Chapter 15: The International Monetary Fund

Chapter 15The International Monetary FundChapter OutlineBEFORE THE IMF AND ITS BIRTHFOREIGN EXCHANGE MARKETSTODAY’S IMFTHE ASIAN FINANCIAL CRISISThe IMF's RoleThe International Monetary Fund (IMF) isa location to which member nations can go for expert economic advice.designed to foster trade among its member.the lender for member nations in short-term economic difficulty.not a lender for development purposes. (This is the function of the World Bank.)The IMF’s BirthAfter World War II the IMF was developed (with the United Nations, the World Bank and the Global Agreement on Tariffs and Trade) to foster economic growth.It was the brainchild of John Maynard Keynes.Trade Requires CurrencyTrade between countries is beneficial.International trade requires that the currency of the trading partners be exchanged. The market where people come to trade currencies is called the foreign exchange market.E.g. the production and export of a radio can require several currency transactions. Foreign Exchange MarketsThe demand for a currency (say the dollar) is also the supply of the other currency (say the yen).The supply for a currency (say the dollar) is also the demand of the other currency (say the yen).Modeling Foreign ExchangeA curve which represents the willingness of those who have Yen to trade them for dollarsA curve which represents the willingness of those who have dollars to trade them for Yen Quantity of yenPrice of yenin dollarsequilibriumexchangerateWho is the IMF and Where Does the Money Come From182 nationsThe money that is loaned comes from quotas that are expressed in Special Drawing Rights (SDRs) a made up currency of the IMF that is comprised of a weighted average of the four major currencies of the world (dollar, yen, pound and Euro.)75% of the quota can be paid in the countries own currency, 25% must be paid in a hard currencycurrencies easily converted to U.S. Dollars or goldHow Decisions are Made Voting is not one country one voteIt is roughly 100,000 SDRs of quota one vote.This gives the US and Europe an important vote.What the IMF DoesThe IMF makes short term loans to countries in economic distress. If a nation requires a short term infusion of hard currency to make it so that trade can continue, the IMF makes the loan.A country can get its 25% hard currency contribution loaned back to it easily.The Asian Financial Crisis: The Cause Part ILarge investments in Asia from the Europe and Japan.Banks in Asia did not hedge (taking an investment position so that changes in prices or exchange rates do not alter the advisability of a business decision) their foreign exchange position. These banks borrowed hard currency and loaned out local currency.The Asian Financial Crisis: The Cause Part IIThailand exchange rate with the dollar was not at a sustainable level.The Thai government attempted to maintain the currencies value by buying it with hard currency.Their hard currency ran out and they were forced to devalue it.Because of the devaluation, banks were unable to pay back the loans in hard currency.Capital fled Asia as more nations were unable to sustain their exchange rates.The IMF to the Rescue?The IMF loaned the Asian nations large sums of hard currency with conditions.The conditions were that they tighten their banking policies and credit to their banks.This prevented stable companies in Asia from getting lines of credit and threatened their stability.The IMF to the Rescue!Had the IMF not made the original loans the problem probably would have been worse.Asian currencies dropped by 50% relative to hard currencies within a few weeks. This could have been worse.