Which of the following was not a characteristic of the fixed exchange rate system of the
finance and monetary structure?
a) The price of gold was fixed at $35 an ounce.
3) Which leader complained that by holding (unofficially) weak U.S. dollars, his country was
helping pay for the unpopular Vietnam War?
a) Harold Wilson of Great Britain
4) Since 1944, the role of the IMF in the monetary and finance structure has been
5) Which indicator is most important when it comes to determining the balance of payments
and whether or not a nation is going into debt?
a) the balance of trade
6) Which term refers to a process in which investors quickly shift their funds out of a nation in
d) a panic attack
7) This event signaled the beginning of the Asian financial crisis in July of 1997:
a) when foreign investors pulled most of their fund out of South Korea
8) Which of the following statements about the financial crisis from 2007 to 2009 is incorrect?
a) The U.S. Federal Reserve played the role of “lender of last resort.”
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b) The Federal Reserve rescued AIG, one of the world’s largest bank insurers.
c) Under Obama, the U.S. Congress passed a $2 trillion stimulus spending package.*
d) The U.S. temporarily government gained majority ownership of General Motors (GM)
and Chrysler.
9) A toxic security is another name for
a) bank mortgages and investments that lost a good deal of their value during the global
10) The policy of the U.S. Federal Reserve to increase the money supply by purchasing
hundreds of billions of dollars in bonds and mortgage-backed securities is called
d) the Dodd-Frank Act.
11) What is “bitter medicine”?
a) The fees major banks have imposed on customers to bring down bank debt
12) Which of the following did the Dodd-Frank Act require?
a) Prosecution of Wall Street insiders
13) Which of the following statements about exchange rates is incorrect?
a) Between 2008 and 2017, the euro appreciated against the U.S. dollar.
14) Which IPE scholar believes that the U.S. dollar is very likely to remain the world’s
indispensable currency for many years to come?
a) Benjamin Cohen
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15) In 2017, approximately what percentage of the world’s official foreign exchange reserves
were in U.S. dollars?
a) 20%
Suggested Readings and Links
Bretton Woods Project. http://www.brettonwoodsproject.org/.
Cohen, Benjamin J. Currency Statecraft: Monetary Rivalry and Geopolitical Ambition. Chicago,
IL: University of Chicago Press, 2018.
Krugman, Paul. The Return of Depression Economics and the Crisis of 2008. New York: W.W.
Norton, 2009.
Newton, Scott. The Global Economy: 1944-2000. London: Arnold, 2004.
Audiovisual Resources
The Crash. PBS FRONTLINE, 1999. Discusses financial crises in Mexico, Asia, and Russia in
the 1990s.
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Inside Job. Charles Ferguson, dir. Sony Pictures Classic, 2010. Won the 2011 Academy Award
for Best Documentary Feature.
Money, Power and Wall Street. A FRONTLINE production with RAINmedia and Kirk
Supplementary Material
This supplementary material for Chapter 8 was written by Professor Ross Singleton and
originally appeared in the 4th edition of this textbook. It has not been updated.
FOREIGN EXCHANGE RATES
Before discussing the basics of the three international monetary and finance structures, let’s
examine some of the economic principles behind currency exchange rates. Just as people in
different nations speak different languages (requiring translation to understand one another), they
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What factors determine the value of one country’s currency relative to other currencies? In
unfettered market conditions (when the state does not interfere in the market), flexible or market-
dollars demanded is inversely related to the price of dollars—the demand curve slopes
downward. (See Figure 7–1.) As the price of the dollar increases (and the dollar appreciates),
fewer dollars will be demanded. Why? This relationship reflects the law of demand. Yes but
why?
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Consider the Mexican (peso) price of Windows Vista, Microsoft’s new operating system. If the
U.S. price is $300, what is the Mexican (peso) price? That clearly depends on the exchange rate.
If the exchange rate is 11.456 pesos per dollar, the Mexican (peso) price will be 3436.8 pesos—
The demand for dollars is also affected by a number of other variables, particularly interest rates
in the United States relative to interest rates in Mexico, the price level in the United States
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because of anticipated capital gains (the price of stocks of U.S. companies rising) and higher
dividend payments. If national income in Mexico rises, Mexican households, businesses, and
government entities will likely increase their purchases of U.S. goods and services and perhaps
increase travel in the United States. Consequently, the demand for dollars will increase.
Now we switch to the supply side. The supply of dollars reflects the desire of U.S. households,
businesses, and government entities to buy Mexican goods and services, assets, and to travel in
Mexico. Dollars are supplied to the foreign exchange market in order to acquire the pesos
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The supply of dollars is also affected by a number of other variables, including interest rates in
Mexico relative to interest rates in the United States, the price level in Mexico relative to the
price level in the United States, business expectations in Mexico relative to business expectations
in the United States, and national income in the United States. As interest rates rise in Mexico
relative to the United States, investors in the United States will find Mexican interest-earning
It should already be evident that this foreign exchange market can also be viewed in reverse,
from the perspective of the other nations engaged in the same kinds of transactions. The supply
of dollars in fact reflects the demand for pesos, and the demand for dollars reflects the supply of
pesos. If we view the market from this reverse perspective, the price on the vertical axis will be
the dollar price of 1 peso, and the demand for and supply of pesos will be illustrated.
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Speculation also plays an important role in foreign exchange markets. If those who invest in
currencies (speculators) hoping to capitalize on changes in exchange rates believe (based on their
understanding of the foreign exchange market model and anticipated changes in the various
determinants of demand and supply) that the peso will appreciate in the future, they will want to
buy pesos now. However, the increase in demand for pesos will raise the peso price as a direct
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As we will see in our discussion of different monetary and finance systems, sometimes
governments intervene directly in currency markets, buying up their own currency or selling it in
an attempt to alter its exchange value. The government (through its central bank) intervenes in