216 Module 8 The International Monetary System and Financial Forces Financial Forces: Fluctuating Currency Values Having reviewed the basics of the international monetary system, we now are ready to focus on the financial forces, external to the firm and largely uncontrollable, that influence the context in which international managers make decisions. These forces include currency exchange rate fluctuation and exchange risk, currency exchange controls, taxation, inflation, and national-level balance-of-payments account balances. Although uncontrollable means that these financial forces originate outside the business and are beyond its influence, financial managers of a company are not helpless before them. When we consider financial management, we discuss ways to manage around them. We begin here with a focus on fluctuating currency values, examining foreign exchange, FX quotation, causes of exchange rate movement, and exchange rate forecasting. FLUCTUATING CURRENCY VALUES In a post–Bretton Woods monetary system, freely floating currencies fluctuate against each other. At times, central banks intervene in the foreign exchange markets by buying and selling large amounts of a currency in order to affect the supply and demand of that particular currency. The basis of this tactic is quite simple: as supply increases, price decreases, other things remaining constant, or ceteris paribus, as economists put it. These interventions are not announced, but we can infer them by looking at the market’s movements, as in the IB in Practice box example of the G7 intervention to weaken the Japanese yen after the 2011 earthquake. For the most part, the major currencies—the U.S. dollar, the British pound sterling, the Japanese yen, and the euro—are allowed by their central banks to fluctuate freely against each other. Fluctuations can be quite large. For example, in January 1999, the euro’s exchange rate was established at US$1.1667. In May 2000, the euro had sunk to US$0.8895, almost a 24 percent drop. Then the trend reversed and by June 2006 the euro was trading at US$1.2644, an increase of more than 42 percent. Two years later, in early June 2008, the euro was trading at US$1.5768. By May 2010 it was back to US$1.28, as a result of the challenges to the euro presented by problems in the Greek economy that revealed key flaws in the single-currency system. In March 2011, the euro was trading at $1.4434, and in April 2014, it was at $1.3750. Figure 8.1 presents these same data, but in terms of how many euros the dollar would buy. Clearly, there is significant movement in these currencies’ values. LO 8-3 Describe the factors that influence exchange rate movement. FIGURE 8.1 Value of the Euro in Dollar Terms, 1999–2014 Foreign Exchange Rate—Euros/USD Euros to One U.S. Dollar 1.2 1.1 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 Jan-1999 Nov-1999 Sep-2000 Jul-2001 May-2002 Mar-2003 Jan-2004 Jan-2009 Nov-2004 Sep-2005 Nov-2009 Sep-2010 Jul-2006 May-2007 Mar-2008 Mar-2011 Apr-2014 Euros/U.S. Dollar
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