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Chapter
10 Outline
Chapter Summary
This chapter explained the workings of the international
monetary system and pointed out its implications for international business.
This chapter made the following points:
- The gold standard is a monetary standard that pegs currencies
to gold and guarantees convertibility to gold.
- It was thought that the gold standard contained an automatic
mechanism that contributed to the simultaneous achievement of a balance-of-payments
equilibrium by all countries.
- The gold standard broke down during the 1930s as countries
engaged in competitive devaluations.
- The Bretton Woods system of fixed exchange rates was
established in 1944. The US dollar was the central currency of this
system; the value of every other currency was pegged to its value. Significant
exchange rate devaluations were allowed only with the permission of
the IMF.
- The role of the IMF was to maintain order in the international
monetary system (i) to
avoid a repetition of the competitive devaluations of the 1930s and
(ii) to control price
inflation by imposing monetary discipline on countries.
- To build flexibility into the system, the IMF stood ready
to lend countries funds to help protect their currency on the foreign
exchange market in the face of speculative pressure, and to assist countries
in correcting a fundamental disequilibrium in their balance-of-payments
position.
- The fixed exchange rate system collapsed in 1973, primarily
due to speculative pressure on the dollar following a rise in US inflation
and a growing US balance-of-trade deficit.
- Since 1973 the world has operated with a floating exchange
rate regime, and exchange rates have become more volatile and far less
predictable. Volatile exchange rate movements have helped reopen the
debate over the merits of fixed and floating systems.
- The case for a floating exchange rate regime claims:
(i) that such a system
gives countries autonomy regarding their monetary policy and (ii)
that floating exchange rates facilitate smooth adjustment of trade imbalances.
- The case for a fixed exchange rate regime claims: (i)
that the need to maintain a fixed exchange rate imposes monetary discipline
on a country, (ii) that
floating exchange rate regimes are vulnerable to speculative pressure,
(iii) that the uncertainty
that accompanies floating exchange rates dampens the growth of international
trade and investment, and (iv)
that far from correcting trade imbalances, depreciating a currency on
the foreign exchange market tends to cause price inflation.
- In today's international monetary system, some countries
have adopted floating exchange rates, some have pegged their currency
to another currency, such as the US dollar, and some have pegged their
currency to a basket of other currencies, allowing their currency to
fluctuate within a zone around the basket.
- In the post-Bretton Woods era, the IMF has continued
to play an important role in helping countries navigate their way through
financial crises by lending significant capital to embattled governments
and by requiring them to adopt certain macroeconomic policies.
- There is an important debate taking place over the
appropriateness of IMF-mandated macroeconomic policies. Critics charge
that the IMF often imposes inappropriate conditions on developing nations
that are the recipients of its loans.
- The present managed-float system of exchange rate determination
has increased the importance of currency management in international
businesses.
- The volatility of exchange rates under the present managed-float system
creates both opportunities and threats. One way of responding to this
volatility is for companies to build strategic flexibility by dispersing
production to different locations around the globe by contracting out
manufacturing (in the case of low-value-added manufacturing) and other
means.
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