The International Monetary System

THE INTERNATIONAL MONETARY SYSTEM

THE INTERNATIONAL MONETARY SYSTEM

1. About the IMS2. Brief History3. High Level of Interdependence4. Advantages of GN5. IMS Issues

ABOUT THE IMS

ABOUT THE IMS The means for exchanging currency or

money between countries  Measures of monetary wealth of

countriesGross Domestic Product (GDP)Gross National Product (GNP)Country GDP (IMF 2012) GDP per capita (IMF

2012

United States $16.24 T $51,704China $8.22 T $6,071Japan $5.96 T $46,707India $1.84 T $4,000Germany $3.45 T $41,866EU $16.67 T $32,518

ABOUT THE IMSBig Mac Index

About itTracks inflationOver/undervalued currencyShows purchasing power

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ABOUT THE IMSPurchasing Power Parity (PPP)

Compares buying power from market to marketGN currencies = more buying power

Effect: 1) Exchange US $ for MSX $, go to Mexico

Peso increases in value relative to dollar2) US demand drops; MX demand increases

US price drops; MX price increases3) Market should adjust over time

Lose incentive to cross border¤

Country Price Currency Exchange RateU.S. Wooden baseball bat US $40 US $1 buys 10 MXN $Mexico Wooden baseball bat MXN

$15US$ buys 2 2/3 bats in Mexico

ABOUT THE IMSAbout currency adjustments

Devaluing a currencyIntentionally make it weaker

Imports more expensiveExports more appealing

Strengthening itBuying up currency so less is in circulation

Imports less expensiveExports less appealing

Redenomination of a currencyRussian 1998- ruble revalued

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ABOUT THE IMSCurrency adjustment effects

Weak yen= expensive luxury brands in Japan “Hermes Warned of Lower Profits under

Abenomics”Weak euro= more investment in non-

euros Denmark, Switzerland drop interest rates

below 0%Strong Swiss franc = higher interest

payments Mortgage borrowers in Poland suffer

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BRIEF HISTORY

BASIS FOR MODERN SYSTEMEuropean exploration, colonization

British dominationGold Standard

Gresham’s LawClipping, altered alloy contentBad $ drives out good

SignificanceSet equivalenceEstablished fixed exchange rates

• Provided stability Post-WWII-US hegemony¤

POST WWIIWhy did the US assume hegemony

after WWII?Democracy Trade partnersAllies

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POST WWIIHow did the US promote economic

hegemony? US Central banker

Gold standard 1840 to ~WWI based on £1944 on $

• US$35=1 oz. gold Foreign Aid: IGOs, Bilateral

Marshall Plan, Truman Plan, IBRD Rebuild WE and Japan; secure Turkey & Greece

Military Aid Investment through MNCs

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END OF US GOLD STANDARDWhy did the system end?

US as central banker = Big strain Lots of US dollars held outside of USLarge investment outflows by MNCsDeclining exportsRising oil prices, cartel

Vietnam WarUS civil rights movement New competition

Japan, Germany= Nixon delinks $Fixed to floating exchange rate ¤

END OF US GOLD STANDARDEffects

Floating exchange rate system Hard on GS

Peg to major currencyBelize, Venezuela, Saudi Arabia-USDFormer African colonies-euro

•Morocco, Ivory Coast, Cameroon¤

END OF US GOLD STANDARDEffects (cont.)o Adopt foreign currency

Ecuador, Panama-USDEuropean microstates

euroo Accept/trade in

foreign currenciesATM – Cambodia

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http://www.phnompenhpost.com/business/acleda-ups-security-measures

END OF US GOLD STANDARDWhat is Zimbabwe’s situation?

100 T dollars- couldn’t buy bread

Adopted $ in 2009Use rands, dollars, pounds

ProblemsCan’t print currencyCoin shortage

Affects SAEcuador- mints centavos

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PEGGING CURRENCIESPost- Bretton Woods, common

Former Caribbean, African colonies to Europeans LA to US

Benefits Stability Ties

Ex-pats Common language Familial ties with émigrés

Problems Float at market rates If dollar, yen, euro, etc., too strong, need to adjust Domestic issues- can’t hold peg

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IMS INTERDEPENDENCY

INTERDEPENDENCYGlobal Currency Flows Most traded currency?

U.S. dollar- 81.01% of world’s trade http://www.reuters.com/article/2013/12/03/us-markets-offshore-yuan-idUSBRE9B204020131203?feedType=RSS&feedName=businessNews

Second most traded currency?Yuan/remnimbi at 8.66%

2004$1.9 T

2007$3.3 T

2010$4 T

2013$5.3 T

http://www.economist.com/news/economic-and-financial-indicators/21586351-global-foreign-exchange-turnover

Global currency exchange

INTERDEPENDENCY

http://www.joneslanglasallesites.com/gcf/global-capital-markets-research/cities

Rank City 2014In Billions

2013In Billions

Change

1 London $44.4 $44.2 +<1%

2 New York $35.9 $31.4 +1.2%

3 Tokyo $30.3 $18.4 + 39%4 Paris $22.1 $16.6 +25%

Primary Banking Centers-60% of global capital through 4 cities

INTERDEPENDENCYHow the GS became indebted

Post WWII- colonies gained independence Reliance on primary resources

Cash crops Raw materials

Desire to industrialize Needed to borrow $

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DEBT CREATIONOil-rich

countries

Western banks

Developing

countries

INTERDEPENDENCYGS= Lots of debt

GN Banks

GS States

Oil States

GN: Lend $ to make interestGS: Export goods to GN

GS: Borrow money to buy oil

Invest Petrodollars to earn interest

INTERDEPENDENCYEconomic crisis in one country contagion Where it all began

Great Depression 1929 Next - Mexico, 1982

Why couldn’t Mexico declare bankruptcy? Followed later by…

Crisis YearMexico “Tequila Crisis” 1994“Asian Flu” Crisis 1997Russian “Ruble Crisis” 1998Argentina 2001,

2014Global Recession (US, EU) 2008Eurozone 2010

GN ADVANTAGES

HISTORICAL ADVANTAGES Industrial Revolution Colonization & Imperialism

Colonies = Resource suppliers GS become indebted Creation of Institutions (post WWII)¤

CREATED INSTITUTIONS

International Monetary Fund (IMF)Bretton Woods Agreement (1944)Purpose: Monetary stability

Short-term crisesGN dominance

Choose Chief- Christine LagardeVoting advantage

Austerity plansStructural Adjustment Plans (SAPs)

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CREATED INSTITUTIONS

International Bank for Reconstruction and Development (IBRD)

Also Bretton Woods (1944)Present-day World Bank Group (WB)Purpose: Rebuild Europe, promote growthGN policy dominance

President- GN- Jim Yong Kim¤

CREATED INSTITUTIONSEuropean Coal & Steel Community (ECSC)

Regional IGO (1951) of 6 statesPurpose: Reduce tariffsPresent-day EU- now 28Western Europe

dominanceSignificance to IMS

Eurozone- 19 membersCommon currency

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http://www.economist.com/blogs/graphicdetail/2015/02/european-economy-guide

CREATED INSTITUTIONSGroup of Five (G-5) (1985)

Purpose: Coordinate monetary policy US, UK, France, Germany, Japan Added Italy, Canada= G-7 Added Russia = G-8 Deleted Russia = G-7 (blame Putin)

G-20 (1999) Sort of replaced G-8 (2009) Include EEs

GDP (85%) Trade (80%) Population (66%)

G-7 still active¤

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IMS ISSUES: INFLATIONDisparity between the value of a good/service

and its costMeans less purchasing powerDetermined by consumer price index

Looks at changes over timeNeed to find balance

Raise interest rates to curb inflationEffect- help lower consumer prices

More people save, fewer spend, prices dropDrop interest rates to encourage inflation

Advantage= encourage spending to stimulate economy

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IMS ISSUES: EUROZONE CRISIS1. What caused the Eurozone crisis? (video,

news)2. What problems did the ECB encounter?3. What was Greece’s situation?4. How did the crisis in Greece cause a

contagion? 5. Why was Germany unscathed by the crisis?

IMS ISSUES: EUROZONE CRISIS1. What caused the Eurozone crisis?

Long-termStructural problems

Lack of competitivenessBloated public sectorsLack of political and economic coordination

Short-termGlobal recession

EU banks took a hit, reduced lendingEffect: reduced consumption, investment

Sovereign debt crisis¤

IMS ISSUES: EUROZONE CRISIS2. What problems did the ECB encounter?

Gov’ts had to borrow $ to bail out their banks, stimulate economies

Too much government spendingHigher unemploymentLower business profitsFewer tax revenuesSet up permanent bailout fund (2011)

European Stability Mechanism€500 B

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IMS ISSUES: EUROZONE CRISIS3. What was Greece’s situation?

High public debtToo much gov’t spending (high debt-to-GDP ratio)

Couldn’t borrow $Interest rates increased on borrowing

Higher risk demands higher interest ratesSubject to IMF, EU (ECB) austerity (SAP)

policiesLed to protestsGov’t fell

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IMS ISSUES: EUROZONE CRISIS4. How did the crisis in Greece cause a contagion?

Italy, Spain, Portugal, Ireland Loans at higher interest rates Forced to accept SAP terms for bailouts*

Reduce budget deficits Public debt Private debt Lack of competitiveness Higher inflation rates Ignored Eurozone spending rules

Deficits, debt level Led to ‘fiscal pact’ between most EU countries Rules agreed upon re: budget deficits ¤

*Situations/terms varied by country

IMS ISSUES: EUROZONE CRISIS5. Why was Germany unscathed by the crisis?

Already reformed risky policies, improved competitiveness

World’s second largest exporter by value and volume Within EU

Respectable products with same currency Borrowed money to buy goods

Outside EU Euro value decreased, made goods cheaper

Drop in unemployment rates¤

IMS ISSUES: EUROZONE EXPANSION1. What issues did Latvians encounter when

transitioning to the euro?Felt change was anti-nationalist

2. Why would Latvia want to join the Eurozone, considering the crisis?

Easier to do business with other euro countriesAvoid fees for exchanging lats into eurosWant link to Western Europe (v. Russia)Small economy—likely to benefit from

integration¤

IMS ISSUES: THE US & BONDSQuantitative Easing- policies gov’ts use to

protect economy US, UK, EU, Japan

US bought bonds to stimulate economy Put $ into the system to stimulate growth

Federal Reserve decreasing bond buying by $10 B/mo Stopped October 2014

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IMS ISSUES: THE US & BONDSEffects

US bought bonds Investors go elsewhere for higher

growth/interest rate returns Affected EEs

US decreased bond buying Investors turned back to US Safer investment market

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IMS ISSUES: THE US & BONDSImplications

Less money in EEs MNCs get less revenue

EEs use foreign reserves to protect own currency rather than buy US bonds

‘Fragile Five’ TKY, BZ, IN, IND, SA

Possible contagion¤

THE SPICE TRADE

IMS ISSUES: PRICES & STABILITY1. How did the spice trade lead Europe

into global monetary dominance?2. Why is reliance on cash crops so risky?3. What are the pros and cons of FTAs for

farmers?4. Why did Vietnam enter pepper

production? What global effect did this have?

IMS ISSUES: PRICES & STABILITY1. How did the spice trade lead Europe into

global monetary dominance? Used to rely on commodities as ‘cash’

• Spices, metals, shells, etc. Colonization

• Cash crops Trade Currency system

Pieces of eight Gold Standard

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IMS ISSUES: PRICES & STABILITY2. Why is reliance on cash crops so risky?

Economies not diversified Large % dependent on cash crop income Currency speculation

Affects purchasing power, prices of exports/imports

Investment recovery not guaranteed Debt cycle

Price volatility Vulnerable to weather, disasters Competition

Lack insurance Effects of FTAs, new producers

IMS ISSUES: PRICES & STABILITY3. What are the pros and cons of FTAs for

farmers? Competition

• Domestic, foreign, new Cheaper, better quality goods Greater market access Limited options if can’t compete

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IMS ISSUES: PRICES & STABILITY4. Why did Vietnam enter pepper

production? What global effect did this have? Less pepper competition Better profits than current crops Less land, fewer inputs

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SPICE TRADE: RECAP

Colonization; neocolonialism Accrued debts in 1960s and 1970s

Lack autonomy over debt management Prices and stability

Primary v. manufactured goodsPrice volatilityLack of national unity

THE INTERNATIONAL MONETARY SYSTEM

1. About the IMS2. Brief History3. High level of interdependence4. Advantages of GN5. Issues in the IMS