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International
Business: The
Topic 3:
Challenges of International Monetary System
Globalization & Balance of Payments
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u The role of international monetary system

Agenda is promoting in international trade and
investment
u Evolution and function of gold standards.
u The role of the IMF in post-world II
u Function of and structure of balance of
payments
u Various definitions of a balance of
payments surplus and deficits.
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u A current medium of exchange in

the form of coins and banknotes;
What is coins and banknotes collectively.

money? u Any good that is widely accepted in

exchange of goods and services, as
well as payment of debts.
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u Medium of exchange – money used for

Three buying and selling goods and services.

functions of u Unit of account – common standard for

money measuring relative worth of goods and

services.

u Store of value – convenient way to store

wealth
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What Is The
International u Refers to the institutional
Monetary arrangements that countries adopt
System? to govern exchange rates.
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u Efficient and unrestricted flow of international
trade and investment.
Features that u Stability in foreign exchange aspects.

IMS should u Promoting Balance of Payments adjustments to

possess prevent disruptions associated.

u Providing countries with sufficient liquidity to

finance temporary balance of payments deficits.

u Should at least try avoid adding further

uncertainty.

u Allowing member countries to pursue independent

monetary and fiscal policies.
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u A floating exchange rate system exists when a

What Is The country allows the foreign exchange market to

determine the relative value of a currency.
International
u Their values are determined by market forces
Monetary and fluctuate day to day
System?
u A fixed exchange rate system exists when
countries fix their currencies against each other at
some mutually agreed on exchange rate.

u European Monetary System (EMS) prior to 1999

 u Grouping of most western European nations
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cooperating to maintain their currencies at fixed
exchange rates
European
European Monetary Union
Monetary u

European Currency Unit to the euro

System (EMS) u

u Euro to replace ECU and domestic currencies

u transition to the euro: how, when, whether

u Euro effect on the U.S. dollar

u dollar may lose ground against the euro on a

global scale

u exchange rate implications

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Ø A pegged exchange rate system exists when a

What Is The country fixes the value of its currency relative to
International a reference currency

Monetary Ø A dirty float exists when a country tries to hold

System? the value of its currency within some range of a

reference currency such as the U.S. dollar.

Ø China pegs the yuan to a basket of other

currencies
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STAGES IN Ø 1. Bimetallism: Before 1875

INTERNATIONAL 2. Classical Gold Standard: 1875-1914
MONETARY 3. Interwar Period: 1915-1944
SYSTEM 4. Bretton Woods System: 1945-1972
4. The Flexible Exchange Rate
Regime: 1973-Present
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What Was
The Gold
Standard? u Refers to a system in which countries
peg currencies to gold and guarantee
their convertibility.

Japan USA
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u The gold standard dates back to ancient

What Was times (1200 A.D) when gold coins were a

medium of exchange, unit of account, and
The Gold
store of value.
Standard?
u payment for imports was made in gold
or silver
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What Was
The Gold
u The gold par value refers to the amount
Standard? of a currency needed to purchase one
ounce of gold
 u 17met
In 1944, representatives from 44 countries
at Bretton Woods, New Hampshire, to design
a new international monetary system that
What Was would facilitate postwar economic growth

The u Under the new agreement

Bretton u a fixed exchange rate system was established

Woods u all currencies were fixed to gold, but only the

U.S. dollar was directly convertible to gold
System? u devaluations could not to be used for
competitive purposes

u a country could not devalue its currency by

more than 10% without IMF approval
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Bretton Woods

(source: Google)
 Ø The Bretton Woods agreement 19
also established two multinational
institutions
What 1. The International Monetary
Institutions Fund (IMF) to maintain order in
the international monetary
Were system through a combination
of discipline and flexibility
Established At
2. The World Bank to promote
Bretton general economic
development
Woods? Ø also called the International Bank
for Reconstruction and
Development (IBRD)
 u The International Monetary Fund (IMF)
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u fixed exchange rates stopped competitive
devaluations and brought stability to the world
What trade environment

Institutions u fixed exchange rates imposed monetary

discipline on countries, limiting price inflation
Were
u in cases of fundamental disequilibrium,
Established devaluations were permitted

At Bretton u the IMF lent foreign currencies to members

Woods? during short periods of balance-of-payments

deficit, when a rapid tightening of monetary or
fiscal policy would hurt domestic employment
 u The World Bank 21
u Countries can borrow from the World Bank in

What two ways

Institutions u Under the IBRD scheme, money is raised

through bond sales in the international
Were capital market

Established u borrowers pay a market rate of interest - the

bank's cost of funds plus a margin for
At Bretton expenses.

Woods? u Through the International Development

Agency, an arm of the bank created in 1960

u IDA loans go only to the poorest countries

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A new exchange rate system was established
in 1976 at a meeting in Jamaica

What Was u The rules that were agreed on then are still in
place today
The
Jamaica u Under the Jamaican agreement

Agreement? u floating rates were declared acceptable

u gold was abandoned as a reserve asset

u total annual IMF quotas - the amount member

countries contribute to the IMF - were
increased to $41 billion – today they are about
$767 billion
 u Floating exchange rates provide 27
u Monetary policy autonomy

Which Is u removing the obligation to maintain

exchange rate parity restores monetary
Better – control to a government

Fixed u Automatic trade balance adjustments

Rates Or u under Bretton Woods, if a country developed

Floating a permanent deficit in its balance of trade

that could not be corrected by domestic
Rates? policy, the IMF would have to agree to a
currency devaluation

u Help countries recover from financial crises

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Ø But, a fixed exchange rate system

1. Provides monetary discipline

Which Is Ø ensures that governments do not
Better – expand their money supplies at

Fixed Rates inflationary rates

Or Floating 2. Minimizes speculation

Rates? Ø causes uncertainty

3. Reduces uncertainty

Ø promotes growth of international

trade and investment
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There is no real agreement as to which
system is better

Who Is u We know that a Bretton Woods-style fixed

Right? exchange rate regime will not work

u But a different kind of fixed exchange

rate system might be more enduring

u could encourage stability that would

facilitate more rapid growth in
international trade and investment
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u Various exchange rate regimes are
followed today
What Type u 21% of IMF members follow a free float
of Exchange policy
u 23% of IMF members follow a
Rate System managed float system
Is In Practice u 5% of IMF members have no legal
tender of their own
Today? u excludes Euro Zone countries

u the remaining countries use less flexible

systems such as pegged
arrangements, or adjustable pegs
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What Type
of Exchange
Rate System
Is In Practice
Today?
Exchange Rate Policies of IMF Members
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u A country following a pegged exchange
rate system pegs the value of its currency
What Is A
to that of another major currency
Pegged
u popular among the world’s smaller nations
Rate
u imposes monetary discipline and leads to
System? low inflation

u adopting a pegged exchange rate

regime can moderate inflationary
pressures in a country
 u Countries using a currency board commit
33to
converting their domestic currency on
demand into another currency at a fixed
What Is A exchange rate
Currency u the currency board holds reserves of foreign

Board? currency equal at the fixed exchange rate to

at least 100% of the domestic currency issued

u the currency board can issue additional

domestic notes and coins only when there are
foreign exchange reserves to back them
 u Created to police monetary system by 34
ensuring maintenance of the fixed-exchange
rate.

u Promote int’l monetary cooperation and

facilitate growth of int’l trade.

u Wanted to avoid prewar problems, so

IMF u Created lending facilities to help countries
with trade deficits.

u Persistent borrowings leads to IMF

control of a country’s economic policy.

u Created adjustable parities.

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u Open to any country willing to

agree to its rules and regulations.

u Must pay a deposit (quota)

Membership
u Quota size reflects global
in the IMF
importance of a nation’s economy.

u Quota determines voting powers.

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u Today, the IMF focuses on lending money
to countries in financial crisis
What Is The u There are three main types of financial
Role crises:
Of The IMF u Currency crisis
Today? u Banking crisis

u Foreign debt crisis

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u A currency crisis

What Is The u occurs when a speculative attack on the

exchange value of a currency results in a
Role sharp depreciation in the value of the
Of The IMF currency, or forces authorities to expend

Today? large volumes of international currency

reserves and sharply increase interest rates
in order to defend prevailing exchange
rates

u Brazil 2002
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u A banking crisis refers to a situation in which

What Is The a loss of confidence in the banking system

leads to a run on the banks, as individuals
Role and companies withdraw their deposits
Of The IMF u A foreign debt crisis is a situation in which a
Today? country cannot service its foreign debt
obligations, whether private sector or
government debt

u Greece and Ireland 2010

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u The Mexican currency crisis of 1995 was a
result of
What Was
u high Mexican debts
The Mexican
u a pegged exchange rate that did not
Currency allow for a natural adjustment of prices
Crisis Of
u To keep Mexico from defaulting on its debt,
1995? the IMF created a $50 billion aid package

u required tight monetary policy and cuts

in public spending
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u The 1997 Southeast Asian financial
crisis was caused by events that
What Was took place in the previous
decade including
The 1. An investment boom - fueled by
Asian huge increases in exports
2. Excess capacity - investments were
Currency based on projections of future
demand conditions
Crisis?
3. High debt - investments were
supported by dollar-based debts
4. Expanding imports – caused current
account deficits
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By mid-1997, several key Thai financial
institutions were on the verge of
What Was default

The u speculation against the baht

Thailand abandoned the baht peg

Asian u
and allowed the currency to float
Currency
u The IMF provided a $17 billion bailout
Crisis? loan package
u required higher taxes, public spending
cuts, privatization of state-owned
businesses, and higher interest rates
 u Speculation caused other Asian 42
currencies including the Malaysian
What Was Ringgit, the Indonesian Rupaih and
The the Singapore Dollar to fall
Asian u These devaluations were mainly driven
Currency by
Crisis? u excess investment and high borrowings,
much of it in dollar-denominated debt

u a deteriorating balance of payments

position
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u The IMF provided a $37 billion aid
package for Indonesia
What Was
The u required public spending cuts, closure of
troubled banks, a balanced budget, and
Asian an end to crony capitalism
Currency u The IMF provided a $55 billion aid
Crisis? package to South Korea
u required a more open banking system
and economy, and restraint by chaebol
 u 44 in
By 2012, the IMF was committing loans to 52 countries
economic and currency crisis

How Has The u All IMF loan packages require tight macroeconomic
and monetary policy
IMF Done? u However, critics worry

u the “one-size-fits-all” approach to macroeconomic

policy is inappropriate for many countries

u the IMF is exacerbating moral hazard - when

people behave recklessly because they know they
will be saved if things go wrong

u the IMF has become too powerful for an institution

without any real mechanism for accountability
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Ø But, as with many debates about

How Has The international economics, it is not
IMF Done? clear who is right
Ø However, in recent years, the IMF
has started to change its policies
and be more flexible
Ø urged countries to adopt fiscal stimulus
and monetary easing policies in
response to the 2008-2010 global
financial crisis
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u BOP records financial transactions made

What is the between consumers, businesses and the
Balance of government in one country with others.
Payments
u These transactions include payments for
(BOP)?
the country's exports and imports of
goods & services, financial capital, and
financial transfers.
 u
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A country has to deal with other countries
in respect of 3 items:-
Balance of § Visible items which include all types
Payments of physical goods exported and imported.
(BOP) § Invisible items which include all those
services whose export and import are not
visible. e.g. transport services, medical
services etc.
§ Capital transfers which are concerned
with capital receipts and capital payment.
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Balance of
u All the receipts on account of goods exported
Payments
u Services rendered
statement u Capital received by residents
includes u Payments of residents

u Capital transferred to foreign

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Components u Current account

of Balance of u Capital account
Payments
 u Current account 52

u It includes visible exports and imports,

and invisible items like receipts and
payments for various services.
Components
u It contains credit and debit items.
of Balance of
u Credit includes merchandise exports
Payments
and invisible exports.

u Debit includes merchandise imports

and invisible imports.
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u Capital account

It is divided into
Components
– private capital
of Balance of
Payments – banking capital

– official capital
 u Capital account 54

– private capital

• Long term (> 1 year)

Components » Foreign investments

of Balance of » Long term loans
Payments » Foreign currency deposits

• Short term (< 1 year)

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u Capital account

– bank capital

Components • External financial assets

of Balance of • Liabilities of commercial and
Payments
cooperative banks authorized to
deal in foreign currency
 u Capital account 56
– Offical capital

• Capital outflow from home country to a foreign

country is treated as debit.

• The inflow of capital from a foreign country to

Components home country is credit.

of Balance of • Credit includes foreign long-term investment in

the home country and short term investment in
Payments the home country.

• Debit includes long term investments in foreign

country and short term investments in foreign

country.
 Credit (+) (receipts) Debits (-) (Payments)
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1. Current account

Exports Imports
Goods; Services; Transfer payments Goods; Services; Transfer payments

2. Capital account

Borrowings from foreign countries Lending to foreign countries

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u It helps

u State of International economic

relationship of country.

uA guide to its monetary & fiscal

Importance
exchange & other polices.
of Balance
of Payment u Inform govt about the international
economic position of the country, to
assist in reaching decissions on the
monetary and fiscal polices
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u It deals with exports and imports of

visible items only.
Balance u It takes into account only
of Trade merchandise exports & imports
only.
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u A disequilibrium in the balance of
payment means its condition of Surplus
Disequilibrium
Or deficit
In The
u A Surplus in the BOP occurs when Total
Balance Of
Receipts exceeds Total Payments. Thus,
Payments BOP= CREDIT>DEBIT

u A Deficit in the BOP occurs when Total

Payments exceeds Total Receipts. Thus,
BOP= CREDIT<DEBIT
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u Cyclical fluctuations
Causes of u Short fall in the exports
Disequilibrium u Economic Development
In The Bop
u Rapid increase in population

u Structural Changes

u Natural Calamites

u International Capital Movements

References 65

Wild, J. J., & Wild, K. L. (2019). International business: The challenges of

globalization (9th ed.). Pearson Higher Ed.