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Multinational Financial Management

Hanna Deseasari 1110534003Yuri Annisa 1110534006 Doni Rahmad 1110534009Vilgia Delarhoza 1110534016Olfa Resha 1110534017Fachriza Mizafin 1110534021

Risma

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Determination of Rate and International Monetary System

I. ALTERNATIVE EXCHANGE RATE SYSTEMSII. A BRIEF HISTORY OF THE INTERNATIONAL

MONETARY SYTEMIII. THE EUROPEAN MONETARY SYSTEM AND

MONETARY UNIONIV. EMERGING MARKET CURRENCY CRISES

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I. ALTERNATIVE EXCHANGE RATE SYSTEMS

I. FIVE MARKET MECHANISMS

a. Freely Floating (“Clean Float”)1. Market forces of supply and demand determine

rates.2. Forces influenced by a. price levels b. interest rates c. economic growth3. Rates fluctuate randomly over time.

b. Managed Float (“Dirty Float”)1. Market forces set rates unless excess volatility

occurs.

2. Then, central bank determines rate.

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ALTERNATIVE EXCHANGE RATE SYSTEMS

C. Target-Zone Arrangement

1. Rate Determination

a. Market forces constrainedto upper and lower range of rates.

b. Members to the arrangement

adjust their national economic policies to maintain target.

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ALTERNATIVE EXCHANGE RATE SYSTEMS

D. Fixed Rate System1. Rate determination

a. Government maintains target rates.

b. If rates threatened, central banks buy/sell currency.

c. Monetary policies coordinated.

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ALTERNATIVE EXCHANGE RATE SYSTEMS

E. Current System1. A hybrid system

a. Major currencies: use freely- floating method

b. Other currencies move in and out of various fixed-rate

systems.

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PART II. A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEM

I. THE USE OF GOLDA. Desirable propertiesB. In short run: High production costs limit changes.C. In long run: Commodity money insures stability.

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A BRIEF HISTORY

II. The Classical Gold Standard (1821-1914)

A. Major global currencies on gold standard.

1. Nations fix the exchange rate in terms of a specific amount of gold.

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A BRIEF HISTORY

2. Maintenance involved the buying and selling of gold at

that price.

3. Disturbances in Price Levels:Would be offset by the price-

specie*-flow mechanism.

* specie = gold coins

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A BRIEF HISTORY

a. Price-specie-flow mechanismadjustments were automatic:1.) When a balance of payments

surplus led to a gold inflow;

2.) Gold inflow led to higher prices which reduced surplus;

3.) Gold outflow led to lower prices and increased surplus.

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A BRIEF HISTORY

III. The Gold Exchange Standard (1925-1931)A. Only U.S. and Britain allowed

to hold gold reserves.

B. Others could hold both gold, dollars or pound reserves.

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A BRIEF HISTORY

C. Currencies devalued in 1931

- led to trade wars.D. Bretton Woods

Conference- called in order to avoid future protectionist and destructive economic

policies

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A BRIEF HISTORY

V.The Bretton Woods System (1946-1971)

1. U.S.$ was key currency;valued at $1 - 1/35 oz. of

gold.

2. All currencies linked to that price in a fixed rate system.

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A BRIEF HISTORY

3. Exchange rates allowed to fluctuate by 1% above or below initially set rates.B. Collapse, 1971

1. Causes:a. U.S. high inflation rate

b. U.S.$ depreciated sharply.

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A BRIEF HISTORY

V.Post-Bretton Woods System (1971-Present)

A. Smithsonian Agreement, 1971:

US$ devalued to 1/38 oz. of gold.

By 1973: World on a freely floating exchange rate system.

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A BRIEF HISTORY

B. OPEC and the Oil Crisis (1973-774)1. OPEC raised oil prices four fold;

2. Exchange rate turmoil resulted;

3. Caused OPEC nations to earn large surplus B-O-P.

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A BRIEF HISTORY

4. Surpluses recycled to debtor nations which set up debt crisis of 1980’s.

C. Dollar Crisis (1977-78)1. U.S. B-O-P difficulties2. Result of inconsistent

monetary policy in U.S.

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A BRIEF HISTORY

3. Dollar value falls as confidence shrinks.

D. The Rising Dollar (1980-85)1. U.S. inflation subsides as the

Fed raises interest rates

2. Rising rates attracts global capital to U.S.

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A BRIEF HISTORY

3. Result: Dollar value rises.

E. The Sinking Dollar:(1985-87)1. Dollar revaluated slowly

downward;2. Plaza Agreement (1985)

G-5 agree to depress US$further.

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A BRIEF HISTORY

3. Louvre Agreement (1987)G-7 agree to support the falling US$.

F. Recent History (1988-Present)1. 1988 US$ stabilized2. Post-1991 Confidence

resulted in stronger dollar

3. 1993-1995 Dollar value falls

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PART III.THE EUROPEAN MONETARY SYSTEM

I. INTRODUCTIONA. The European Monetary System (EMS)

1. A target-zone method (1979)

2. Close macroeconomic policy

coordination required.

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THE EUROPEAN MONETARY SYSTEM

B. EMS Objective:to provide exchange rate stability to all members by holding exchange rates

within specified limits.

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THE EUROPEAN MONETARY SYSTEM

C. European Currency Unit (ECU)

a “cocktail” of European currencies with specified weights as the unit of account.

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THE EUROPEAN MONETARY SYSTEM

1. Exchange rate mechanism (ERM)

- each member determines mutually agreed upon central cross rate for its currency.

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THE EUROPEAN MONETARY SYSTEM

2. Member Pledge:to keep within 15% margin above or below the central rate.

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THE EUROPEAN MONETARY SYSTEM

D. EMS ups and downs1. Foreign exchange

interventions: failed due to lack of

support by coordinated monetary policies.

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THE EUROPEAN MONETARY SYSTEM

2. Currency Crisis of Sept. 1992a. System broke downb. Britain and Italy

forced towithdraw from EMS.

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THE EUROPEAN MONETARY SYSTEM

G. Failure of the EMS:

members allowed political

priorities to dominate

exchange rate policies.

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THE EUROPEAN MONETARY SYSTEM

H. Maastricht Treaty1. Called for Monetary

Union by 1999 (moved to 2002)

2. Established a single currency:

the euro

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THE EUROPEAN MONETARY SYSTEM

3. Calls for creation of a singlecentral EU bank

4. Adopts tough fiscal standards

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THE EUROPEAN MONETARY SYSTEM

I. Costs / Benefits of A Single CurrencyA. Benefits

1. Reduces cost of doing business

2. Reduces exchange rate risk

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THE EUROPEAN MONETARY SYSTEM

B. Costs1. Lack of national

monetary flexibility.

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PART IV. EMERGING MARKET CURRENCY CRISES

I. Transmission MechanismsA. Trade links

contagion spreads through tradeB. Financial System

-more important transmission mechanism-investors sell off to make up for losses

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EMERGING MARKET CURRENCY CRISES

II. Origins of Emerging Market CrisesA. Moral hazard

B. Fundamental Policy Conflict

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EMERGING MARKET CURRENCY CRISES

III. Policy Proposals for Dealing with Emerging Market Crises

A. Currency Controls

B. Freely Floating Currency

C. Permanently Fixed Exchange Rate