THE INTERNATIONAL MONETARY FUND (3)

The IMF and its leading member put up a gallant but hopeless fight to make stable exchange rates work. Indeed they continued to defend the indefensible for years after it became clear that the U.S.dollar , which had been the lynch-pin of the new Bretton Woods system , was becoming progressively overvalued in the 1960s.Germany,Japan,and other countries with undervalued currencies ran chronic payments surpluses , while the U.S. was running chronic and growing payments deficits . Under the Bretton woods rules, the surplus countries had only two choices:they could appreciate currencies and thereby get rid of their undervaluation and lose their payments surpluses;or,if appreciation was politically unpopular at home because it would hurt jobs and profits in the swollen export industries,Germany and Japan had no choice but to take in U.S. dollar IOUs in ever-increasing amounts-thereby contributing to an increase in their own domestic money supplies and in their own uncomfortable rates of domestic inflation.
As will be seen,after 1971 the Bretton Woods system of pegged exchange rates broke down permanently and has been replaced by a system of managed floating-exchange rates.

THE INTERNATIONAL MONETARY FUND (2)

From 1945 until 1971 when the Bretton woods system broke down forever, the IMF nurtured the illusion that it could keep exchange rates stable most of the time.only under the extreme pressure of fundamental disequilibria persisting in a country is balance of payments would the IMF except that country to depreciate its exchange rate. Increasingly in the 1950s and 1960s,the imf found that pegging of exchange rates could not succeed in a world where costs and demands were changing differentially between regions , and where speculators could safely bet that the currencies which were overvalued would become unpegged .

THE INTERNATIONAL MONETARY FUND

The IMF,Like the world bank,grew out of the 1944 international conferences.It hoped to secure the advantage of the gold standard without its disadvantage;e.g.,exchange rates were in the beginning envisaged to be relativity stable,but with international cooperation to replace the previous automatic mechanism.Also,countries were to be spared the need to make adjustments by deflating themselves into drastic unemployment.And the IMF still hopes to lessen the need for important controls.Ordinarily,a country pays for its imports by means of its exports or long-term borrowing.Suppose a country,say,England,is in need of short-term credit from the IMF.How exactly does the IMF enable such a debtor country to get hold of dollars?It does this by extending "purchasing rights" It simply lets the British but with British currency some of the Fund ’s own holdings of dollars.After the British balance of payments has improved, Britain is expected to buy back with gold or dollars (or,as we will see,with SDRs or "paper gold" )the pounds it has sold to the fund.

financial globalization:recent phenomenon?(3)

In today is rapidly globalizing world ,where the value of foreign exchange transaction involving international assets far exceeds the value of foreign exchange transaction involving good and services ,it is important to examine more closely the nature of these modern transaction .the actors in the international financial system have developed a huge and bewildering variety of different types of traded assets ,with each asset designed to satisfy particular liquidity ,risk ,and return demands of financial investors and asset holders.we survey different general types of assets that are exchanged internationally ,and we provide information on their size,characteristics ,and markets .we begin by looking at international bank lending and then examine international bonds and stocks (equities ). we then consider in some detail a number of specific financial instruments that belong to the broad category "financial derivatives " Our purpose here is to familiarize you in a general way with the range of financial instruments available for transferring wealth across country borders and to indicate the many possibilities that exist internationally for satisfying financial investors particular preferences.

financial globalization:recent phenomenon?(2)

while the global capital market did begin to grow in the 1960s,it did not reach the previous high levels of the earlier period until well into the 1980s.while the two growth periods are quite similar in terms of the changes in communications and transportation that accompanied the growth spurts ,they do differ in terms of the type of foreign exchange regime in place and the challenges facing policymakers.the earlier period operated under a gold standard,while the current system contains of a variety of systems anchored by flexible exchange rate arrangements between the two periods.in the earlier period ,the volume of capital flows to developing regions was roughly equal to those flowing to the more wealthy countries.today ,relatively little capital is flowing to the developing countries ,and the bulk of the capital flows are between wealthy countries and are intended to reduce risk through asset diversification and the fine-tuning of portfolios.

financial globalization:recent phenomenon?(1)

in spite of the many different issues and disagreements surrounding globalization,the phenomenon is currently perceived as present in nearly all aspects of economic life and is often taken for granted.further,it is generally viewed as a relatively recent phenomenon,particularly in the area of capital flows and international finance.in a recent article, Alan M.Taylor provides a historical look at the globalization of finance and point out some interesting facts.Capital flows have indeed surged in volume in the past few decades in the both the developing and developed world ,often creating difficult challenge for policymakers.Surprisingly, a similar phenomenon took place in an earlier period of globalization between 1870and 1914.The striking parallels between the two periods,roughly 100 years apart,have raised some interesting questions,particularly in light of the collapse of the earlier globalization phenomenon starting in 1914 and continuing through the 1940s and 1950s.while two world wars and major world recession certainly contributed to the striking changes in global finance ,it seems prudent to step back and examine the current global capital phenomenon in terms of our earlier experiences.

The international bond market (Debt securities)(3)

the two types of markets-the foreign bond markets and the euro bond markets-together constitute the aggregate international bond market .in actual practice,the distinction between foreign bonds and euro bonds is somewhat blurred (for example,because one bank may underwrite an offering by itself and use neither a domestic syndicate nor a multinational syndicate ).In either the foreign bond or the euro bond markets ,the issued securities themselves can play a fixed interest rate or a variable(floating)interest rate (usually tied to LIBOR ).in addition ,some bonds are sold at a substantial discount below face value and issued as "zero-coupon"bonds .in this instance ,there are no regular interest payments ,and the total interest is received when the bond matures at its face value.

the goals of the IMF (5)

When all countries subscribed their quotas,the IMF became a holder of gold and of a pool of member country currencies.how do these quotas link up with balance-of-payment loans to member countries ?suppose that Kenya has a BOP deficit and that it needs,because of a foreign exchange shortage,to obtain British pounds to pay for some of its imports.Kenya can"borrow" or"draw" pounds from the IMF since the IMF has a quantity of pounds on hand from the united kingdom quota . According to IMF rules,a country can potentially obtain loans of up to 125 percent of its quota.This figure of 125 percent is divided into five segments (or tranches,as they are officially called),with the first 25 percent called the gold tranche or reserve tranche,the next 25 percent called the first credit tranche, the next 25 percent the second credit tranche,and so on.the application for the first 25 percent is automatically approved by the IMF ,but,as a country gets further and further into the credit tranches,the IMF will attach increasingly stringent conditions before approving the additional loans .these conditions are designed to ensure that the borrowing country is taking action to reduce its BOP deficit. For example ,the IMF may prescribe that the country adopt certain monetary and fiscal policies or may even recommend a change in the value of the borrowing country is currency .These potential interferences by an international agency with the national policies of members have generated considerable ill will,because they are regarded by would -be borrowers as intrusions upon national sovereignty.Incidentally ,the IMF levies a small service charge on these BOP loans; there is no interest charge on reserve tranche loans ,but interest is assessed on credit tranche loans.

the goals of the IMF (4)

if a loan could provide finance to the borrower until the payments imbalance reversed itself,then there would be no need for alteration of the deficit nation is macro policies in the direction of sacrificing internal goals.in addition,an IMF loan might reduce the likelihood that the deficit country would impose tariffs and other restrictive instruments on imports to conserve its foreign exchange reserves.Along the same line,fewer exchange controls on capital movements might be introduced.Hence,the availability of IMF loans not only could serve the purpose of giving more autonomy to domestic macro policy instruments but also contributed to a third objective of the IMF: to help preserve relatively free trade and payments in the world economy.what were the sources of the funds for BOP loans? when a country joins the IMF (there are now 184 IMF member nations),it is assigned an IMF quota.this country quota is a sum of money to be paid to the IMF based on such factors as the national income of the country and the size of its foreign trade sector.

the goals of the IMF (3)

As you may remember,the conceptual gold standard adjustment mechanism involved,for deficit countries,a fall in wages and prices as gold flowed out.This mechanism,or the alternative mechanism of an increase in interest rates to attract foreign short-term capital,posed the difficulty that the resulting contraction of economic activity could cause a rise in unemployment and a fall in real income.in contrast,a surplus country experienced upward pressure on its wages and prices ,downward adjustments in its interest rates,and the resulting threat of inflation .but ,if the rules of the game were being followed,internal objectives were to be sacrificed to the objective of attaining balance-of-payments equilibrium .after the great depression of the 1930s, governments were unwilling to use their monetary and fiscal policy instruments solely for external balance .Conflicts arose between the external target and the internal targets of macroeconomic policy.The IMF sought to reduce this conflict.Attempts were made to alleviate the conflict through the use of loans by the IMF to deficit countries. The rationale behind these short-term loans (three to five years) was that a country is BOP deficit might be temporary because of the stage of the business cycle in which the country was located.

the goals of the IMF (2)

Thus,parity values were established by agreement,but variations of 1 percent above and below parity were permitted.These limits were to be maintained by central banks,which would buy dollars if the price of the dollar fell to the /1 percent floor or would sell dollars if the price of the dollar rose to the + 1 percent ceiling.The word adjustable in the phrase' paged but adjustable' refers to the fact that, if a country experienced prolonged BOP deficits or surpluses at the pegged exchange rate,an IMF-approved devaluation or upward revaluation of the currency,s parity value could be undertaken.In fact,as the IMF evolved,there were few changes in parity values.The desire for stable and relatively fixed rates was a reaction to the wide fluctuations,the competitive deprecations,the shrinkage in trade,and the instability of the world economy in the interwar period off the 1920s and 1930s.Another objective of the IMF was the reconciliation of country adjustments to payments imbalances with national autonomy in macroeconomic policy.

the goals of the imf (1)

the international monetary fund (Imf) was key institution in the functioning of the post-world war II international monetary system known as the Bretton woods system.in this context,the IMF had several objectives. in broad terms one important goal of the IMF was to seek stability in exchange rates. When the institution was first set up and for three decades thereafter,the IMF charter called for a system of Pegged but adjustable exchange rates.As the 'Iinchpin' of the Bretton woods system,the dollar was defined by the united states as having a value of 1/35 of an ounce of gold.Other countries then defined their currency values in terms of the dollar.

advantages of a currency board

four major advantages are usually cited when comparing a currency board arrangement with a central bank with discretionary control of the money supply.
1- A currency board ensures convertibility .the maintenance of a 100 percent reserve system makes it certain that assets are available to cover any demand for conversion into foreign currency .
2- a currency board instills macroeconomic discipline .because the currency board is prohibited from buying domestic assets,it cannot finance a fiscal deficit .the government is forced to borrow from the public at home or aboard or maintain a balanced budget.in other words ,the government cannot simply "print money" to finance a government budget deficit since the money supply is strictly tied to the quantity of foreign exchange held by the currency board .it is hence also argued that a currency board will secure discipline over inflation .the process of tying the local currency to a reserve (and presumably low inflation) currency at a fixed exchange rate enhances price stability.
3- A guaranteed payment adjustment mechanism is provided. The payment adjustment mechanism is simply the gold-standard adjustment mechanism that is actually aversion of David Hume is price-specie-flow mechanism .these three advantages combine to create greater confidence in the system.
4- the increased confidence leads to the promotion of higher rates of trade ,investment ,and growth.

Do Fixed or flexible Exchange rates provide for greater "discipline" on the part of policymakers?(4)

On the other hand ,if a country has a Bop surplus,there is upward pressure on the price level because of the expanding money supply .while this could potentially be helpful from the standpoint of employment and growth,it will aggravate internal performance with respect to the goal of price stability.for example ,Germany has often had a Bop surplus but at the same time did not want its inflation rate to rise .thus,whether a country is in Bop deficit or surplus,the attainment of some internal goal will be frustrated because of the fixed rate system. the resolution of the question of whether discipline and hence price stability is more prevalent with fixed rates than with flexible rates requires extensive empirical research .it can be noted that world inflation was more rapid in the floating-rate period of the 1970s than in the pegged rate period of the 1960s,but events occurring independently of the exchange rate system-such as the behavior of OPEC-undoubtedly played a role in generating this difference in world inflation .

Do Fixed or flexible Exchange rates provide for greater "discipline" on the part of policymakers?(3)

Two major replies can be made to these points .first,with respect to the vicious circle hypothesis ,flexible-rate advocates think that the depreciation that was a response to the inflation and that is alleged to cause further inflation can actually be clear signal to the authorities that monetary restraint is needed .This signal can therefore lead to the quick instigation of anti-inflationary policies.thus,in this view,the danger of inflation is no greater under flexible than under fixed rates.
In response to the alleged discipline in necessarily always desirable .Countries also have other domestic goals besides maintenance of the fixed exchange rate and price stability,such as the generation of high levels of employment and of reasonably rapid economic growth .A BOP deficit implies that,whether the adjustment is accomplished trough the automatic reduction of the money supply or through contractionary tedencies will serve to worsen the internal situation.the united states faced this dilemma in a number of years in the 1960s.

Do Fixed or flexible Exchange rates provide for greater "discipline" on the part of policymakers?(2)

Note that the result in the preceding discussion is a tendecy for deflation in the deficit country and inflation in the surplus country .Therefore ,if prices are flexible in bot directions ,it is likely that prices will be relatively stable in the world as a whole .IN practice ,the world could have some inflation if prices are less flexible downward than upward.however,the inflation will probably not be as rapid as it would be if the discipline of fixed rates did not exist .
In addition to this emphasis on the discipline of fixed exchange rates ,proponents of such a system stress that flexible rates could actually aggravate inflationary tendencies in a country .the point is made that,under flexible rates ,inflation in a country becomes self perpetuating ;this argument is sometimes called the vicious circle hypothesis.Suppose that a country is undergoing rapid inflation because of an excess supply of money and excess demand in the economy.The inflation will cause the country is currency to depreciate in the exchange markets ,which will add to aggregate demand in the economy and generate further inflationary pressure.in addition ,the rise in prices will lead to correspondingly higher money wages,which also induces more inflation .thus ,inflation will cause depreciation, but the depreciation itself will cause further inflation .this sequence of events continues until the monetary authorities put a stop to the monetary expansion.

Do Fixed or flexible Exchange rates provide for greater "discipline" on the part of policymakers?(1)

A point made in favor of fixed exchange rates is that such a system provides for the "discipline" needed in economic policy to prevent continuing inflation.that is ,in a fixed-rate system,there should be no tendency for greater inflation to occur in one country than in the world as a whole .Consider a country with a balance -payment (BOP) deficit .if the cause of the deficit is a more rapid inflation than that in trading partners,then the country is authorities will need to apply anti-inflationary policy to protect the country is international reserve position .the fixed-rate system virtual forces this type of policy action ,because failure to do so will lead to eventual elimination of the country is international reserves if the automatic adjustment mechanism takes considerable time . what about the situation in BOP surplus country? given the objective of a fixed exchange rate , the forces working in the opposite direction from that for a deficit country are set into motion .Accumulation of foreign exchange reserves (which may be difficult to sterilize )will expand the money supply.This enhancement of the money supply will drive the interest rate downward ,increase aggregate demand and prices,increase private purchases of goods and foreign financial assets,and thus eliminate the surplus.

reasons for international Movements of capital (4)

7-firms also argue that they need to invest abroad for defensive purposes to protect market share.firm A,for example ,reasons that it needs to begin production in the foreign market location in order to preserve its competitive position because its competitors are establishing plants in the foreign market currently served by A is exports or because firms in the host country are producing in larger volume and competing with A is goods.
8- Finally ,foreign firms may find investment in a host country to be profitable because of some firm-specific knowledge or asset that enable the foreign firm to outperform the host country is domestic firms .Superior management skills or an important patent might be involved .At any rate,the opportunity to generate a profit by exploiting this advantage in new setting in a new setting entices the foreign firm to make the investment .
A considerable amount of further empirical research is needed in order to determine the most important causes of international capital mobility ,and different reasons will apply to different industries ,different periods,and different investors .for examples of econometric work that has been done on the causes of foreign direct investment.

reasons for international Movements of capital (3)

5- tariffs and nontariff barriers in the host country also can induce an inflow of foreign direct investment .if trade restrictions make it difficult for the foreign firm to sell in the host country market,then an alternative strategy for the firm is to " get behind the tariff wall" and produce within the host country itself.IT as been argued that U.S companies built such Tariff factories in Europe in the 1960s,shortly after the European Economic community (common market) was formed ,with its common external tariff on imports from the outside world .such U.S investment continued in the 1990s as Europe pressed for even closer economic integration and adopt a common currency for 11 countries in 1999.
6-A foreign firm may consider investment in a host country if there are low relative wages in the host country,although studies indicate that low wages per se are not as much an enticement for FDI as envisioned by the general public .Clearly,the existence of low wages because of relative labor abundance in the recipient country is an attraction when the production process is labor intensive.in fact ,the production process often can be broken up so that capital-intensive or technology-intensive production of components takes place within developed countries while labor-intensive assembly operations that use the components take place in developing countries .this division of labor is facilitated by offshore assembly provisions in the tariff schedules of developed countries.

reasons for international Movements of capital (2)

2- similarly ,because manufacturing and services production in developed countries is catering increasingly to high-income tastes and wants ,it can be hypothesized that developed-country firms will invest overseas if the recipient country has a high per capita income . This suggestion leads us to expect that there would be little manufacturing investment flowing from developed countries to developing countries.However,per capita income must be kept distinct from total income (GDP),since firms in developed countries are eager to move into China because of its sheer market size and despite its relatively low per capita income.
3- Anoter reason for direct investment in a country is that the foreign firm can secure access to mineral or row material deposits located there and can then process the raw materials and sell them in more finished from.Examples would be FDI in petroleum and copper.
4- It has also been suggested that firms may want to invest abroad as a means of risk diversification .Just as investors prefer to have a diversified financial portfolio instead of holding their assets in the stock of a single company ,so firms may wish to distribute their real investment assets across industries or countries.if a recession or downturn occurs in one market or industry,it will be beneficial for a firm not to have all its eggs in one basket.some of the firm is investment in other industries or countries may not experience the downturn or may at least experince it wit reduced severity.