Page 515 - Introduction to Business

CHAPTER 14 Understanding the Financial System, Money, and Banking 489

Thus, after World War II, the U.S. dollar became a standard of value for all world
currencies. One hope of pegging currency values of countries to the dollar was it
would prevent governments from issuing too much currency and causing inflation.
In 1971, the Bretton Woods agreement broke down as the United States moved
away from pegging the dollar to gold. While the dollar continued to be important in
denominating the value of other currencies, many countries allowed their
currencies to float, or vary, in world markets to one degree or another. In the
remaining part of the twentieth century, the breakdown of the world monetary sys-
tem in 1971 led to problems of wide fluctuations in currency values, periodic infla-
tion, and occasional economic stagnation.

The European Euro. In many ways, these problems set the stage for the largest
monetary event since the emergence of the dollar as the numeraire currency, or numeraire currency A currency that
currency benchmark, in the world. In 1999, 12 European countries formed the Euro- serves as a benchmark for all other
currencies in the world
pean Monetary Union (EMU). The EMU introduced the euro as a new currency to
euro The new currency issued in 2002
replace the currencies of the 12 member countries. In 2002, euro coins and notes
by the 12 countries in the European
were distributed for the first time. The euro was an immediate success and quickly Monetary Union
became the second most important currency in the world, ahead of the Japanese
yen. For countries using the euro, problems of currency fluctuations, inflation, and
related economic downturns should be substantially reduced. For the individual
European consumer or businessperson, it means not having to always be converting
one currency to another as he or she travels or conducts business between coun-
tries. Frequent currency exchanges are expensive and time consuming.

Hard Currencies. Together, the dollar, euro, and yen account for around 60
percent of the world economy. In effect, the dollar, euro, and yen describe three
currency areas of the world that lend monetary stability to each respective regional
economy. The British pound sterling is another example of a leading world cur-
rency. These so-called hard currencies are used by emerging market countries to hard currencies Currencies that are
peg the values of their soft currencies. For example, Argentina for many years relatively stable in value, are issued by
large industrial countries, and include
pegged their peso currency value to the U.S. dollar, wherein the value of the peso the U.S. dollar, Japanese yen, European
was kept within a set range of values per dollar. Thus, currency pegging is a way for euro, and British pound sterling
emerging market countries to enhance their monetary stability. However, it should soft currencies Currencies that are
be recognized that, while each hard currency is fairly stable within its own region of issued by emerging market countries
whose economies are developing
the world, its value can fluctuate considerably against the other hard currencies.
currency pegging The currency of a
Thus, currency risk is still a major factor in international trade and finance, even
country that is kept within a fixed range
between large industrial countries. of values relative to a hard currency
Currency risk can have serious effects on inflation, economic production, and currency risk The fluctuation in a
employment in countries. For example, in 1994 the value of the Mexican peso country’s currency value relative to
dropped suddenly due to panic by the public. Mexican firms and the government other currencies in the world
were experiencing difficulties in making debt payments. The possibility of debt
default raised fears among people that the peso would fall in value relative to the
U.S. dollar. Runs on banks occurred as citizens attempted to exchange their pesos
for dollars. The massive selling pressure on the peso caused its value to collapse.
The peso was no longer a store of value, which greatly damaged its acceptability as
money among the public. In 1998, Russia faced similar problems after the govern-
ment defaulted on its outstanding debt. The Russian ruble fell suddenly in value
and the dollar replaced it as a currency among many citizens. Today, payments can
be made in either rubles or dollars in many places in Russia, and holders of large
quantities of rubles tend to favor the dollar due to its being a more stable store of
value.

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