International Business: The New Realities

Fifth Edition

Chapter 9
The International Monetary
and Financial Environment

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Learning Objectives
9.1 Learn about exchange rates and currencies in
international business.
9.2 Explain how exchange rates are determined.
9.3 Understand the emergence of the modern exchange
rate system.
9.4 Describe the monetary and financial systems.
9.5 Identify the key players in the monetary and financial
systems.
9.6 Understand the global debt crisis.

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Currencies and Exchange Rates
• More than 170 currencies in use worldwide.
• Currency regimes are simplifying. E.g., The euro in
Europe; the dollar in Panama and Belize.
• Most currencies are not very convertible. The dollar, yen,
pound, euro are hard currencies – universally accepted
and preferred in international transactions.
• Exchange rate: Price of one currency in terms of
another.
• Exchange rates affect the fortunes of the firm in various
ways – costs of inputs, sales performance, which market
entry strategies to use, etc.
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Constantly fluctuating exchange rates require
international managers to keep in mind three facts
• The prices the firm charges can be quoted in the firm’s
currency or in the currency of each foreign customer.
• Because several months can pass between placement
and delivery of an order, fluctuations in the exchange
rate during that time can cost or earn the firm money.
• The firm and its customers can use the exchange rate
as it stands on the date of each transaction, or they can
agree to use a specific exchange rate.

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Recent Exchange Rates against the Dollar
(1 of 2)
Currency Currency per U.S. Dollars per
One U.S. Dollar Unit of Currency
Australian dollar 1.29 0.77
Brazilian real 3.25 0.31
British pound 0.73 1.38
Canadian dollar 1.28 0.78
Chinese renminbi (yuan) 6.33 0.16
Euro 0.82 1.22
Indian rupee 65.23 0.02
Japanese yen 106.58 0.01
Mexican peso 18.84 0.05

Source: Adapted from www.x-rates.com.

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Recent Exchange Rates against the Dollar
(2 of 2)

Currency Currency per U.S. Dollars per

One U.S. Dollar Unit of Currency
New Zealand dollar 1.39 0.72
Norwegian kroner 7.90 0.13
Saudi Arabian riyal 3.75 0.27
Singapore dollar 1.33 0.76
South Africa rand 11.79 0.09
Turkish lira 3.80 0.26

Source: Adapted from www.x-rates.com.

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The Four Risks of International Business

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Foreign Exchange Markets
• Foreign exchange: All forms of internationally-traded monies
including foreign currencies, bank deposits, checks, and
electronic transfers.
• Foreign exchange market: The global marketplace for buying and
selling national currencies.
• Exchange rates are in constant flux. In 2012, for example, the
Indian rupee was trading at 48 rupees to the U.S. dollar. By 2013,
the rate had depreciated to 58 rupees-the rupee’s value went
down relative to the dollar by more than 20 percent.
• This shift made the rupee less expensive for Americans,
and the U.S. dollar more expensive for Indians. Such
shifts can complicate international business.

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Exchange Rates Over Time

Sources: Based on data from the International Monetary Fund and World Bank.

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Example: Euro vs. the Dollar
• Suppose, last year, the exchange rate was 1 = $1.
• Now, suppose the rate has gone to: 1.50 = $1.
• What is the effecat of this change on Europeans?

Effect on European Firms:

• European firms pay more for inputs from the U.S.
• Higher costs reduce profitability; require higher prices.
• European firms can increase their exports to the U.S.
• European firms can raise their prices to the U.S.
• Increased exports to the U.S. lead to higher revenues. What is the
effect on European consumers?

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How Exchange Rates Are Determined
• In a free market, the “price” of any currency (the exchange
rate) is determined by supply and demand:
-- The greater the supply of a currency, the lower its price.
-- The lower the supply of a currency, the higher its price.
-- The greater the demand for
a currency, the higher its price.
-- The lower the demand for
a currency, the lower its price.

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Equilibrium Price of Euros for Dollars

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Factors that Influence the Supply and
Demand for a Currency (1 of 4)
Economic growth is the increase in value of the
goods and services produced by an economy.
• Measured as the annual increase in real GDP
(in which the inflation rate is subtracted from
growth).
• Driven by entrepreneurship and innovation.
• The nation’s central bank regulates
the money supply, issues currency
and manages the exchange rate, to
accommodate economic growth.

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Factors that Influence the Supply and
Demand for a Currency (2 of 4)
Inflation refers to increases in the prices of goods and services;
thus, money buys less than before.
• Some countries (e.g., Argentina, Israel, Russia) have
experienced hyperinflation.
• High inflation erodes a currency’s purchasing power.
• Interest rates and inflation are positively related; high inflation
forces banks to pay high interest.
• That is, investors expect to be compensated for inflation-
induced decline in the value of their money.
• Example: If inflation is 10%, banks must pay more than 10% to
attract deposits.
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Inflation in Selected Countries, 1985-2018
(3 of 4)

Note: Chart shows annual percentage rate of inflation. Lefthand scale is for Turkey, Venezuela, and
the United States; right-hand scale is for Argentina, Brazil, and Poland.
Sources: Based on International Monetary Fund, World Economic Outlook Database, 2018, www.imf. org; and CIA
World Factbook, 2018, www.cia.gov.

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Factors that Influence the Supply and
Demand for a Currency (4 of 4)
• Market psychology refers to investor behavior, such as
herding behavior or momentum trading.
• Government action. Governments intervene to influence the
value of their own currencies, e.g., the Chinese government
regularly intervenes in the foreign exchange market to keep
the renminbi undervalued, to help ensure exports.
• Balance of payments is the nation’s balance sheet of trade,
investment, and transfer payments with the rest of the world.
It reflects the difference between the total amount of money
coming into and going out of a country.

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Value of the Currency and Trade Surplus
vs. Trade Deficit (1 of 2)
• Trade surplus – Exports exceed imports; may result
when the exporter’s currency is undervalued, as in
China’s official policy regarding its currency.
• Trade deficit – Imports exceed exports; the government
may devaluethe nation’s currency to correct a trade
deficit.
• Devaluation government – Action to reduce the official
value of its currency relative to other currencies.
• Balance of payments – The annual accounting of all
economic transactions of a nation with all other nations.

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The Balance of Trade (2 of 2)
Example:
• Japan exports cars to the U.S. Car importers in the U.S.
pay exporters in Japan, resulting in a surplus item in
Japan’s balance of trade and a deficit in the U.S. balance
of trade.
• If the total value of U.S. imports from Japan exceeds the
total value of U.S. exports to Japan, then Japan will have
a trade deficit with the U.S. What other factors cause
trade deficits?

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Development of the Modern Exchange Rate
System
• After the Great Depression and World War II, the world
economy and trading system were in a sorry state.
• At war’s end, seeking stability in the international
monetary and financial systems, 44 countries signed the
Bretton Woods agreement.
• Bretton Woods established a fixed exchange rate system
in which the U.S. dollar was pegged to a set value for
gold ($35 per ounce), and other major currencies were
pegged to the dollar.
• For nearly 30 years, the system kept exchange rates of
major currencies at a fixed level.
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Bretton Woods Agreement

The Bretton Woods Agreement, which set the course for contemporary global financial
relations, was conceived by 44 nations at the Mount Washington Hotel in Bretton Woods, New
Hampshire, United States, in 1944.

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Breakdown and Legacy of Bretton Woods
• Bretton Woods dissolved in 1971, as the world
economy was evolving and governments could no
longer maintain fixed exchange rates on the gold
standard. Bretton Woods established the:
• Concept of international monetary cooperation,
especially aimed at minimizing currency risk.
• International Monetary Fund (IMF): Agency
that promotes exchange rate stability, monitors
exchange systems, provides funding to
developing economies.
• World Bank: Agency that provides loans and
technical assistance to combat global poverty
around the world.

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The Exchange Rate System Today
• Today, advanced economy currencies (dollar, euro,
pound, yen) float according to market forces, their value
determined by supply and demand.
• Conversely, most developing and emerging economies
use fixed exchange rate systems.
• In fixed regimes, the value of a currency is pegged to the
value of another, or to a basket of currencies, at a
specified rate.
Examples
• China pegs its currency to a basket of currencies
• Belize pegs its currency to the dollar.

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The International Monetary and Financial
Systems
• International monetary system: The institutional
framework, rules, and procedures by which national
currencies are exchanged for one another.
• Global financial system: The collection of financial
institutions that facilitate and regulate the flows of
investment and capital funds worldwide.
It includes the national and
international banking systems,
the international bond market,
and national stock markets.

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Globalization of Financial and Monetary
Activities
Growing integration of financial and monetary global activity
is due to:
• Evolution of monetary and financial regulations, worldwide.
• Emergence of new technologies and payment systems in
global finance, e.g., the Internet.
• Increased global and regional interdependence of financial
markets.
• Growing role of single-currency systems, e.g., the Euro.

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Ethical Connections
• The global financial crisis of 2008–2009 raised many ethical
issues.
• Globalization of the financial sector allowed the crisis to
spread quickly, harming people worldwide.
• Financial globalization has contributed greatly to economic
development in poor countries.
• Critics point to self-interest in the banking sector as a basic
cause of the crisis. But self-interest is a human condition.
Pensioners and other investors happily accept rapid gains in
stocks and bonds, often ignorant of how the gains are made.
• Some argue the real cause of the crisis was a failure of
governments to adequately regulate the financial sector.

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Key Participants and Relationships
in the Global Monetary and Financial Systems (1 of 4)

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Key Participants in the Monetary and
Financial Systems (2 of 4)
• The Firm. International transactions require firms to deal
with huge sums of foreign exchange.

• National Stock Exchanges and Bond Markets.

Facilities for trading securities and bonds.

• Commercial Banks. Lend money to finance business

activity, play a key role in nations’ money supplies, and
exchange foreign currencies.

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Key Participants in the Monetary and
Financial Systems (3 of 4)
• Central Banks. Regulate money supply, issue currency,
manage exchange rates, control national reserves.

• Bank for International Settlements. Supervises Central

Bank monetary policy and other activities.

Banks, stock exchanges, and other

participants in the global monetary and
financial systems make international
business possible. Shown here is the
Bank of England in London.

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Types of Banks and Their Primary
Activities (4 of 4)
• Investment banks underwrite (guarantee the sale of) stock and
bond issues and advise on mergers, such as the merger of
Goldman Sachs in the U.S. and Nomura Securities in Japan.
• Merchant banks provide capital to firms in the form of shares
rather than loans. The Arab-Malaysian Merchant Bank is an
example.
• Private banks manage the assets of the very rich. Union Bank
in Switzerland (UBS) and ABN AMRO Private Banking in
Luxembourg are examples.
• Offshore banks are located in jurisdictions with low taxation
and regulation, such as Switzerland and Bermuda.
• Commercial banks deal mainly with corporations or large
businesses. Credit Lyonnais in France is an example.

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Financial District in Beijing

Chinese banks play a growing role in global finance. China is home to the world’s four largest
banks: ICBC, China Construction Bank, Agricultural Bank of China, and Bank of China.

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You Can Do It: Maria Petit (1 of 2)
• Maria got her undergraduate degree from a state university
a few years ago. Read her profile in Chapter 9.
• Maria’s majors: Finance, International Business, and
Spanish
• Maria’s jobs: All at Motorola
– Credit analyst and auditor (based in
the United States, but frequent travel
to Latin America)
– Finance manager (United Kingdom)
– Financial controller (Dubai, United
Arab Emirates)
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You Can Do It: Maria Petit (2 of 2)
Challenges
• Understanding current and evolving regulations in the finance and
accounting area across numerous countries
• Not knowing the local language slows the pace of meetings
• Being a women in countries with fewer female managers

Maria’s Success Factors

• Develop a deliberate career strategy
• Cultivate relationships with helpful people, both in college and in
the work world
• Work hard to maximize your job performance
• Establish yourself as a knowledgeable professional helps
overcome gender stereotypes
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The Global Debt Crisis
• Growing imbalances in the finances of numerous
national governments is an emergent crisis in the
international monetary and financial environment.
• Gross government debt is especially high in Japan and
Greece. In these countries, as well as in Belgium, Italy,
and the United States, gross government debt exceeds
100 percent of each nation’s GDP.
• Fiscal imbalances are an important source of risk and
uncertainty in the global business environment.

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Gross Government Debt as a % of GDP

Source: Based on International Monetary Fund, World Economic Outlook Database, 2018.
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Copyright

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