Chapter 17 Multinational Financial Management 541This decision is made by the government, usually without warning. For
example, on July 21, 2005, the Chinese government suddenly announced that
it was revaluing the yuan to make it 2.1% stronger against the U.S. dollar.
(The new exchange rate was CNY 8.1097/$.) Even though it was widely
believed that the yuan was signi! cantly undervalued, this revaluation caught
many by surprise since the exchange rate had been pegged at a! xed rate of
CNY 8.2781/$ for nearly a decade. Just as importantly, on that date, the
Chinese government abandoned the strict peg to the U.S. dollar and instead
adopted a more " exible system where the yuan is now linked to a basket of
foreign currencies including the dollar. Since then, the yuan has steadily
appreciated relative to the U.S. dollar. On May 26, 2008, the exchange rate
was CNY 6.9365/$; so it cost 14.5% fewer yuan to buy a dollar than
previously.- Depreciation or appreciation of a currency refers to a decrease or increase, respec-
tively, in the foreign exchange value of a " oating currency. These changes are
caused by market forces rather than by governments.
17-3b Current Monetary Arrangements
At the most basic level, we can divide currency regimes into two broad groups:
" oating rates and! xed rates. Within the two regimes, there are gradations among
subregimes in terms of how rigidly they adhere to the basic positions. Looking
! rst at the " oating-rate category, the two main subgroups are as follows:
- Freely " oating. Here the exchange rate is determined by the supply and demand
for the currency. Under a freely-! oating regime, governments may occasion-
ally intervene in the market to buy or sell their currency to stabilize " uctua-
tions, but they do not attempt to alter the absolute level of the rate. This policy
exists at one end of the continuum of exchange-rate regimes. For example, the
currencies of Australia, Brazil, and the Philippines, among many others, are
allowed to " oat with a minimum of intervention. - Managed " oating. Here there is signi! cant government intervention to manage
the exchange rate by manipulating the currency’s supply and demand. For
example, the governments of Colombia, Israel, and Poland manage their
respective currency’s " oat. Governments rarely reveal their target exchange
rate levels when they use a managed-! oat regime because doing so would
make it too easy for currency speculators to pro! t.
Most developed countries follow either a freely-" oating or a managed-" oat regime.
A few developing countries do so as well, often reluctantly and as a result of a
market that forces them to abandon a! xed-rate regime.
Types of! xed-exchange-rate regimes include the following:
- No local currency. The most extreme position is for the country to have no local
currency of its own, using another country’s currency as its legal tender (such
as the U.S. dollar in the Panama Canal Zone, in Ecuador, and in the Turks and
Caicos Islands) or belonging to a group of countries that shares a common cur-
rency (such as the euro). With this arrangement, the local government surren-
ders the ability to use exchange rates to tinker with its economy. - Currency board arrangement. Under a variation of the! rst subregime, a country
technically has its own currency but commits to exchange it for a speci! ed for-
eign money unit at a! xed exchange rate. This requires the country to impose
domestic currency restrictions unless it has enough foreign currency reserves
to cover all requested exchanges. This is called a currency board arrangement.
Argentina had a currency board arrangement before its crisis of January 2002,
when it was forced to devalue the peso and default on its debt.
Freely-Floating
Regime
Occurs when the
exchange rate is
determined by supply and
demand for the currency.Freely-Floating
Regime
Occurs when the
exchange rate is
determined by supply and
demand for the currency.Managed-Float
Regime
Occurs when there is
significant government
intervention to control the
exchange rate via
manipulation of the
currency’s supply and
demand.Managed-Float
Regime
Occurs when there is
significant government
intervention to control the
exchange rate via
manipulation of the
currency’s supply and
demand.
Currency Board
Arrangement
Occurs when a country
has its own currency but
commits to exchange it for
a specified foreign money
unit at a fixed exchange
rate and legislates
domestic currency
restrictions unless it has
the foreign currency
reserves to cover requested
exchanges.Currency Board
Arrangement
Occurs when a country
has its own currency but
commits to exchange it for
a specified foreign money
unit at a fixed exchange
rate and legislates
domestic currency
restrictions unless it has
the foreign currency
reserves to cover requested
exchanges.