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Global Business Today Ninth Edition Chapter 11

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came to a head when investors, who had been pouring money into Mexico, suddenly withdrew

their investments after the Mexican government announced that, despite earlier promises, it would

no longer maintain its pegged exchange rate. The peso quickly dropped in value ending up about

40 percent below what it had been. Some students will probably suggest that one of the biggest

challenges for governments facing a financial crisis is the domino effect it seems to have

throughout the economy. In the case of Mexico, IMF assistance to stabilize the situation meant

that the country had to follow what initially seemed to be unattractive policies.

2. Why did the United States provide assistance to Mexico? Why was it important to the United

States to stabilize Mexico?

Lecture Note: To extend the discussion of this feature and what can be learned from Mexico’s

experiences, consider {http://www.businessweek.com/stories/1999-03-14/why-countries-shouldnt-

break-their-currency-promises}.

E) The causes of the financial crisis that erupted across Southeast Asia during the fall of 1997 were

sown in the previous decade when these countries were experiencing unprecedented growth.

F) Huge increases in exports, and hence the incoming funds, helped fuel a boom in commercial

and residential property, industrial assets, and infrastructure. As the volume of investments

ballooned during the 1990s, often at the bequest of national governments, the quality of many of

these investments declined significantly. Often the investments were made on the basis of

projections about future demand conditions that were unrealistic. The result was the emergence of

significant excess capacity.

G) Investments made on the basis of unrealistic projections about future demand conditions

created significant excess capacity. These investments were often supported by dollar-based debts.

When inflation and increasing imports put pressure on the currencies, the resulting devaluations

led to default on dollar denominated debts. A final complicating factor was that by the mid-1990s

although exports were still expanding across the region, so were imports.

H) The Asian meltdown began in mid-1997 in Thailand when it became clear that several key Thai

financial institutions were on the verge of default. Following the devaluation of the Thai Baht,

wave after wave of speculation hit other Asian countries. These devaluations were largely driven

by similar factors to those that underlay the earlier devaluation of the Thai Baht. A combination of

excess investment, high borrowings – much of it in dollar denominated debt, and a deteriorating

balance of payments position.

Evaluating the IMF’s Policy Prescription

I) By 2013, the IMF was committed to loans to 52 countries that were struggling with economic

and currency crises. All IMF loan packages come with conditions attached, generally a

combination of tight macroeconomic policy and tight monetary policy.

Teaching Tip: To explore current issues at the International Monetary Fund in more depth, go to

{http://www.imf.org/external/}.

Video Note: The video in the International Business Library on Pinterest

(http://www.pinterest.com/mheibvideos/) IMF, World Bank Members Mull Third World Aid

explores efforts by the IMF and the World Bank to get developed countries to contribute funds that

could then be distributed to developing countries in need.

Inappropriate Policies

J) The IMF’s policies have recently come under fire. One criticism is that the IMF’s “one-size-

fits-all” approach to macroeconomic policy is inappropriate for many countries.

Lecture Note: To extend this discussion, consider {http://www.businessweek.com/articles/2014-

10-07/imf-explains-why-it-keeps-overestimating-growth},

{http://news.bbc.co.uk/2/hi/business/7647015.stm}, and {http://www.businessweek.com/ap/2012-

09-06/hungarian-prime-minister-unfriends-imf–on-facebook}.

Moral Hazard

K) A second criticism of the IMF is that its rescue efforts are exacerbating a problem known to

economists as moral hazard. Moral hazard arises when people behave recklessly because they

know they will be saved if things go wrong.

Lecture Note: To extend this discussion, consider

{http://www.businessweek.com/magazine/content/11_23/b4231014848770.htm}.

Lack of Accountability

L) The final criticism of the IMF is that it has become too powerful for an institution that lacks any

real mechanism for accountability.

Observations

M) As with many debates about international economics, it is not clear which side has the winning

hand about the appropriateness of IMF polices.

FOCUS ON MANAGERIAL IMPLICATIONS

Video Note: The video in the International Business Library on Pinterest

(http://www.pinterest.com/mheibvideos/) Dollar’s Falling Value Ripples through U.S. Economy

provides an interesting perspective of how the value of the dollar is affecting different companies.

The video fits in well with a discussion of how companies can cope with changing exchange rates.

A) The managerial implications of the material discussed in this chapter fall into three main areas

– currency management, business strategy, and corporate-government relations.

Currency Management

B) An obvious implication with regard to currency management is that companies must recognize

that the foreign exchange market does not work quite as depicted in Chapter 10. The current

system is a managed float system in which government intervention can help drive the foreign

exchange market. Companies need to be aware of this and adjust their foreign exchange

transaction accordingly.

C) A second message contained in this chapter is that under the present system, speculative buying

and selling of currencies can create volatile movements in exchange rates.

Business Strategy

D) The volatility of the present floating exchange rate regime presents a conundrum for

international businesses. Exchange rate movements are difficult to predict, and yet their

movement can have a major impact on the competitive position of businesses. One response to the

uncertainty that arises from a floating exchange rate regime might be to build strategic flexibility

to minimize the economic exposure of the firm.

Management Focus: Airbus and the Euro

Summary

This feature describes how Airbus is protecting itself from exchange rate fluctuations. French

aircraft maker Airbus prices its planes in dollars. However, because over half the company’s costs

are in euros, the company has the potential to see significant fluctuations in its earnings if it does

not hedge its foreign exchange exposure. The following questions can help in the discussion of the

feature:

Suggested Discussion Questions

1. What type of foreign exchange exposure does Airbus face? How can Airbus protect itself from

its exposure to changing exchange rates? How does the company’s switch to more U.S. suppliers

help the company?

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217

2. Airbus has asked its European based suppliers to start pricing in U.S. dollars. What does Airbus

hope to gain by this request? What does it mean for suppliers?

Discussion Points: Airbus’ decision to ask suppliers to price their components in dollars is an

effort to control exchange rate risk. The company prices its planes in dollars, but was paying for

components in a variety of currencies. By shifting to a strictly dollar run business, the company

not only consolidates all of its transactions and so hedges its exposure more easily and cheaply, it

also increases the proportion of its costs that are in dollars. For American suppliers, the shift to

pricing in dollars is beneficial because it eliminates exchange rate risk. For other suppliers

however, the shift may mean an introduction of exchange rate risk.

Teaching Tip: Students can learn more about Airbus by going to the company’s web site at

{http://www.airbus.com/en/}.

Lecture Note: Fluctuating exchange rates have had both positive and negative implications for

Airbus. To learn more, consider {http://www.businessweek.com/ap/2012-07-01/officials-ala-dot-

airbus-plant-will-employ-1-000}.

Corporate-Government Relations

E) As major players in the international trade and investment environment, businesses can

influence government policy towards the international monetary system. International businesses

should use their influence to promote policy decisions that facilitate the growth of international

trade and investment.

Critical Thinking and Discussion Questions

1. Why did the gold standard collapse? Is there a case for returning to some type of gold standard?

What is it?

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218

2. What opportunities might current IMF lending policies to developing nations create for

international businesses? What threats might they create?

3. 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?

4. 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?

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219

5. 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?

6. 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 dollar if OPEC members decide to invest more of their

petrodollars towards 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 United States economy?

Answer:

Global Business Today Ninth Edition Chapter 11

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220

rate. So, for example, if the dollar was expected to depreciate relative to the euro or yen, non-

dollar denominated assets might be more attractive all else being equal.

c) Oil producers have significantly increased their holdings of dollars as a result of higher oil

prices. Should OPEC members decide to sell their dollars to invest in non-dollar denominated

assets such as euro denominated stocks or bonds, we would expect to see downward pressure on

the dollar.

d) If China and the oil producers simultaneously decide to sell off their dollars, there would be

significant downward pressure on the dollar. This downward pressure would probably cause

considerable pessimism among investors, and the U.S. economy, and the world economy in

general, would likely suffer.

Closing Case: Currency Trouble in Malawi

Summary

The closing case explores the economic and political turmoil in the East African state of Malawi

from 2004 to 2012. The outlook for Malawi, one of the poorest countries in the world, seemed to

be good in 2004 when former World Bank economist Bingu wa Mutharika was elected president.

Bingu wa Mutharika attracted donor money and subsidized agriculture, helping boost the country’s

economy, but then began to take a more dictatorial approach to governing. Donations and aid to

the country stopped. At the same time, the country’s tobacco exports stalled sending the country

into a foreign currency crisis. Discussion of the case can revolve around the following questions:

QUESTION 1: What were the causes of Malawi’s currency troubles?

QUESTION 2: Why did Mutharika resist IMF calls for currency devaluation? If he had lived and

remained in power, what do you think would have happened to the economy of Malawi assuming

that he did not change his position?

QUESTION 3: Now that Malawi’s currency has been devalued, what do you think the economic

consequences will be? Is this good for the economy?

05-31/malawi-peter-mutharika-sworn-in–as-new-president} and

{http://www.businessweek.com/news/2014-08-06/malawian-president-mutharika-hopes-for-imf–

agreement-by-november}.

Continuous Case Concept

China is currently a hot market for automakers. Companies see the market as being one of the

world’s most significant markets in the next decade and are shifting production to China. Some

companies are even developing cars specifically for the local market. However, pressure on

China to revalue its currency could change the nature of the market.

• In June 2010, the Chinese government indicated that the Yuan would be more flexible and

allowed to appreciate in value relative to other currencies. Ask students to consider the

strategic implications of a stronger Yuan for the auto companies. Do any of the companies

benefit from a stronger Yuan? Do consumers?

• Next, ask students to consider the effects a floating Yuan might have on the industry. Is it

beneficial for companies producing in China? Why or why not?

• Finally, if China moves to a floating regime, should the auto companies move their

production from other locations in the world to China? Why or why not?

This feature can be used at the beginning of the discussion of the international monetary system.

The feature also works well as conclusion to the material presented in the chapter and can help

students understand the opportunities and threats for companies related to exchange rate

movements.

globalEDGE Exercises

The resources for each exercise can be easily located by using the search box at the top of the

globalEDGE website at http://globalEDGE.msu.edu

Global Business Today Ninth Edition Chapter 11

Exercise 1

Search phrase: Global Financial Stability Report

Resource Name: IMF: Global Financial Stability Report

Website: http://www.imf.org/external/pubs/ft/GFSR/index.htm

globalEDGE Category: Finance

Additional Info:

The report is published semi-annually by the Capital Markets Division of the International

Monetary Fund, and examines current risks facing the global financial system and policy actions

that may mitigate these. As a result it provides a great overview of the state of the global financial

system.

Exercise 2

Search phrase: Deutsche Bank Research

Resource Name: Deutsche Bank Research

Website: http://www.dbresearch.com/

globalEDGE Category: Finance

Additional Info:

A research focused website published by the Deutsche Bank, the site provides timely analysis of

the international finance markets. A special section is dedicated to Emerging Markets can be

reached under the “Research” section of the main navigation.

Additional Readings and Sources of Information

Clinton on Africa Trip Visits Malawi

http://www.businessweek.com/ap/2012-08-05/clinton-on-africa-trip-visits-malawi

Iceland Must drop Bank Creditor Program World Bank Advisor Says

http://www.businessweek.com/news/2014-05-01/iceland-must-drop-bank-creditor-program-world-bank-

adviser-says

How Bretton Woods Reshaped the World

http://news.bbc.co.uk/2/hi/business/7725157.stm

Insight: Bretton Woods Two?

http://news.bbc.co.uk/2/hi/7724298.stm

Nigeria Orders Audit for Billions of Petrodollars

http://www.businessweek.com/ap/2014-02-14/nigeria-orders-audit-for-billions-of-petrodollars

OPEC Where All Those Petrodollars Will Go

Global Business Today Ninth Edition Chapter 11

http://www.businessweek.com/stories/2004-10-24/opec-where-all-those-petrodollars-will-go

Petrodollars Turn Aberdeen into Independence Battleground

http://www.businessweek.com/news/2014-06-19/petrodollars-turn-aberdeen-into-independence-

battleground

The Euro as Good and Bad as Gold

http://www.businessweek.com/magazine/the-euro-as-good-and-bad-as-gold-11172011.html

IMF Lays Out the Risks to Global Growth

http://www.businessweek.com/videos/2012-10-09/imf-lays-out-the-risks-to–global-growth

Airbus Plans 1st U.S. Factory

http://www.businessweek.com/ap/2012-07-02/news-summary-airbus-plans-1st-us-factory

OPEC Pouring Petrodollars into U.S. Treasuries

http://www.businessweek.com/videos/2012-03-19/dmd1203190711-scarlet-dot-mpg