Int Fin Sys

7/30/2019 Int Fin Sys

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Chapter 2


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Discussion Points

Evolution of the International MonetarySystem

Current Exchange Rate Arrangements European Monetary System The Mexican Peso Crisis Argentine Peso Crisis Fixed versus Flexible Exchange Rate

Regimes

Euro CrisisSlide 2


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Slide 3

Bimetallism: Before 1875Classical Gold Standard: 1875-1914Interwar Period: 1915-1944Bretton Woods System: 1945-1972The Flexible Exchange Rate Regime:1973-Present


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A double standard in the sense thatboth gold and silver were used asmoney.Both gold and silver were used asinternational means of payment and theexchange rates among currencies were

determined by either their gold or silvercontents.


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During this period in most major countries:Gold alone was assured of unrestrictedcoinageThere was two-way convertibility betweengold and national currencies at a stableratio.

Gold could be freely exported or imported.The exchange rate between two countrys currencies would be determined by theirrelative gold contents.


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For example, if the dollar is pegged togold at U.S.$30 = 1 ounce of gold, and

the British pound is pegged to gold at 6= 1 ounce of gold, it must be the casethat the exchange rate is determined bythe relative gold contents:

$30 = 6

$5 = 1


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There are shortcomings:The supply of newly minted gold is sorestricted that the growth of world trade andinvestment can be hampered for the lack ofsufficient monetary reserves.Even if the world returned to a gold

standard, any national government couldabandon the standard.


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Exchange rates fluctuated as countrieswidely used predatory depreciations oftheir currencies as a means of gainingadvantage in the world export market.Attempts were made to restore the goldstandard, but participants lacked thepolitical will to follow the rules of thegame .The result for international trade and

investment was profoundly detrimental.


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Named for a 1944 meeting of 44 nationsat Bretton Woods, New Hampshire.

The purpose was to design a postwarinternational monetary system.The goal was exchange rate stability

without the gold standard.The result was the creation of the IMFand the World Bank.


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Under the Bretton Woods system, theU.S. dollar was pegged to gold at $35 per

ounce and other currencies were peggedto the U.S. dollar.Each country was responsible formaintaining its exchange rate within 1%of the adopted par value by buying orselling foreign reserves as necessary.The Bretton Woods system was a dollar-based gold exchange standard.


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GermanmarkBritish

poundFrenchfranc

U.S. dollar

Gold

Pegged at $35/oz.

ParValue


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Flexible exchange rates were declaredacceptable to the IMF members.

Central banks were allowed to intervene inthe exchange rate markets to iron outunwarranted volatilities.

Non-oil-exporting countries and less-developed countries were given greateraccess to IMF funds.


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Free FloatThe largest number of countries, about 48, allowmarket forces to determine their currencys value.

Managed FloatAbout 25 countries combine government interventionwith market forces to set exchange rates.

Pegged to another currencySuch as the U.S. dollar or euro.

No national currencySome countries do not bother printing their own, theyjust use the U.S. dollar. For example, Ecuador,Panama, and El Salvador have dollarized .


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On 20 December, 1994, the Mexicangovernment announced a plan to devalue the

peso against the dollar by 14 percent.This decision changed currency traders expectations about the future value of the peso.They stampeded for the exits.In their rush to get out the peso fell by as muchas 40 percent.


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The Mexican Peso crisis is unique in that itrepresents the first serious international

financial crisis touched off by cross-borderflight of portfolio capital.Two lessons emerge:

It is essential to have a multinational safety netin place to safeguard the world financial systemfrom such crises.An arrival of foreign capital can lead to anovervaluation in the first place.


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The Argentinean Peso Crisis 2002

In 1991 the Argentine government passeda convertibility law that linked the peso tothe U.S. dollar at parity.

The initial economic effects were positive:Argentinas chronic inflation was reducedForeign investment poured in

As the U.S. dollar appreciated on the worldmarket the Argentine peso becamestronger as well.


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The strong peso hurt exports fromArgentina and caused a protractedeconomic downturn that led to theabandonment of peso dollar parity inJanuary 2002.

The unemployment rate rose above 20percentThe inflation rate reached a monthly rate of 20 percent


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There are at least three factors thatare related to the collapse of thecurrency board arrangement and theensuing economic crisis:

Lack of fiscal discipline

Labor market inflexibilityContagion from the financial crises inBrazil and Russia


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In theory, a currencys value mirrors thefundamental strength of its underlyingeconomy, relative to other economies. In the

long run .In the short run , currency traders expectationsplay a much more important role.In todays environment, traders and lenders,

using the most modern communications, act byfight-or-flight instincts. For example, if theyexpect others are about to sell Brazilian reals forU.S. dollars, they want to get to the exits first .


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Arguments in favor of flexible exchangerates:

Easier external adjustments.National policy autonomy.

Arguments against flexible exchangerates:

Exchange rate uncertainty may hamperinternational trade.No safeguards to prevent crises.


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Slide 24

International Monetary Fund (IMF)- 1944 Oversees monetary and exchange ratepolicies of its members who pay quotas(membership fees) used to assistcountries with temporary imbalances intheir balance of payments

World Bank - 1944

Investment bankIssues bonds to make long-term loans atlow interest rates to poor countries foreconomic development projects


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Slide 25

World Bank consists of International Bank for Reconstruction &Development

Makes 12-15 year loans to poor (not poorest)countriesCharges an interest rate just above the rate atwhich bank borrows

International Development AssociationMakes interest-free loans with a maturity of 35-40 years to worlds poorest countries


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Slide 26

International Finance Corporation Legally separate from the World Bank, butclosely associated with it

Mobilizes funding for private enterpriseprojects in poor countries

Bank for International Settlements(BIS)

An international financial organization thatpromotes international cooperation amongcentral banks and provides facilities forinternational financial operations


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Slide 27

This is also known as Eurozone sovereign debtcrisisThe term indicates the financial woes caused due tooverspending by come European countriesWhen a nation lives beyond its means by borrowingheavily and spending freely, there comes a pointwhen it cannot manage its financial situation.When that country faces insolvency. (Insolvency:

when it is unable to repay its debts and lenders startdemanding higher interest rates, the cornered nationbegins to get swallowed up by what is known as theSovereign Debt Crisis


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What causes a debt crisis to occur are astopped or slowed economic growth,declined tax revenues, increased governmentspending, or a combination of the factors.


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The EDC began in 2008 with the crash ofIcelands banking system, which spread toGreece.Greece had experienced corruption and

spending as its government continuedborrowing money despite not being able toproduce sufficient income through work andgoods.It was admitted that Greece's debts hadreached 300bn euros, the highest in modernhistorySpain, Portugal, and the other nations laterfollowed Greece.


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COUNTRIES STATISTICS

France Debt/G.D.P: 81.7%Unemployment. Oct 2011: 9.8%S&P Rating: AAA

Germany Debt/G.D.P: 83.2%Unemployment. Oct 2011: 5.5%S&P Rating: AAA

Greece Debt/G.D.P: 142.8%Unemployment. July 2011: 18.3%S&P Rating: CC

Italy Debt/G.D.P: 119%Unemployment. Oct 2011: 8.5%S&P Rating: A

Portugal Debt/G.D.P: 93%Unemployment. Oct 2011: 12.9%S&P Rating: BBB-

Spain Debt/G.D.P: 60.1%Unemployment. Oct 2011: 22.8%S&P Rating: AA

The mainEuropeancountries

affected inthe

European

Debt Crisisare asfollows:


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PORTUGAL In the first quarter of 2010 Portugal had one ofthe best rates of economic recovery in the EU.The country matched or even surpassed its

neighbors in Western Europe. A report was released that the Portuguese

government public debt has increased due tomismanaged structural and cohesion fundswhich then resulted to the verge of bankruptcyof the country.

Bonuses and wages of head officers also

resulted to their economic situation


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In May 2011- Eurozone leaders officially approveda 78 billion bailout package for Portugal, whichbecame the third Eurozone country, after Irelandand Greece, to receive emergency funds.

According to the Portuguese finance minister, theaverage interest rate on the bailout loan isexpected to be 5.1 percent

As part of the deal, the country agreed to cut itsbudget deficit from 9.8 percent of GDP in 2010 to5.9 percent in 2011, 4.5 percent in 2012 and 3percent in 2013.


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SPAIN The country's public debt relative to GDP in2010 was only 60%

Spain's public debt was approximately U.S.$820 billion in 2010

As one of the largest euro zone economies thecondition of Spain's economy is of particular

concern to international observers, and facedpressure from the United States, the IMF,other European countries and the EuropeanCommission to cut its deficit more

aggressively


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In May 2010, Spain announces the new austeritymeasures designed to further reduce the country'sbudget deficit, in order to signal financial markets that itwas safe to invest in the country

Spain succeeded in minimizing its deficit from 11.2% ofGDP in 2009 to 9.2% in 2010 and around 6% in 2011 To build up additional trust in the financial markets, the

government amended the Spanish Constitution in 2011to require a balanced budget at both the national andregional level by 2020.

The amendment states that public debt cannot exceed60% of GDP, though exceptions would be made in caseof a natural catastrophe, economic recession or otheremergencies.


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GREECE October 4 2009-With the new president,

Papandreou November 5 2009-Greece reveals that their budget

deficit is 1207 percent of GDP December 8 2009- Greece's long-term debt to

BBB+, from A-. March 3 2010- Greece tries to persuade the

financial market that they can repay their debts April 23 2010- Papandreou asks help from

International Monetary Fund after Greece is pricedout of the international bond markets.

May 2 2010- European finance ministers lend 110bn which covers until 2013. Greece pledges tobring its budget deficit into line, throughunprecedented budget cuts.


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April 17 2011- Greek borrowing costs start risingsharply again, on fears that its austerity measuresare failing to work. Greece is now deep inrecession.June 19 2011- Admits that they need to borrow

money againJune 29, 2011- EU leaders agree on 109bn bailout which will see private sector lenders takehaircuts of 20% and extension to the EuropeanFinancial Stability Facility (EFSF).

October 27 2011- Europe leaders agree new dealsthat slash Greek debt and increase the firepowerof the main bailout fund to around 1 trillion.November 6 2011- Prime Minister resigns


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The Eurozone debt crisis impacted marketsentiment.The countrys economic condition will remainsound able to withstand the effects of thelingering debt crisis in Europe and uncertainties inthe United States2012 will be a tough one, with reduced globalgrowth outlook due to global uncertainties.Trouble abroad curbed the countrys economicgrowth last year and dampened the market. Thedebt crisis in the euro zone rattled investors andheightened demand for safe haven and assetssuch as US dollars and bonds.


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Emergency loans have been extended asbailouts mainly by stronger economies likeFrance and Germany, as also by the IMF.

The EU member states have also created theEuropean Financial Stability Facility (EFSF) toprovide emergency loans.Restructuring of the debtAusterity measures have been enforced.


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Slide 39

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