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Chapter 11 ‒ The International Monetary System
11-8
A currency crisis occurs when a speculative attack on the exchange value of a currency
results in a sharp depreciation in the value of the currency, or forces authorities to expend
The 1997 Southeast Asian financial crisis was caused by a series of events that took place
in the previous decade.
Evaluating the IMF Policy Prescriptions
Critics of the IMF worry:
• The “one-size-fits-all” approach to macroeconomic policy is inappropriate for
many countries.
• The IMF is exacerbating moral hazard. (This can occur when people behave
recklessly because they know they will be saved if things go wrong.)
• The IMF has become too powerful for an institution without any real mechanism
for accountability.
Slides 11-21 ‒ 11-22 Implications for Managers
The present floating rate system mandates that firms carefully manage their foreign
exchange transactions and exposures.
Managers must recognize that the current international monetary system is a managed
float system in which government intervention can help drive the foreign exchange
market.
Managers need strategic flexibility.
Companies should promote an international monetary system that facilitates international
growth and development.
CRITICAL THINKING AND DISCUSSION QUESTIONS
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: The gold standard worked reasonably well from the 1870s until the start of
World War I in 1914, when it was abandoned. During the war, several governments
financed their massive military expenditures by printing money. This resulted in
Chapter 11 ‒ The International Monetary System
11-9
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
inflation, and by the war's end in 1918, price levels were higher everywhere. Several
countries returned to the gold standard after World War I. However, the period that
ensued saw so many countries devalue their currencies that it became impossible to be
certain how much gold a currency could buy. Instead of holding on to another country's
currency, people often tried to exchange it into gold immediately, lest the country
devalue its currency in the intervening period. This put pressure on the gold reserves of
various countries, forcing them to suspend gold convertibility. As a result, by the start of
World War II, the gold standard was dead. The great strength of the gold standard was
that it contained a powerful mechanism for simultaneously achieving balance-of-trade
equilibrium by all countries. This strength is the basis for reconsidering the gold standard
as a basis for international monetary policy.
QUESTION 2: What opportunities might current IMF lending policies to developing
nations create for international businesses? What threats might they create?
ANSWER 2: The IMF lending policies require the recipient countries to implement
QUESTION 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 business?
ANSWER 3: Critics argue that the tight macroeconomic policies imposed by the IMF in
the recent Asian crisis are not well-suited to countries that are suffering NOT from
QUESTION 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 for
choosing between the systems? Which system is the more desirable for an international
business?
ANSWER 4: The case for fixed exchange rates rests on arguments about monetary
discipline, speculation, uncertainty, and the lack of connection between the trade balance
and exchange rates. In terms of monetary discipline, the need to maintain fixed exchange
rate parity ensures that governments do not expand their money supplies at inflationary
rates. In terms of speculation, a fixed exchange rate regime precludes the possibility of
speculation. In terms of uncertainty, a fixed rate regime introduces a degree of certainty
in the international monetary system by reducing volatility in exchange rates. Finally, in
Chapter 11 ‒ The International Monetary System
11-10
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
terms of trade balance adjustments, critics question the closeness of the link between the
exchange rate and the trade balance. The case for floating exchange rates has two main
elements: monetary policy autonomy and automatic trade balance adjustments. In terms
of the former, it is argued that a floating exchange rate regime gives countries monetary
policy autonomy. Under a fixed rate system, a country’s ability to expand or contract its
money supply as it sees fit is limited by the need to maintain exchange rate parity. In
terms of the latter, under the Bretton Woods system, if a country developed a permanent
deficit in its balance of trade that could not be corrected by domestic policy, the IMF
would agree to a currency devaluation. Critics of this system argue that the adjustment
mechanism works much more smoothly under a floating exchange rate regime. They
argue that if a country is running a trade deficit, the imbalance between the supply and
demand of that country’s currency in the foreign exchange markets will lead to
depreciation in its exchange rate. An exchange rate depreciation should correct the trade
deficit by making the country’s exports cheaper and its imports more expensive. It is a
matter of personal opinion in regard to which system is better for an international
business. We do know, however, that a fixed exchange rate regime modeled along the
lines of the Bretton Woods system will not work. Nevertheless, a different kind of fixed
exchange rate system might be more enduring and might foster the kind of stability that
would facilitate more rapid growth in international trade and investment.
QUESTION 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?
ANSWER 5: Were North America to adopt a common currency, it would become
increasingly attractive for foreign investment and would increase trade and investment
QUESTION 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 the dollar-, euro-, and yen-
denominated assets to oil producers flush with petrodollars? What might lead them to
direct more funds toward 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-denominated 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 $3.3 trillion. What would happen to the value of the dollar if
Chapter 11 ‒ The International Monetary System
11-11
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 6:
a. If oil producers decide to invest their earnings in domestic infrastructure projects, it
would be expected that the countries involved would see a boost in economic growth and
b. The relative attractiveness of an investment whether it is denominated in dollars, euro,
or yen depends on expected returns and the degree of risk associated with the investment.
c. Oil producers have significantly increased their holdings of dollars as a result of higher
d. If China and the oil producers simultaneously decide to sell off their dollars, there
CLOSING CASE: China’s Exchange Rate Regime
Summary
The closing case explores China’s exchange rate regime. China has been accused of
manipulating its currency to help boost exports; however, data show that these claims are
untrue, at least since China adopted its managed float system in 2005. Prior to that, China
pegged its currency to the U.S. dollar. When the Chinese economy began to take off in
the later 1990s, China’s currency was undervalued relative to others. This policy was
apparently designed to improve the competitiveness of its exports. China reevaluated its
currency policy in the 2000s, and made the decision to move to the managed float it
follows today. Discussion of the case can begin with the following questions:
QUESTION 1: Why do you think that the Chinese historically pegged the value of the
yuan to the U.S. dollar?
Chapter 11 ‒ The International Monetary System
11-12
ANSWER 1: Most students will probably suggest that the United States has been a
QUESTION 2: Why did the Chinese move to a managed float system in 2005?
ANSWER 2: China’s export-led economy was booming in the 2000s prompting calls for
QUESTION 3: What are the benefits that China might gain by allowing the yuan to float
freely against other major currencies such as the U.S. dollar and the euro? What are the
risks? What do you think they should do?
ANSWER 3: Responses to this question will vary by student. Some students might argue
QUESTION 4: Is there any evidence that the Chinese kept the level of their currency
artificially low in the past to boost exports? Are they keeping it artificially low today?
ANSWER 4: Donald Trump’s assertions that China is keeping its currency artificially
QUESTION 5: What policy stance should the U.S. and EU adopt toward China with
regard to how it manages the value of its currency?
ANSWER 5: Responses to this question will vary by students, but most will probably
Another Perspective: For more information on China’s policy toward its currency, go to
{https://www.nytimes.com/2017/04/11/business/economy/trump-china-currency-
manipulation-trade.html} and {https://www.cnbc.com/2017/03/15/china-currency-
manipulator-claims-are-false-sp-global-ratings.html}.
Chapter 11 ‒ The International Monetary System
11-13
Teaching Tip: To extend the discussion of China and exchanges rates, consider IMF: The
Chinese…Ask the IMF in the International Business Library at:
http://bit.ly/MHEIBVideo. Click “Ctrl+F” on your keyboard to search for the video title.
MHE INTERNATIONAL BUSINESS VIDEO LIBRARY
Please click here to visit our International Business Video Library which provides an
ongoing stream of updated video suggestions correlated by key concept and major topic.
Every new clip posted is supported by teaching notes and discussion questions. Please
feel free to leave comments in the library that you feel might be helpful to your
colleagues.
INCORPORATING globalEDGE™ EXERCISES
Use the globalEDGE™ website {globaledge.msu.edu/} to complete the following
exercises:
Exercise 1
The Global Financial Stability Report is a semiannual report published by the
International Capital Markets division of the International Monetary Fund (IMF). The
report includes an assessment of the risks facing the global financial markets. Locate and
download the latest report to get an overview of the most important issues currently under
discussion. Also, download a report from five years ago. How do the issues from five
years ago compare with financial issues identified in the current report?
Exercise 2
An important element to understanding the international monetary system is keeping
updated on current growth trends worldwide. A German colleague told you yesterday that
Deutsche Bank Research provides an effective way to stay informed on important topics
in international finance from a European perspective. Find an emerging market research
report for analysis. On which emerging market region did you choose to focus? What are
the key takeaways from your chosen report?
Answers to Exercises
Exercise 1 Answer
Chapter 11 ‒ The International Monetary System
11-14
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
The report is published semiannually 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 Answer
