IFM - Evolution of IMS

INTERNATIONAL
FINANCIAL MANAGEMENT
EVOLUTION OF
INTERNATIONAL MONETARY
SYSTEM(IMS)
1
INTERNATIONAL FINANCIAL MANAGEMENT
IMS has evolved over the course of centuries
and defines the financial environment in which
MNCs operate.
IMS consists of :
- laws - Institutions
- rules - procedures
-agreements - mechanisms
the above affects:
- FE rates - International trade
- BOPs - capital flows
- Adjustments
This system is ever changing as
international business and political
environment is ever changing 2
Evolution of IMS can be analyses in FOUR
stages as follows:
Gold standard (1986 -1913)
Inter war years 1914-44)
Britton wood System (1945-1973)
Flexible Exchange rte regime from 1973.
3
Evolution of IMS (contd..)
(1) Gold standard (1986 -1913)
Fundamental principle of the classic gold
standard was that each country should set
a par value for its currency in terms of
gold and they should maintain
Each country has to fix the rate at which
its currency could be converted in to the
weight of gold
The exchange rate between two countries
was determined by their gold content.
4
Three important features of Gold standard were:
(1) Each country must fix once for all, the rate of
conversion of their paper currency issued by them in to
gold
(2) There must be free flow of gold between
countries
(3) There must be 2 way convertibility between
gold and national currencies at a stable ratio
eg. USA declared the dollar to be convertible to
gold at the rate of 1 ounce of gold = Us$ 20.67 =
UK declared 1 ounce of gold = 4.2474
Thus 1 UK = US$ 4.866( US$ 20.67 4.2474)
5
Each country agreed to buy or sell gold at
its own parity rate on demand
This helped to preserve the value of each
individual currency in terms of gold.
Under this system it is extremely necessary
for a country to back currency value by
maintaining adequate gold reserves
Under this system stability in
exchange rates achieved
automatically.
6
(1) Decline of Gold standard (1986 -1913)
a) To run the system every country should follow three
rules discussed earlier (slide 5)
- all the countries should adhere to the above rules
- Such rules require nations willingness keeping in
view :
BOP
FE considerations beyond their domestic policy and goals
This assumption is unrealistic
b)Gold is a scarce commodity hence gold volume
could not grow fast. This scarcity could allow to
print more currency.
- This scarcity further aggravated by use of gold
for ornamental purpose/industrial consumption
7
(1) Decline of Gold standard (1986 -1913)
c) Another problem is the unrealistic
expectation that countries would subordinate
their national economy to the dictates of gold
and external monetary conditions
- In other words a country with high resulting
in recession/unemployment /discourage
imports etc.
- Hence they could not implement this
discipline
Because of this rigidity of system , this
system was abandoned starting with UK in
1931 in the midst of world wide recession 8
(2) Inter war years (1914-44) -Modified gold
standard
The gold standard system as an IMS worked well
until world war I
World war I interrupted and disturbed the stability

of exchange rates in r/o major countrys
currencies.
Role of UK as major creditor nation cam to an end
USA has emerged as leading creditor nation

9
standard
World war I ended the classical gold standard

in Aug.1914, as major countries such as UK,
Austria, Hungary, Poland and Russia suspended
redemption of bank notes in gold and imposed
embargos.
After the war all the above countries suffered a

very high inflation
a10
standard
Many countries resorted to predatory depreciations

of their currencies to gain advantage in exports
Many small countries which were on gold

exchange standard kept their reserves in London
and New York.
But rumors of war and abnormal conditions forced

the depositing countries to with draw their gold
reserves. This also lead to abandonment of gold
standard
a11
standard
Major countries began to recover from the
war and stabilize their economies
They attempted to restore gold standard
Post world war I period
Several countries tried to recover form war
and to stabilize their economies
Taken several steps to revive
USA returned to gold std --- 1919
UK returned
1925
Switzerland/France etc 1928
a12
standard
UK fixed exchange parity at the old rate

of $1 = 4.866
This was the great mistake done by UK
In fact UK suffered more inflation than
USA during/after world war I. Resulted in
Economic stagnation
USA in 1919 returned to modified gold std
and US$ was devalued from previous
$20.67 = 1 ounce of gold to $ 35 = 1
ounce of gold
a13
standard
From 1934 till the end of world war II
(1939-44) the exchange rates were
theoretically determined by each currency
value in terms of gold
The only major currency that continued to
remain convertible was US $
Thus the inter war period was
characterized by half hearted attempts to
revive gold STD, economic and political
instability, wide fluctuating exchange
rates, bank failures and Fin. crisis
a14
3) Bretton wood system(1945-1971)
World wars ruined the economies of various
countries
Economies suffered
IMS collapsed
Countries resorted to devaluation to correct BOP

deficit
There was a race for devaluation
Result: violent fluctuations in FOREX
International trade was stand still 15

3) Bretton wood system(1945-1971)
Necessitated post war revival
In July 1944 forty four (44) nations met at

Bretton woods new Hampshire USA, to
discuss and design new IMS
Thus emerged a new and stable exchange

system viz. BRETTON WOOD SYSTEM in
1944
UK,USA took lead to create: Free, Stable,

multilateral monetary system 16
3) Bretton wood system (cond..)
Objectives:
Suitable and stable IMS to establish
Remove existing Exchange controls
Free convertibility - all countries to
ensure
BWS is dollar based IMS
Two institutions viz. IMF and WM emerged
to help the growth of economy
Basic purpose of BWS:
Facilitate expansion of trade
Use US$ as standard value

Stability of exchange rate 17
Parities: Each country should fix parities to
their currencies in terms of Dollar or gold
All countries (except USA) exchange
currencies for gold or US$
Only US$ convertible in to gold i.e. @ $ 35=
1 ounce
Band: Each currency is allowed to fluctuate
plus or minus 1 % of par value by
intervention by central banks
If a currency is too weak allowed
devaluation up to 10% with the approval of
IMF
Central banks intervention allowed up to (+)
or (-)1% 18
Maintenance of FE reserves by central
banks: Necessitated to manage float
Special drawing Rights (SDRs): if FE
reserves are not sufficient tap SDRs or
other facilities like loans
Observation note: success of BWS
depends upon Central Banks
intervention in FE markets
Change par values : (a) Only with IMF
approval(b) if BOP is in disequilibrium
BWS worked well from 1947 - 71
19
Collapse of Bretton wood system
BWS collapsed on account of:
(1) America's huge BOP deficit
massive deficit in USA
gold reserves maintained by USA are not
sufficient to cover supply of US$ (paper currency)
Massive inflation in USA in 70-71
(2) USA withdrawal of commitment ( US$ 35 = 1
ounce of gold)
On 15-8-1971 No commitment from USA to
honor US$ 35/ per ounce of gold
(3) IMFs stringent policy
persistent deficit of countries (BOP) were
subjected to follow stringent economic policies by
IMF if any country wants help from IMF
This resulted in problems to various countries
20
SMITHSONIAN AGREEMENT Dated: 18-12-1971
From 1971 fluctuations of various currencies

started.
US dollar fell against other currencies.
Countries imposed exchange controls no

trade
To solve these problems Group Ten (G10)

(Belgium, Japan, France, USA, UK, Sweden, Germany, Canada,
Italy and
Netherlands) brought SMITHSONIAN AGREEMENT
on 18-12-1971 21
FEATURES OF SMITHSONIAN AAGAREEMENT
(1)Brought new set of parity rates called central

rates
(2)Central rates lack approval of IMF
(3) Though US$ is not convertible to gold(from

1971) still
it was defined in terms of gold
(4) Currencies of other nine countries defined in

terms of
gold
22
(5) Devaluation by USA : US$ 35/ounce of gold -
no longer good
- now US$ 38 = 1 ounce of gold
- USA agreed to devalue US$ from 35 to
38/ounce of gold in return of a promise that
other countries to up value their currencies.
(6) Up value by other countries:
- Japan, Germany and other European
countries simultaneously up valued their
currencies by 7%
(7) BAND: (+ or - ) 2.25% from central rates
allowed against US$ without intervention of
Govt.
- This affects in double = 4.5% 23
(8) ARGUMENTS ON SMITHSONIAN AGREEMENT
A wider band (+ or - 2.25%) allow countries to
retain:
Discipline as was in gold STD system
Smoother adjustment/ Greater freedom of
flexible exchange rates
RESULT:
- Smithsonian failed to reduce
speculations
- Govt. control on FE did not decrease
Smithsonian Agreement comes to an end
in 1973 as other countries have gone for
floating rates. 24
4) Flexible Exchange rate Regime
The collapse of BWS was followed by the

flexible exchange rate regime which was
approved in Jan,1976 when the members of
IMF met in JAMAICA and agreed to develop a
new set of rules for IMS
Important elements of Jamaica Agreement:
Flexible exchange rates were accepted by all the

members of IMF
Central Banks were permitted to intervene in the
exchange markets for settling the unwarranted
fluctuations 25
4) Flexible Exchange rate Regime
Gold was demonetized and no longer

used as international reserve
Non oil export countries and less

developed countries were allowed
greater access to IMF
IMF to help countries facing BOP deficit.
26
4) Flexible Exchange rate Regime(contd.)
Exchange rates have become more volatile
since 1973 after collapse of BWS.
Decrease in Dollar value between 1970-73

denotes the shift from BWS to flexible exchange
rate system
The fall of US dollar (graph)

1970-73 Decline
1980-84 Spectacular rise (Reagan Administration)
capital inflows more
1985 Persistent decline
1988 Stabilized
27
The fall in the exchange rate partially is

the effect of record high US trade deficit
(about $ 160 billions in 1985)
1985 : G5 countries (France, Japan, Germany,
UK,USA) met
at PLAZA HOTEL in N.Y and reached
PLAZA ACCORD
PLAZA agreed that dollar is desirable to

depreciate against major currencies to solve
USA deficit problem 28
The slide of US$ that had begun in February

1985,further dropped by the PLAZA accord
The persistent fall of dollar caused concern to

major industrial countries
1987: G7 (G5 + Canada, Italy) economic

summit was convened in Paris to address the
problem of fall of US $
This meeting produced the LOUVRE ACCORD

29
According to LOUVRE ACCORD:
G7 countries to cooperate to achieve grater
exchange rate
stability
G7 to exercise more closely consult and coordinate their
macro economic policies
LOURVE ACCORD marked the starting of
Managed float
G7 would jointly intervene the exchange

market
Since LOUVRE accord exchange system

became relatively stable 30
1996-2001 : Robust performance US

economy. Dollar appreciated highly.
Other countries heavily invested in USA
2001: US$ began to depreciate due to

sharp stock market correction
31

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INTERNATIONAL

Inter war years 1914-44)

Britton wood System (1945-1973)

Flexible Exchange rte regime from 1973.

World war I interrupted and disturbed the stability

Role of UK as major creditor nation cam to an end

USA has emerged as leading creditor nation

World war I ended the classical gold standard

After the war all the above countries suffered a

Many countries resorted to predatory depreciations

Many small countries which were on gold

But rumors of war and abnormal conditions forced

UK fixed exchange parity at the old rate

Countries resorted to devaluation to correct BOP

There was a race for devaluation

Result: violent fluctuations in FOREX

International trade was stand still 15

Necessitated post war revival

In July 1944 forty four (44) nations met at

Thus emerged a new and stable exchange

UK,USA took lead to create: Free, Stable,

Use US$ as standard value

From 1971 fluctuations of various currencies

US dollar fell against other currencies.

Countries imposed exchange controls no

To solve these problems Group Ten (G10)

FEATURES OF SMITHSONIAN AAGAREEMENT

(1)Brought new set of parity rates called central

(2)Central rates lack approval of IMF

(3) Though US$ is not convertible to gold(from

(4) Currencies of other nine countries defined in

The collapse of BWS was followed by the

Important elements of Jamaica Agreement:

Flexible exchange rates were accepted by all the

Gold was demonetized and no longer

Non oil export countries and less

IMF to help countries facing BOP deficit.

Decrease in Dollar value between 1970-73

The fall of US dollar (graph)

The fall in the exchange rate partially is

PLAZA agreed that dollar is desirable to

The slide of US$ that had begun in February

The persistent fall of dollar caused concern to

1987: G7 (G5 + Canada, Italy) economic

This meeting produced the LOUVRE ACCORD

G7 would jointly intervene the exchange

Since LOUVRE accord exchange system

1996-2001 : Robust performance US

Other countries heavily invested in USA

2001: US$ began to depreciate due to

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