Global Business Today Eleventh Edition Chapter 11
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The International Monetary System
Table of Contents
Learning Objectives
Chapter Summary
Chapter Opening Activity
Chapter Outline
Opening Case: Can Dollarization Save Venezuela?
Introduction
The Gold Standard
The Bretton Woods System
The Collapse of the Fixed Exchange Rate System
The Floating Exchange Rate Regime
Fixed versus Floating Exchange Rates
Exchange Rate Regimes in Practice
Crisis Management by the IMF
Focus on Managerial Implications: Currency Management, Business Strategy, And
Government Relations
End-of-Chapter Resources
Critical Thinking and Discussion Questions
globalEDGE™ Research Task
Closing Case: Egypt and the IMF
Continuous Case Concept
Additional Readings and Sources of Information
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Learning Objectives
11.1 Describe the historical development of the modern global monetary system.
11.2 Explain the role played by the World Bank and the IMF in the international monetary
system.
11.3 Compare and contrast the differences between a fixed and a floating exchange rate system.
11.4 Identify exchange rate regimes used in the world today and why countries adopt different
exchange rate regimes.
11.5 Understand the debate surrounding the role of the IMF in the management of financial
crises.
11.6 Explain the implications of the global monetary system for management practice.
Chapter Summary
The objective of this chapter is to explain how the international monetary system works and its
implications for international business. The chapter begins by reviewing the historical evolution
of the monetary system, starting with the gold standard and the Bretton Woods System. The
chapter explains the role of the International Monetary Fund (IMF) and the World Bank, both of
which were initiated by the Bretton Woods Conference. The fixed exchange rate system that was
initiated by the Bretton Woods Conference collapsed in 1973. The majority of the chapter
explains the workings of the current international monetary system. The pluses and minuses of
fixed exchange rates versus floating exchange rates are discussed. Scholars differ regarding
which system is best. The current role of the IMF and the World Bank are discussed, including
the way the IMF has helped nations restructure their debts.
Chapter Opening Activity
Ask students to think about how challenging it is for an SME to suddenly conduct business in a
new currency. Consider a local firm: select one, or invent one and give it a name, such as
Gamma Co., that has always issued quotes and received payment in British pounds, and
suddenly it must prepare quotes in Mexican pesos and German euros for potential foreign
customers. How does the company do this? How can it prepare quotes that assure that when it is
paid, it will receive the price charged?
Further, if Gamma Co. has to increase capacity at its home-country plant to meet the new
demand placed on it by exports, how will it finance the new materials, equipment, and labor it
needs? Will the local bank finance this increased capacity for international sales? Assuming
Gamma Co. is paid on time, how will the additional income be accounted for and taxed? Must
Gamma Co. pay taxes on the income it earns from selling in Germany and Mexico? Students
may research international banking products that help business customers manage currency risk
and commercial risk, and protect receivables. One international bank offering global trade
services is JPMorgan Chase https://commercial.jpmorganchase.com/pages/commercial-
banking/services/gb-trade-services. U.S. students should research the U.S. Export-Import Bank,
http://www.exim.gov, which is not a bank at all but a program of the federal government that
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Global Business Today Eleventh Edition Chapter 11
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Chapter Outline
Can Dollarization Save Venezuela?
opening case
Summary
The opening case describes the currency crisis in Venezuela. Despite having the largest oil
reserves in the world, Venezuela is on the brink of complete collapse. Crude oil has been
Venezuela’s primary export, yet oil output in 2017 was just half of 1998 levels. Decades of
corrupt government actions have left the country in a desperate situation with inflation rates as
high as 2700 percent per year and a currency that is virtually worthless. While the International
Monetary Fund (IMF) would normally step in to help with the currency crisis, Venezuela’s
president Nicolas Maduro seems to be more partial to another solution, dollarization.
Discussion Questions
1. What is dollarization? Can it work in Venezuela?
2. What caused the currency crisis in Venezuela?
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Lecture Note: To extend this case discussion, consider
https://www.bloomberg.com/news/articles/2018-04-13/harvard-economist-says-dollarization-
won-t-fix-venezuela-crisis and https://www.wsj.com/articles/the-dollar-rescued-ecuador-can–it–
save-venezuela-1522152001.
Introduction
A) The international monetary system refers to the institutional arrangements that countries
adopt to govern exchange rates. When the foreign exchange market determines the relative value
of a currency, that country is adhering to a floating exchange rate. The world’s four major
trading currencies—the U.S. dollar, the European Union’s euro, the Japanese yen, and the British
pound—are all floating currencies.
B) A pegged exchange rate means that the value of a currency is fixed to a reference country
and then the exchange rate between that currency and other currencies is determined by the
reference currency exchange rate. The opening case describes Malawi’s peg to the U.S. dollar.
C) A managed-float system or dirty-float occurs when the value of a currency is determined by
market forces, but with central bank intervention if it depreciates too rapidly against an important
reference currency. China has adopted this policy in 2005.
D) Countries that adopt a fixed exchange rate system fix their currencies against each other.
Prior to the introduction of the euro, some European Union countries operated with fixed
exchange rates within the context of the European Monetary System (EMS).
CONNECT
Click and Drag
The Evolution of the Global Monetary System
Summary
This activity focuses on the international monetary system. The global monetary system has
evolved in response to the needs of governments, international companies, and currency traders.
Activity
Students are asked to match developments in the evolution of the global monetary system to the
correct spot in the timeline.
Class Discussion
Understanding the evolution of the global monetary system can help international managers
better understand the system and how it operates. Discuss the institutions that comprise the
international monetary system and their role within it.
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CONNECT
Click and Drag
Understanding Exchange Rates
Summary
This activity focuses on exchange rates. Companies that have business in or with other countries
are affected by changing exchange rates.
Activity
Students are asked to match arguments for and against various exchange rate systems.
Class Discussion
Understanding how exchange rates are determined is essential for international business
managers. Changing exchange rates have a direct impact on the profitability of an international
company. Discuss how current fluctuations in a country’s currency occur, for example, the
British pound following the Brexit vote, and what that means to companies doing business with
that country.
CONNECT
Video Case
Chinese Currency
Summary
This activity focuses on the international monetary system. The value of major currencies
including the U.S. dollar, the yen, and the euro is determined via a managed-float system.
Activity
Students are asked to watch a video on exchange rates and then respond to a series of questions
related to the video.
Class Discussion
Government policy influences the value of the U.S. dollar, the yen, and the euro. International
managers need to understand why and when a government might intervene in the currency
market and what the implications of that intervention. Discuss China’s policy on its currency the
yuan. What does it mean for companies doing business in China or with China?
The Gold Standard
A) The gold standard had its origin in the use of gold coins as a medium of exchange, unit of
account, and store of value—a practice that stretches back to ancient times. As the volume of
international trade increased, governments agreed to convert paper currency into gold on demand
at a fixed rate.
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Lecture Note: In 1961, former Federal Reserve Board chairman, Alan Greenspan, wrote an
article on the advantages of the gold standard. The article, which is available at
http://www.usagold.com/gildedopinion/Greenspan.html, is well worth reading.
MECHANICS OF THE GOLD STANDARD
B) The practice of pegging currencies to gold and guaranteeing convertibility is known as the
gold standard. For example, under the gold standard one U.S. dollar was defined as equivalent
to 23.22 grains of fine (pure) gold.
C) The exchange rate between currencies was determined based on how much gold a unit of each
currency would buy. The amount of a currency needed to purchase one ounce of gold was
referred to as the gold par value.
STRENGTH OF THE GOLD STANDARD
D) The great strength claimed for the gold standard was that it contained a powerful mechanism
for simultaneously achieving balance-of-trade equilibrium (when the income a country’s
residents earn from its exports is equal to the money its residents pay for imports) by all
countries.
THE PERIOD BETWEEN THE WARS: 1918–1939
E) The gold standard worked fairly well from the 1870s until the start of World War I. Trying to
spur exports and domestic employment, a number of countries started regularly devaluing their
currencies, with the end result that people lost confidence in the system and started to demand
gold for their currency. This put pressure on countries’ gold reserves and forced them to suspend
gold convertibility.
F) By the start of World War II, in 1939, the gold standard was dead.
The Bretton Woods System
A) In 1944, at the height of World War II, representatives from 44 countries met at Bretton
Woods, New Hampshire, to design a new international monetary system. With the collapse of
the gold standard and the Great Depression of the 1930s fresh in their minds, these statesmen
were determined to build an enduring economic order that would facilitate postwar economic
growth. The agreement reached at Bretton Woods established two multinational institutions—the
International Monetary Fund (IMF) and the World Bank. The task of the IMF was to maintain
order in the international monetary system and that of the World Bank would be to promote
general economic development.
B) The U.S. dollar was the only currency to be convertible to gold, and other currencies would
set their exchange rates relative to the dollar. Devaluations were not to be used for competitive
purposes, and a country could not devalue the currency by more than 10 percent without IMF
approval.
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THE ROLE OF THE IMF
C) The aim of the Bretton Woods agreement, of which the IMF was the main custodian, was to
try to avoid a repetition of the chaos that occurred between the wars through a combination of
discipline and flexibility.
Teaching Tip: More information on the IMF is available at http://www.imf.org. Students can
click on “About the IMF” to get an overview of the IMF and its activities.
Discipline
D) A fixed exchange rate regime imposes discipline in two ways. First, the need to maintain a
fixed exchange rate puts a brake on competitive devaluations and brings stability to the world
trade environment. Second, a fixed exchange rate regime imposes monetary discipline on
countries, thereby curtailing price inflation.
Flexibility
E) Although monetary discipline was a central objective of the Bretton Woods agreement, it was
recognized that a rigid policy of fixed exchange rates would be too inflexible. The IMF stood
ready to lend foreign currencies to members to tide them over during short periods of balance-of–
payments deficits, when a rapid tightening of monetary or fiscal policy would hurt domestic
employment.
CONNECT
Video Case
Talk of a Weak Dollar Has Divided Opinion at Davos
Summary
This activity focuses on the international monetary system and in particular its institutions. The
International Monetary Fund (IMF) is responsible for maintaining order in the international
monetary system.
Activity
Students are asked to watch a video on the international monetary system and then respond to a
series of questions related to the video.
Class Discussion
International managers need to understand the role of the IMF in the international monetary
system. Discuss recent efforts by the IMF and their implications for companies.
THE ROLE OF THE WORLD BANK
F) The official name of the World Bank is the International Bank for Reconstruction and
Development (IBRD). The bank lends money under two schemes. Under the IBRD scheme,
money is raised through bond sales in the international capital market. Borrowers pay what the
bank calls a market rate of interest—the bank’s cost of funds plus a margin for expenses. A
second scheme is overseen by the International Development Agency (IDA), an arm of the bank
created in 1960. IDA loans go only to the poorest countries.
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Teaching Tip: More information on the World Bank can be accessed at
http://www.worldbank.org. Click on “Data” or “Research” to pull information on World Bank
activities.
The Collapse of the Fixed Exchange Rate System
A) The collapse of the exchange rate system established in Bretton Woods can be traced to U.S.
macroeconomic policy decisions from 1965 to 1968. Under President Johnson, the U.S. financed
huge increases in welfare programs and the Vietnam War by increasing its money supply,
leading to significant inflation.
B) Speculation that the dollar would have to be devalued relative to most other currencies, as
well as underlying economics and some forceful threats by the U.S., forced other countries to
increase the value of their currencies relative to the dollar
C) The key problem with the Bretton Woods system was that, since the dollar was the base
currency, the system relied on an economically well-managed United States. When the United
States began to print money, run high trade deficits, and experience high inflation, the system
was strained to the breaking point
The Floating Exchange Rate Regime
A) The floating exchange rate regime that followed the collapse of the fixed exchange rate
system was formalized in January 1976 when IMF members met in Jamaica and agreed to the
rules for the international monetary system that are in place today.
THE JAMAICA AGREEMENT
B) The purpose of the Jamaica meeting was to revise the IMF’s Articles of Agreement to reflect
the new reality of floating exchange rates. The three main elements of the Jamaican agreement
include the following:
• Floating rates were declared acceptable.
• Gold was abandoned as a reserve asset.
• Total annual IMF quotas—the amount member countries contribute to the IMF—were
increased to $41 billion. Since then, they have been increased to $311 billion and
membership in the IMF has expanded to 184 countries.
EXCHANGE RATES SINCE 1973
C) Since March 1973, exchange rates have become much more volatile and far less predictable
than they were between 1945 and 1973. The volatility has been partly due to a number of
unexpected shocks to the world monetary system including:
• The oil crisis in 1971
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• The oil crisis of 1979
• The unexpected rise in the dollar between 1980 and 1985
• The rapid fall of the U.S. dollar against the Japanese yen and German deutsche mark
between 1985 and 1987, and against the yen between 1993 and 1995
• The partial collapse of the European Monetary System in 1992
• The 1997 Asian currency crisis
• The global financial crisis of 2008–2010 and the sovereign debt crisis in the European
Union during 2010–2011
Did You Know Video Clip
The video clip asks: “Did you know China has recently been trying to stop its currency from
falling in value on foreign exchange markets?”
Discussion Questions
1. Has the Chinese yuan increased or decreased in value compared to the U.S. dollar in recent
years?
2. Why have some U.S. politicians accused China of manipulating its currency? Why would this
benefit China?
3. Why did the Chinese government start buying back US$100 billion of its yuan a month in
2015? What effect did this have on the value of the yuan?
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Lecture Note: To learn more about fluctuations of the Chinese yuan, consider
https://www.bloomberg.com/news/articles/2018-07-22/china-s-luck-on-yuan-devaluation-risks-
running-out-on-trump-ire and https://www.bloomberg.com/news/articles/2018-04-09/china-is–
said-to-study-yuan-devaluation-as-a-tool-in-trade-spat.
Video Note: To explore the influence of Chinese currency choices on the global economy,
consider How Currency Choices “Made in China” Have Big Impact on Global Economy in the
International Business Library at http://bit.ly/MHEIBVideo. Click “Ctrl+F” on your keyboard to
search for the video title.
Additionally, our McGraw-Hill Education International Business Video Library at
http://bit.ly/MHEIBVideo 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.
Fixed versus Floating Exchange Rates
A) The breakdown of the Bretton Woods system has not stopped the debate about the relative
merits of fixed versus floating exchange rate regimes.
THE CASE FOR FLOATING EXCHANGE RATES
B) The case for floating exchange rates has two main elements: monetary policy autonomy and
automatic trade balance adjustments.
Monetary Policy Autonomy
C) It is argued that a floating exchange rate regime gives countries monetary policy autonomy.
Under a fixed 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. Advocates of a floating exchange rate
regime argue that removal of the obligation to maintain exchange rate parity restores monetary
control to a government.
Trade Balance Adjustments
D) 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, IMF approval was needed for a currency
devaluation. Critics of this system argue that the adjustment mechanism works much more
smoothly under a floating exchange rate regime.
Crisis Recovery
E) Advocates of floating exchange rates argue that exchange rate adjustments can help a country
deal with economic crises. The devaluation of a currency that typically follows a currency crisis
promotes export-led economic growth. Critics point out, however, that the devalued currency
also causes import prices to rise and consequently increases inflation.
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THE CASE FOR FIXED EXCHANGE RATES
F) The case for fixed exchange rates rests on arguments about monetary discipline, uncertainty,
and the lack of connection between the trade balance and exchange rates.
Monetary Discipline
G) The need to maintain a fixed exchange rate parity ensures that governments do not expand
their money supplies at inflationary rates.
Speculation
H) Critics of a floating exchange rate regime also argue that speculation can cause fluctuations in
exchange rates. A fixed exchange rate system limits the destabilizing effects of speculation.
Uncertainty
I) Speculation also adds to the uncertainty surrounding future currency movements that
characterizes floating exchange rate regimes, and can negatively affect the growth of
international trade and investment.
Trade Balance Adjustments and Economic Recovery
J) Those in favor of floating exchange rates argue that floating rates help adjust trade imbalances.
WHO IS RIGHT?
K) There is no real agreement as to which system is better. We do, however, know that a fixed
exchange rate regime modeled along the lines of the Bretton Woods system will not work. It is
telling that speculation ultimately broke the system, a phenomenon that advocates of fixed rate
regimes claim is associated with floating exchange rates. 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.
Lecture Note: In uncertain times, calls for a return to the gold standard are not uncommon. To
extend this discussion, consider https://www.npr.org/2016/06/16/482279689/trump-favors-
returning-to-the-gold-standard-few-economists-agree.
Exchange Rate Regimes in Practice
A) A number of different exchange rate policies are pursued around the world. Twenty-one
percent of IMF members follow a free float policy, 23 percent a managed-float system, and 5
percent have no legal tender of their own (excludes the European Union countries that have
adopted the euro). The remaining countries use less flexible systems, such as pegged
arrangements, or adjustable pegs.
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country FOCUS: China’s Exchange Rate Regime
Summary
This feature describes the development of China’s monetary policy over time. The Chinese yuan
was pegged to the U.S. dollar at a fixed exchange rate for most of its history. However, after
opening to foreign trade and investment in the 1980s, the yuan was devalued so the country
could be a more competitive exporter. By 2005, there was a general consensus that the Chinese
currency was undervalued. As a result, the country introduced a managed floating exchange rate
system. This allowed the yuan to appreciate against foreign currencies. After a general slowdown
in the Chinese economy and a subsequent depreciation of the yuan in late 2015, the government’s
monetary policy led to the purchase of the country’s currency with U.S. dollars to maintain the
value of the yuan and prevent many Chinese companies for going bankrupt. These actions
reduced China’s foreign exchange reserves to $3.011 trillion by January 2017, the lowest level
since 2012.
Discussion Questions
1. Explain the managed floating exchange rate system that China introduced in July 2005. Why
was it introduced?
2. Have the Chinese artificially depressed the value of the yuan as some have claimed in the
United States? Explain your position.
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CURRENCY BOARDS
C) A country that introduces a currency board commits itself to converting its domestic
currency on demand into another currency at a fixed exchange rate. To make this commitment
credible, the currency board holds reserves of foreign currency equal at the fixed exchange rate
to at least 100 percent of the domestic currency issued.
Crisis Management by the IMF
A) With the introduction of the floating rate system and the emergence of global capital markets,
many of the original reasons for the IMF’s existence have disappeared. Financial difficulties have
not disappeared, however, and the IMF has found a way to grow and redefine its mission.
Video Note: Greek Budget Crisis Could Stagnate U.S. Recovery fits in well with this discussion.
Find it in the International Business Library at http://bit.ly/MHEIBVideo. Click “Ctrl+F” on
your keyboard to search for the video title.
FINANCIAL CRISES IN THE POST-BRETTON WOODS ERA
B) 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 large
volumes of international currency reserves and sharply increase interest rates in order to defend
the prevailing exchange rate.
C) A banking crisis refers to a situation in which a loss of confidence in the banking system
leads to a run on the banks, as individuals and companies withdraw their deposits.
D) A foreign debt crisis is a situation in which a country cannot service its foreign debt
obligations, whether private sector or government debt.
country FOCUS: The IMF and Iceland’s Economic Recovery
Summary
This feature describes the economic crisis in Iceland in 2008. In the years prior to the crisis,
Iceland’s banks grew through international expansion financed by debt. When, because of the
global financial crisis in 2008, the banks were unable to refinance their debt, the banks went into
bankruptcy sending the economy into a nosedive. To stem the fall, Iceland turned to the IMF for
assistance. Thanks to the IMF and other foreign loans, Iceland has been able to begin to turn its
economy around. The low value of the krona helped spark an export-led economic recovery. In
2013, Iceland’s economy grew at 4 percent and its unemployment rate continued to fall.
Discussion Questions
1. What type of exchange rate system does Iceland follow? Explain how this system helped the
country to recover from the 2008–2009 global financial crisis.