Transcript Multinational Finance

Chapter 2 World Trade and
the International Monetary System
Learning objectives
 Integration of the world’s markets for
goods, services, and financial instruments
 Balance-of-payments statistics
 Exchange rate systems
– Fixed vs. floating, and everything in between
 History of international monetary system
– Recent currency crises
– The evolving role of the IMF
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2.1 Integration of the World’s Markets
Integration of the markets for goods & services
Exports of goods & services as a
percentage of worldwide GDP
Source: United Nations (data.un.org)
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2.1 Integration of the World’s Markets
Integration of financial markets

An increase in cross-border financing through
issues of securities

Increasingly interdependent national financial
markets, including cooperative linkages among
securities exchanges

An increasing number of cross-border mergers,
acquisitions, and joint ventures
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2.2 Balance-of-Payments Statistics
Balance-of-payments (BoP) statistics
track a country’s inflows and outflows of goods,
services, and capital.

The trade balance measures whether a country is a
net importer or exporter of goods.

The current account is a broader measure of
import-export activity that includes trade in goods,
services, and other income.

The financial account summarizes changes a
country’s international investment position; that is,
changes in its cross-border ownership of financial
assets and liabilities.
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2.2 Balance-of-Payments Statistics
Balance-of-payment statistics ($ billions)
Goods: Exports
Goods: Imports
Trade balance
Services: Credit
Services: Debit
Balance on services
Income: Credit
Income: Debit
Balance on income
Net current transfers
Balance on current account
China
& HK
USA
Eurozone
2,667
2,345
322
321
407
-86
351
387
-36
11
188
1,635
2,371
–736
709
478
231
820
602
218
124
–411
2,598
2,273
325
914
827
87
787
733
54
188
277
Source: International Monetary Fund (imf.org)
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2.2 Balance-of-Payments Statistics
Balance-of-payment statistics ($ billions)
China
& HK
USA
Eurozone
Net acquisition of financial assets 1,027
Direct investment assets
318
Portfolio investment assets
10
Other investment assets
249
Reserve assets
449
820
353
547
–76
–4
1,033
186
586
257
5
Net incurrence of financial liabilities
Direct investment liabilities
Portfolio investment liabilities
Other investment liabilities
893
464
91
338
909
93
693
123
722
152
456
114
–329
–138
374
Financial Account
Source: International Monetary Fund (imf.org)
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2.2 Balance-of-Payments Statistics
Merchandise trade in 2014
GDP
($tr)
China
17.63
EU
17.59
USA
17.46
India
7.28
Japan
4.75
Germany 3.61
Russia
3.57
Brazil
3.07
France
2.59
Indonesia 2.55
UK
2.42
Mexico
2.14
Italy
2.07
S. Korea
1.78
World
107.50
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Source: cia.gov
Exports Imports Trade Balance Population GDP per
($tr)
($tr)
(% of GDP)
(millions) Capita
2.34
1.96
2.2%
1,356
$13,004
2.17
2.31
–0.8%
511
34,393
1.61
2.33
–4.1%
319
54,752
0.34
0.51
–2.3%
1,236
5,886
0.71
0.81
–2.1%
127
37,371
1.55
1.32
6.3%
81
44,607
0.52
0.32
5.5%
142
25,044
0.24
0.24
0.0%
203
15,164
0.58
0.68
–3.7%
66
39,044
0.18
0.17
0.3%
254
10,071
0.50
0.80
–12.3%
64
37,965
0.41
0.41
0.0%
120
17,816
0.50
0.45
2.5%
62
33,495
0.57
0.53
2.7%
49
36,317
19.08
18.86
0.2%
7,175
$14,983
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2.3 Exchange Rate Systems
Exchange rate systems
 Pegged
or fixed exchange rate systems
- Forges a direct link between inflation
differentials and employment levels
- Can result in large one-time adjustments
 Floating
exchange rate systems
- Allows exchange rates to adjust for inflation
differences
- Allows employment levels and wages to
equalize through the exchange rate mechanism
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2.3 Exchange Rate Systems
Recent exchange rate arrangements
Hard peg
Soft peg
Africa
Angola, Botswana,
Egypt, Ethiopia,
Libya, Morocco
Asia &
Bulgaria,
China, Indonesia,
Pacific
Hong
Singapore,
Vietnam
Europe Bosnia &
Croatia, Denmark,
Herzegov., Georgia, Latvia,
Lithuania
Ukraine
Middle
Iraq, Kuwait,
East
Saudi Arabia
Americas Ecuador,
Argentina,
Panama,
Jamaica,
El Salvador Venezuela
Floating
Kenya, S Africa,
Tanzania, Uganda,
Zambia
Afghanistan,
Australia, India,
Japan, Pakistan
Czech Rep,
Hungary, Poland,
Sweden, UK, EMU
Israel, Turkey
Residual
Algeria,
Nigeria,
Sudan
Malaysia,
Myanmar,
Russia
Switzerland
Brazil, Canada,
Chile, Colombia,
Mexico, US
Paraguay
Iran, Syria,
Source: International Financial Statistics (imf.org), August 2014
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2.4 The International Monetary System
Major events in the history of FX rates
1946 Bretton Woods Conference
- In order to stabilize exchange rates after the
end of the war, it was agreed that the U.S.
dollar would be convertible into gold at
$35/ounce.
- Other currencies were pegged to the dollar.
- The International Monetary Fund (IMF) and the
World Bank also were created at this
conference.
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2.4 The International Monetary System
Major events in the history of FX rates
1971 Exchange rate turmoil
- U.S. dollar fell off the gold standard.
- Most currencies began to float on world markets.
1979 European Exchange Rate Mechanism
- The European Exchange Rate Mechanism (ERM)
was established to maintain European currencies
within a band around central rates.
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2.4 The International Monetary System
Major events in the history of FX rates
1991 Treaty of Maastricht
- EC members agree to a broad agenda of reforms.
- A single European currency (euro) is proposed as
the ultimate goal of monetary union.
1999 Introduction of the euro
- Emu-zone currencies are pegged to the euro.
2002 The euro begins public circulation
2008 Global financial crisis
- Greece struggles with default.
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2.4 The International Monetary System
The European Union (EU) & the Eurozone
19 eurozone members (2015)
Austria, Belgium, Cyprus, Estonia,
Finland, France, Germany, Greece,
Ireland, Italy, Latvia, Lithuania,
Luxembourg, Malta, Netherlands,
Portugal, Slovak Rep., Slovenia, Spain
9 EU members not in the eurozone
Bulgaria, Croatia, Czech Republic,
Denmark, Hungary, Poland, Romania,
Sweden, United Kingdom
Candidates for EU membership
Albania, Iceland, Montenegro, Serbia,
the former Yugoslav Republic of
Macedonia, Turkey
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2.4 The International Monetary System
Recent monetary crises

Currency crises in Latin America
- Mexico (1995), Brazil (1999), Argentina (2002)

The Asian contagion of 1997
- Korea, Indonesia, and Thailand

The Russian ruble crisis in 1998

The global financial crisis of 2008

Greece in the aftermath of the 2008 crisis
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2.4 The International Monetary System
Currency crises

Contributing factors in each crisis
- A fixed or pegged exchange rate system
overvalued the local currency.
- There was a large amount of foreign currency
debt.

Consequences of currency crises
- Currency crises have a pronounced negative
short-term impact on the local economy.
- A market-based exchange rate can have an
invigorating long-term impact on the local
economy and on the local stock market.
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2.4 The International Monetary System
Troubles in Latin America
Contributing factors
• Pegged fx rates
• Foreign currency
debt exposed to a
devaluation in the
local currency
Sources:
msci.com and bis.org
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2.4 The International Monetary System
The 1997 Asian contagion
Contributing factors
• Pegged fx rates
• Foreign currency
debt exposed to a
devaluation in the
local currency
Sources:
msci.com and bis.org
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2.4 The International Monetary System
Russia’s 1998 currency crisis
Contributing factors
• A pegged fx rate
 In each crisis, IMF loans were tied to
structural reforms that promoted
fiscal-monetary restraint, market
liberalization, competition,
efficiency, and transparency.
• Foreign currency
debt exposed to a
devaluation in the
local currency
 This creates a moral hazard in that it changes
expectations and hence the behaviors of lenders,
borrowers, and governments.
Sources: msci.com and bis.org
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2.4 The International Monetary System
The debate over IMF lending

Proponents of IMF lending policies believe
- Short-term loans help countries overcome temporary
financial crises.

Critics of IMF lending believe
- Fiscal constraints and capital market liberalizations
increase economic and financial risks.
- IMF loans can leave a legacy of debt that can last for
decades.
- IMF loans are often spent trying to support an
unsustainable exchange rate.
- IMF remedies benefit developed countries and not the
country in crisis.
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2.4 The International Monetary System
IMF lending and moral hazard

Moral hazard
- The existence of a contract can change the
behaviors of parties to the contract.

The IMF’s challenge
- Develop policies that promote economic stability.
- Ensure that the consequences of poor investment
decisions are borne by investors and not by
taxpayers.
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2.4 The International Monetary System
The global financial crisis of 2008

Began in the U.S. real estate market
- Subprime (low-quality) home loans were
securitized into collateralized debt obligations
(CDOs) and resold to investors.

A crisis of confidence and liquidity
- Illiquidity in the subprime CDO market spilled over
to other markets, including real estate, stocks,
bonds, commercial paper, and bank lending.
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2.4 The International Monetary System
The drama in Greece

The 2008 crisis pushed Greece toward default.

Greece’s circumstance had similarities to
other currency crises:
- A fixed exchange rate system (the euro) inhibited
market mechanisms from reallocating resources
across Europe and within Greece.
- There was a large amount of government debt.
What’s next? Time will tell…
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