Chapter 11 ‒ The International Monetary System
The International Monetary System
Learning Objectives
• LO11-1: Describe the historical
development of the modern
global monetary system.
• LO11-3: Compare and contrast
the differences between a fixed
and a floating exchange rate
system.
• LO11-4: Identify exchange rate
regimes used in the world today
and why countries adopt different
exchange rate regimes.
This chapter discusses the evolution of the
international monetary system and the
implications of this system for international
business, focusing on the institutional context
within which exchange rates move.
and the World Bank have played an important
role in the world economy
The role of the IMF is to maintain order in the
international monetary system to avoid a
repetition of the competitive devaluations of
the 1930s, and to control price inflation by
imposing monetary discipline on countries.
IMF-mandated macroeconomic policies are
11
Chapter 11 ‒ The International Monetary System
OUTLINE OF CHAPTER 11: THE INTERNATIONAL MONETARY
SYSTEM
Opening Case: Pakistan Takes Another IMF Loan
Introduction
The Gold Standard
Mechanics of the Gold Standard
Strength of the Gold Standard
The Period between the Wars: 1918–1939
The Collapse of the Fixed Exchange Rate System
The Floating Exchange Rate Regime
The Jamaica Agreement
Exchange Rates Since 1973
Fixed versus Floating Exchange Rates
The Case for Floating Exchange Rates
The Case for Fixed Exchange Rates
Who Is Right?
Crisis Management by the IMF
Country Focus: The IMF and Iceland’s Economic Recovery
Financial Crises in the Post-Bretton Woods Era
Evaluating the IMF’s Policy Prescriptions
Chapter 11 ‒ The International Monetary System
CLASSROOM DISCUSSION POINT
Ask students how much their currency is worth. Try to get them to identify its value in
terms of another currency. Then ask students how they might know the value of the
currency. Students will probably indicate options like the posting at the currency kiosk at
the airport, or the rates that are printed in the newspaper or are available online.
OPENING CASE: Pakistan Takes Another IMF Loan
Summary
The opening case explores the balance of payments crisis in Pakistan that forced the
country to accept a $6 to $8 billion loan package from the IMF in 2019. Pakistan’s rising
trade deficit forced the country to use foreign exchange reserves to pay for imports,
drawing down the reserves from $19 billion in 2018 to less than $7 billion in 2019.
QUESTION 1: What led to Pakistan’s economic crisis? What role did China’s Belt and
Road Initiative play in the crisis?
ANSWER 1: Thanks to an increase in its trade and budget deficit, Pakistan was already
well on the way to a its economic crisis before China’s Belt and Road Initiative
exacerbated the situation. The initiative was designed to improve the infrastructure in
QUESTION 2: Why is Pakistan reluctant to take assistance from the IMF?
ANSWER 2: Despite concerted efforts to avoid an IMF bailout, in 2019, Pakistan agreed
Chapter 11 ‒ The International Monetary System
QUESTION 3: How is the IMF loan package expected to help Pakistan?
ANSWER 3: While the bailout package from the IMF and conditions of that package
have not yet been made public, it is expected that Pakistan will likely be required to fix
LECTURE OUTLINE
This lecture outline follows the Power Point Presentation (PPT) provided along with this
instructor’s manual. The following provides a brief overview of each Power Point slide
along with teaching tips and additional perspectives.
Slide 11-3 – 11-4 What Is the International Monetary System?
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, the country is adhering to a floating exchange rate
regime. Governments adopt various types of exchange rate systems including the pegged
rate, the managed-float or dirty-float, and the fixed rate.
Chapter 11 ‒ The International Monetary System
Strength of the Gold Standard
The gold standard provides a powerful mechanism to pull trade imbalances between
countries back into balance-of-trade equilibrium.
The Period Between the Wars: 1918–1939
The gold standard worked fairly well from the 1870s until the start of World War I in
1914, but by 1939 the gold standard had collapsed.
Slides 11-8 – 11-10 The Bretton Woods System
The Bretton Woods system established a fixed exchange rate system where all currencies
were fixed to gold, but only the U.S. dollar was directly convertible to gold. Devaluations
could not to be used for competitive purposes and a country could not devalue its
currency by more than 10 percent without IMF approval.
The Bretton Woods system also provided for two multinational institutions—the
International Monetary Fund (IMF) and the World Bank (IBRD).
The Role of the IMF
The IMF was charged with executing the main goal of the Bretton Woods agreement—
avoiding a repetition of the chaos that occurred between the wars through a combination
of discipline and flexibility.
The Role of the World Bank
The World Bank is also known as the International Bank for Reconstruction and
Development (IBRD).
Chapter 11 ‒ The International Monetary System
Slide 11-11 The Collapse of the Fixed Exchange System
The Bretton Woods system worked well until the late 1960s, before collapsing.
Slides 11-12 ‒ 11-14 The Floating Exchange Rate Regime
The Jamaica Agreement
The Jamaica Agreement was signed in 1976 following the collapse of Bretton Woods.
The rules that were agreed on then are still in place today.
Under the Jamaica agreement:
• floating rates were declared acceptable,
• gold was abandoned as a reserve asset, and
• total annual IMF quotas were increased to $41 billion.
Exchange Rates since 1973
Exchange rates have become more volatile and less predictable than they were between
1945 and 1973.
The Case for Fixed Exchange Rates
Supporters of fixed exchange rates focus on monetary discipline, uncertainty, and the
lack of connection between the trade balance and exchange rates.
Who Is Right?
There is no real agreement as to which system is better.
Slides 11-18 – 11-19 Exchange Rate Regimes in Practice
Currently:
• Twenty-one percent of IMF members follow a free-float policy.
• Twenty-three percent of IMF members follow a managed-float system.
• Five percent of IMF members have no legal tender of their own (excluding EU
countries).
Chapter 11 ‒ The International Monetary System
• The remaining countries use less flexible systems such as pegged arrangements or
adjustable pegs.
CONNECT
Case Analysis
China’s Exchange Rate Regime
Activity
Students are asked to read a short case on China’s exchange rate regime and then respond to a
series of questions related to the case.
Class Discussion
International managers need to understand the international monetary system and the effect of
changing exchange rates on corporate profits. Discuss how companies can protect themselves
against adverse exchange rate movements.
Pegged Exchange Rates
A country following a pegged exchange rate system, pegs the value of its currency to that
of another major currency.
Currency Boards
Countries using a currency board commit to converting their domestic currency on
demand into another currency at a fixed exchange rate.
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.
Chapter 11 ‒ The International Monetary System
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
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.
CONNECT
Video Case
Did You Know that the Turkish Lira Loses 40 percent of its Value Against the U.S. Dollar?
Summary
This activity focuses on understanding the international monetary system, its history and
institutions, and how currency values are determined.
Activity
Students are asked to watch a video on exchange rates and then respond to a series of questions
related to the video.
Chapter 11 ‒ The International Monetary System
Slides 11-20 ‒ 11-24 Crisis Management by the IMF
Today, the IMF focuses on lending money to countries experiencing financial crises.
Financial Crises in the Post–Bretton Woods Era
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 prevailing exchange rates.
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.
Managers need strategic flexibility.
Companies should promote an international monetary system that facilitates international
growth and development.
Chapter 11 ‒ The International Monetary System
CONNECT
Video Case
Air-Omnibus and the Euro
Summary
This activity focuses on the international monetary system and the impact of fluctuating exchange
rates on corporate profits. Companies can take several steps to protect themselves from exchange
rate exposure.
CONNECT
Case Analysis
A Business’s Strategic Choice
Summary
This activity focuses on the international monetary system and the choices that businesses make
within that context. Firms should be aware of the risks involved with exchange rates as they make
strategic choices.
Activity
Students are asked to read a short case on exchange rates and then respond to a series of questions
related to the case.
Chapter 11 ‒ The International Monetary System
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
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
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
governmental reforms to stabilize monetary policy and encourage economic growth. One
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
excessive government spending and inflation, but from a private-sector debt crisis with
inflationary undertones. Anti-inflationary monetary policies and reductions in
Chapter 11 ‒ The International Monetary System
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
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
among the three countries. The exchange rates between Canada and the United States
Chapter 11 ‒ The International Monetary System
QUESTION 6: Reread the Country Focus “The IMF and Iceland’s Economic
Recovery,” and then answer the following questions:
a. What were the main causes of Iceland’s economic troubles in 2008?
b. Was Iceland facing a classic currency crisis, or was this a banking crisis?
c. How did Iceland recover from its 2008–2009 crisis? What are the important lessons to
draw from this case?
d. Iceland did not implement the austerity policies that are so often associated with IMF
loans, and yet the economy recovered. Does this suggest that austerity policies do not
work?
ANSWER 6:
a. The overexpansion of Iceland’s banks which began in 2000, hit a crisis point in 2008 in
the midst of the global financial crisis. The banks found they could no longer refinance
the large debt loads they had taken on, and because Iceland’s government was unable to
bail them out, the banks went into failure. This prompted a 90 percent plunge in the local
c. Iceland follows a floating exchange rate. This system actually helped the country
recover from its financial crisis in 2008. As a result of the global financial crisis and the
ensuing banking crisis in Iceland, the value of the Icelandic krona dropped significantly.
While the lower krona made imports more expensive, it also allowed the country’s
exporters to be more competitive in global markets. Higher exports sparked the country’s
economic recovery. Many students will suggest that Iceland’s ability to recovery
relatively quickly is testament to the success of the floating exchange rate system. Some
students may also point out that while Iceland’s recovery was relatively quick, the
country also endured some very difficult times in the process.
Chapter 11 ‒ The International Monetary System
QUESTION 7: Reread the Country Focus “China’s Exchange Rate Regime,” and then
answer the following questions:
a. Why do you think that the Chinese historically pegged the value of the yuan to the U.S.
dollar?
b. Why did the Chinese move to a managed float system in 2005?
c. What are the benefits that China might gain by allowing the yuan to float freely against
ANSWER 7:
a. Most students will probably suggest that the United States has been a central force in
the global economy for much of the last century and a central figure in the international
b. China’s export-led economy was booming in the 2000s prompting calls for a
revaluation of its exchange rate system. In 2005, China moved from its practice of
pegging the yuan to the dollar to a managed float. Under the new regime, China fixed its
c. Responses to this question will vary by student. Some students might argue that if
d. Donald Trump’s assertions that China is keeping its currency artificially low to boost
exports is not borne out by the facts. Instead, data show that China has actually been
doing just the opposite. Since 2005, China has allowed its currency to rise against other
currencies. Even during the 2015 economic slowdown in China, the country continued to
try to maintain the value of its currency by buying yuan on the open market.
e. Responses to this question will vary by students, but most will probably suggest that
Chapter 11 ‒ The International Monetary System
CLOSING CASE: Can Dollarization Save Venezuela?
Summary
The closing case explores 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 exports, 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 a million percent in 2018 and a currency that is
virtually worthless. While the International Monetary Fund (IMF) would normally step in
the help with the currency crisis, Venezuela’s president Nicolas Maduro seems to be
more partial to another solution, dollarization. Discussion of the case can begin with the
following questions:
QUESTION 1: What are the root causes of Venezuela’s economic problems?
ANSWER 1: Venezuela’s problems date back to the beginning of the century and the
election of Hugo Chavez. In a move that angered foreign oil companies, Chavez abruptly
raised the royalty rates that the companies were required to pay in order to do business in
QUESTION 2: Why won’t Venezuela bring in the IMF to help with its economic
problems?
ANSWER 2: Many students will probably suggest that Venezuela’s President Nicolas
Maduro dislikes the policies the IMF requires in exchange for its assistance. Typically,
QUESTION 3: How might dollarization help solve Venezuela’s economic problems?
What is required for dollarization to be implemented?
ANSWER 3: Dollarization involves abandoning the bolivar, Venezuela’s currency, and
introducing cash denominated in dollars. The goal is to keep the economy moving,
Chapter 11 ‒ The International Monetary System
QUESTION 4: In addition to dollarization, what else needs to happen for Venezuela to
fix its economic problems?
ANSWER 4: Responses to this question will vary by student. Many will suggest that for
Venezuela to successfully adopt dollarization it will also need to take steps to get its
economy on track. Many students will probably suggest that the first step in the process is
to eliminate government corruptions. Other students will likely agree that diversifying the
industrial base will be important to correct an over dependency on oil revenues. Some
students may suggest that attracting foreign investors could be important to bring in
MHE INTERNATIONAL BUSINESS VIDEO LIBRARY
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.
CONNECT
Geography
Summary
This activity is designed to test the student’s knowledge of geography. Questions related to
chapter material are asked, requiring students to understand the topics and the locations of the
countries involved.
Activity
Students are asked to respond to a series of questions related to the geographic location of several
countries.
Chapter 11 ‒ The International Monetary System
Class Discussion
Understanding the geographic location of countries is essential to the understanding of
international business. Ask students to discuss the implications of the geographic locations of the
countries in this exercise on the subject matter.
INCORPORATING globalEDGE™ EXERCISES
Exercise 1
The Global Financial Stability Report is a semiannual report published by the
International Capital Markets division of the International Monetary Fund. 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
Additional Info:
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.
Chapter 11 ‒ The International Monetary System
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 and can be reached under the “Research” section of the main navigation.