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NPM
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: Indira Sjahputri
: 1506772870
Class : KP 151 MMUI
: Multinational Finance
: Summary of Chapter 3 Multinational Business Finance

The International Monetary System

This chapter consist six sections about several factors affecting the International monetary
system described below.:
A. History of the International Monetary System
The studies of international monetary system history provides a useful perspective against
which to understand todays rather eclectic system of fixed rates, floating rates, crawling
pegs, and others, and to evaluate weaknesses and challenges for governments and business
enterprises conducting global business. This part will describe the evolution of each era from
1876 present.
1. The Gold Standard ( 1876 1913)
In Gold standard era each country could set the rate as it could be converted into a weight of
gold. Exchange rates between currencies was fixed because the government of each country
on gold standard agreed to buy and sell gold on its fixed parity rate.
2. The Interwar Years and World War II ( 1914 1944)
In this period, the currencies were allowed to fluctuate over a fairly wide range in terms of
gold and each other relation. The supply and demand of countries exports and imports caused
moderate change in exchange rate that caused several exchange rates performed under the
previous gold standard.As a result, fluctuations in currency values could not be offset by the
relatively illiquid forward exchange market except at exorbitant cost. The net result was that
the volume of world trade did not grow in the 1920s in proportion to world gross domestic
product but instead declined to a very low level with the advent of the Great Depression in
the 1930s. At this time, many of the main trading currencies lost their convertibility into other
currencies. One of the few currencies that continued to be convertible during World War II
and its chaotic aftermath is Dollar.
3. Bretton Woods and the International Monetary Fund (1944)
As WWII drew to a close, the Allied Powers met at Bretton Woods, New Hampshire to create
a post-war international monetary system. The Bretton Woods Agreement established a US
dollar based international monetary system and created two new institutions the International
Monetary Fund (IMF) and the World Bank. The International Monetary Fund is a key
institution in the new international monetary system and was created to help countries defend
their currencies against cyclical, seasonal, or random occurrences and assist countries having
structural trade problems if they promise to take adequate steps to correct these problems.
The International Bank for Reconstruction and Development (World Bank) helped fund postwar reconstruction and has since then supported general economic development.
4. Fixed Exchange Rates (1945 - 1973)

The currency arrangement negotiated at Bretton Woods and monitored by the IMF worked
fairly well during the post-WWII era of reconstruction and growth in world trade. However,
widely diverging monetary and fiscal policies, differential rates of inflation and various
currency shocks resulted in the systems demise. The US dollar became the main reserve
currency held by central banks, resulting in a consistent and growing balance of payments
deficit which required a heavy capital outflow of dollars to finance these deficits and meet the
growing demand for dollars from investors and businesses. Eventually, the heavy overhang of
dollars held by foreigners resulted in a lack of confidence in the ability of the US to met its
commitment to convert dollars to gold. The lack of confidence forced President Richard
Nixon to suspend official purchases or sales of gold by the US Treasury on August 15, 1971.
This resulted in subsequent devaluations of the dollar. Most currencies were allowed to float
to levels determined by market forces as of March, 1973
5. The floating Era of Eclectic Arrangements (1973 - 1997)
The exchange rates has been more volatile since March 1973. In these recent years, there are
several key events and external shocks that affected currency values. The most important
shocks in recent years have been the European Monetary System (EMS) restructuring in 1992
and 1993; the emerging market currency crises, including that of Mexico in 1994, Thailand
(and a number of other Asian currencies) in 1997, Russia in 1998, and Brazil in 1999; the
introduction of the euro in 1999; and the currency crises and changes in Argentina and
Venezuela in 2002.
6. The emmerging Era (1997 - Present)
The post-Asian Crisis of 1997 period has seen the growth in both breadth and depth of
emerging market economies and currencies. However, there are several arguments that argues
that the global monetary system is already more than a decade into the embracement of a
number of major emerging market currencies.
B. IMF Classification of Currency Regimes
The global monetary system is an eclectic combination of exchange rate regimes and
arrangements. For many years, IMF has been the central clearinghouse for the exchange rate
classifications. There are 8 spesific categories of currency regimes that described by IMF,
such as exchange arrangements with no separate legal tender, Currency board arrangements,
Other conventional fixed peg arrangements, Pegged exchange rates within horizontal bands,
Crawling pegs , Exchange rates within crawling pegs, Managed floating with no preannounced path, Independent floating .
C. Fixed Versus Flexible Exchange Rates

The choice of currency regime in a Country reflects the national priorities about all facets of
the economy, including inflations, unemployment, interest rate levels, trade balances, and
economic growth. The Ideal Currency possessed three attributes that reffered as The
Impossible Trinity because the forces of economic wont allow the simultaneous to achieve
all of three. The sides of the triangle describe about monetary independence, exchange rate
stability, or full financial integration. This following framework will describe about the
ultimate objective of Trinity element:
Picture C.1 The Impossible Trinity

D. A Single Currency for Europe: The Euro

These are domestic currencies of one country on deposit in a second country. The
Eurocurrency markets serve two valuable purposes: Eurocurrency deposits are an efficient
and convenient money market device for holding excess corporate liquidity & The
Eurocurrency market is a major source of short-term bank loans to finance corporate working
capital needs (including export and import financing). In the Eurocurrency market, the
reference rate of interest is the London Interbank Offered Rate (LIBOR). This rate is the most
widely accepted rate of interest used in standardized quotations, loan agreements, and
financial derivatives transactions.

E. Emerging Markets and Regime Choices

A unit of domestic currency only can be introduced if there is an additional unit of foreign
exchanged has been obtained first. Thus, a currency board exists when a countrys central
bank commits to back its monetary base entirely with foreign reserves at all times. In 2002,
the country ended the currency board as a result of substantial economic and political turmoil.
Therefore, there is Dollarization which is the use of the US dollar as the official currency of
the country, such as Panama, Ecuador, etc. One attraction of dollarization is that sound
monetary and exchange-rate policies no longer depend on the intelligence and discipline of
domestic policymakers.
F. Exchange Rate Regimes: What Lies Ahead?
The picture shows the trade offs between exchange rate regimes based on rules, discretion,
cooperation and independence. The vertical line
shows that different exchange rate arrangement
may dictate whether a countrys government has
strict intervention requirements or it may have a
discretion in the foreign exchange markets.
The horizontal line shows the paticipation of each
countries in a spesific system, whether it
cooperate with other countries or independently
operating as a member of the system.
All exchange rate regimes must deal with the trade-off between rules and discretion, as well
as between cooperation and independence. Regime structures like the gold standard required
no cooperative policies among countries, only the assurance that all would abide by the
rules of the game. However, the present international monetary system is characterized by
no rules, with varying degrees of cooperation. Although there is no present solution to the
continuing debate over what form a new international monetary system should take, many
believe that it could succeed only if it combines cooperation among nations with individual
discretion to pursue domestic social, economic, and financial goals.
Reference:
Eiteman, David K, Arthur I. Stonehill, Michael H. Moffet. (2010). Multinational Business
Finance. 12th edition. USA: Pearson Education, Inc.