History of Foreign Exchange Rates

History of Foreign Exchange Rates

The Gold Standard (1876 – 1913)

? Gold has been a medium of exchange since 3000 B.C. The "rules of the game" were simple; each country set the rate at which its currency unit could be converted to gold. So the currency exchange rates were in effect "fixed." But, expansionary monetary policy was limited to the government's supply of gold.

? The Gold Standard was in effect until the outbreak of WWI.

The Inter-War Years and WW II (1914 – 1944)

? During this period, currencies were allowed to fluctuate. Increasing fluctuations in currency values became realized as speculators sold short weak currencies. In 1934 the US adopted a modified gold standard.

? During WWII and its chaotic aftermath, the US dollar was the only major trading currency that continued to be convertible to gold

Bretton Woods and the International Monetary Fund (1944)

? At the end of WWII, the Allied Powers met at Bretton Woods, New Hampshire to create a post-war international monetary system.

o The International Monetary Fund was created to:

? Help countries defend their currencies against cyclical, seasonal, or random disruptions.

? Assist countries having structural trade problems if they promise to take adequate steps to correct these problems.

o The International Bank for Reconstruction and Development (World Bank) was created to help fund post-war reconstruction and has since then supported general economic development.

? The Bretton Woods Agreement established a US dollar-based international monetary system and created two new institutions - the International Monetary Fund (IMF) and the World Bank.

Fixed Exchange Rates (1945 – 1973)

? The currency arrangement negotiated at Bretton Woods and monitored by the IMF worked fairly well during the post-WWII era of reconstruction and growth in world trade. However, widely diverging monetary and fiscal policies, differential rates of inflation, and various currency shocks resulted in the system's demise.

? The US dollar became the main reserve currency held by central banks resulting in a consistent and growing balance of payments deficit which required a heavy capital outflow of dollars to finance these deficits and meet the growing demand for dollars from investors and businesses.

? Eventually, the heavy overhang of dollars held by foreigners resulted in a lack of confidence in the ability of the US to meet its commitment to convert dollars to gold. The lack of confidence forced President Richard Nixon to suspend official purchases or sales of gold by the US Treasury on August 15, 1971.

? This resulted in subsequent devaluations of the dollar.

? Most currencies were allowed to float to levels determined by market forces as of March, 1973.

Fixed versus Flexible Exchange Rates

Exchange Rate Regime Classifications

1. Exchange arrangements with no separate legal tender

2. Currency board arrangements

3. Other conventional fixed peg arrangements

4. Pegged exchange rates with horizontal bands

5. Crawling pegs

6. Exchange rates within crawling bands

7. Managed floating with no pre-announced path for the exchange rate

8. Independent floating

Q: What drives value? (Global Perspective 1.2)

A: Innovation, quality, customer care, management skill, alliances, R&D, technology, brand recognition, satisfied employees, and environmental awareness.

Q: What destroys value?

A:

Strategic: Customer demand shortfalls, competitive pressure, M&A integration problems, misaligned products, customer pricing pressure, loss of a key customer, regulatory problems, R&D delays, supplier problems

Hazards: Lawsuits and natural disasters

Operational: cost overruns, accounting irregularities, management