The International

Monetary System
and the Balance
of Payments

Griffin & Pustay

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Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

International Business, 6th Edition

chapter 7

Chapter Objectives
Discuss the role of the international monetary
system in promoting international trade and
investment
Explain the evolution and functioning of the
gold standard
Summarize the role of the World Bank Group
and the International Monetary Fund in the
post-World War II international monetary
system established at Bretton Woods

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Chapter Objectives (continued)

Explain the evolution of the flexible
exchange rate system
Describe the function and structure of the
balance of payments accounting system
Differentiate among the various
definitions of a balance of payments
surplus and deficit

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International Monetary System

The international monetary system
establishes the rules by which
countries value and exchange their
currencies and provides a mechanism for
correcting imbalances between a
countrys international payments and
receipts.
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Balance of Payments
The Balance of Payments (BOP)
Accounting System records
international transactions and
supplies vital information about the
health of a national economy and
likely changes in its fiscal and
monetary policies.
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History of the International

Monetary System
The Gold Standard
The Sterling-Gold Standard
The Collapse of the Gold Standard
The Bretton Woods Era
The End of the Bretton Woods Era

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The Gold Standard

Countries agree to buy or sell their
paper currencies in exchange for gold
on the request of any individual or firm
and to allow the free export of gold
bullion and coins.

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Fixed Exchange Rate System

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Sterling-Based Gold Standard

British pound sterling was the most
important currency from 1821 to
1918.
Most firms would accept either gold
or British pounds.

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Map 7.1 The British Empire, 1913

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The Collapse of the Gold

Standard
Economic pressures of WWI
Countries suspended pledges to buy or
sell gold at currencies par values
Gold standard readopted in 1920s
Dropped during Great Depression
British pound allowed to float in 1931
Float: value determined by supply and demand

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Figure 7.1 The Contraction of

World Trade, 1929-1933

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The Bretton Woods Era

44 countries met in Bretton Woods, New
Hampshire, in 1944
Goal: to create a postwar economic
environment to promote worldwide peace and
prosperity
Renewed gold standard on modified basis
(dollar-based)
Created International Bank for Reconstruction
and Development and International Monetary
Fund

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International Bank for Reconstruction and

Development (the World Bank)
Goal 1: to help finance
reconstruction of European
economies
Accomplished in mid-1950s
Goal 2: to build economies of the
worlds developing countries

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Figure 7.2 Organization of the

World Bank Group

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Objectives of the
International Monetary Fund
To promote international monetary
cooperation
To facilitate the expansion and balanced
growth of international trade
To promote exchange stability, to maintain
orderly exchange arrangements among
members, and to avoid competitive
exchange depreciation
To assist in the establishment of a
multilateral system of payments
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Objectives of the
International Monetary Fund
(continued)
To give confidence to members by making
the general resources of the IMF
temporarily available to them and to
correct maladjustments in their balances of
payments
To shorten the duration and lessen the
degree of disequilibrium in the international
balances of payments of members

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Membership in the IMF

Open to any country willing to agree
to rules and regulations
185 member countries as of 2008
Membership requires payment of a
quota

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A Dollar-Based Gold Standard

Countries agreed to peg the value of
currencies to gold
U.S. $ keystone of system
Fixed exchange rate system
Adjustable peg
Functioned well in times of economic
prosperity
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The End of the Bretton Woods System

Susceptible to speculative runs on the bank
U.S. $ became only source of liquidity
necessary to expand international trade
People questioned the ability of U.S. to meet
obligations (Triffin Paradox)
IMF created special drawing rights (SDRs)
paper gold
Bretton Woods system ended August 15, 1971

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Performance of the International Monetary

System since 1971
Most currencies began to float
Value of U.S. $ fell relative to most major
currencies
Group of Ten agreed to restore fixed
exchange rate system with restructured
rates of exchange

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International Monetary System

since 1971
Development of floating exchange rate
system
Supply and demand for a currency determine
its price in the world market
Managed float central banks can affect
supply and demand

Legitimized in 1976 with the Jamaica

Agreement
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Table 7.1 The Groups of

Five, Seven, and Ten

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Table 7.2 Key Central Banks

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Country

Bank

Canada

Bank of Canada

European Union

European Central Bank

Japan

Bank of Japan

United Kingdom

Bank of England

United States

Federal Reserve Bank

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European Union
Believed flexible system would hinder
ability to create integrated economy
Created European Monetary System to
manage currency relationships
ERM participants maintained fixed
exchange rates among their currencies
Facilitated creation and adoption of euro
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Map 7.2 Exchange Rate Arrangements as

of 2007

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Figure 7.3 Exchange Rates of Dollar vs. Yen,

the Euro, and the Deutsche Mark, 1970-2005

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International Debt Crisis

OPEC quadrupled world oil prices
Resulted in inflationary pressures in
oil-importing countries
Exchange rates adjusted
Transfer of wealth
Countries borrowed more than they could
repay
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Approaches to Resolve the

International Debt Crisis

The Baker Plan

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The Brady Plan

The Balance of Payments

Accounting System
The BOP accounting system is a
double-entry bookkeeping system
designed to measure and record all
economic transactions between
residents of one country and residents of
all other countries during a particular
time period.
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Figure 7.4
The Asian Contagion

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Balance of Payments (BOP)

Accounting System
Measures and records all economic
transactions between residents of one country
and residents of all other countries during
specified time period
Provides understanding of performance of each
countrys economy in international markets
Signals fundamental changes in country
competitiveness
Assists policy makers in designing appropriate
public policies

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Four Important Aspects of the

BOP Accounting System
Records international transactions made in
some time period
Records only economic transactions
Records transactions between residents of
one country and all other countries
Residents include individuals, businesses,
government agencies, nonprofit organizations

Uses a double-entry system

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Major Components of the BOP

Accounting System
Current Account
Capital Account
Official Reserves
Errors and Omissions

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Types of Current Account

Transactions
Exports and imports of goods
Exports and imports of services
Investment income
Gifts

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Capital Account

Foreign Direct
Investment

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Portfolio
Investment

Table 7.4 Capital Account Transactions

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Table 7.5 BOP Entries, Capital Account

Debt (Outflow)
Portfolio (short-term)

Portfolio (long-term)

Foreign direct
investment

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Credit (Inflow)

Receiving a payment from a

foreigner

Making a payment to a
foreigner

Buying a short-term foreign

asset

Selling a domestic shortterm asset to a foreigner

Buying back a short-term

domestic asset from its
foreign owner

Selling a short-term
foreign asset acquired
previously

Buying back a long-term

domestic asset from its
foreign owner

Selling a domestic longterm asset to a foreigner

Buying a foreign asset for

purposes of control

Selling a long-term
foreign asset previously
acquired

Buying back from its foreign

owner a domestic asset

Selling a domestic asset

to a foreigner

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Official Reserves Account

Records level of official reserves
Four types of assets
Gold
Convertible currencies
SDRs
Reserve positions at the IMF
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Official Reserves Account

Reserve
positions

Gold

Assets
SDRs

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Convertible
securities

Errors and Omissions

BOP must balance
Current Account + Capital Account
+ Official Reserves Account = 0
Current Account + Capital Account
+ Official Reserves Account + Errors
and Omissions = 0

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Table 7.6. U.S. Balance of Payments in 2007

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Figure 7.5a. Leading U.S. Merchandise

Exports, 2007

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Figure 7.5b. Leading U.S. Merchandise

Imports, 2007

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Figure 7.6. Trade Between the U.S. and its

Major Trading Partners, 2007

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Defining BOPs Surpluses and Deficits

Official Settlements Balance reflects
changes in a countrys official
reserves; essentially, it records the
net impact of the Central Banks
intervention in the foreign-exchange
market in support of the local
currency

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Figure 7.7 The U.S. BOP

According to Various Reporting Measures

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