international monetary system

international monetary system

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  INTERNATIONAL MONETARY SYSTEM PRESENTED BY: LIKHILSUKUMARAN
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  Meaning International monetary systemsare sets of internationally agreed rules, conventions and supporting institutions, that facilitate international trade, cross border investment and generally there allocation of capital between nation states.
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  Features that IMSshould possess  Flow of international trade and investment.  Stability in foreign exchange.  They provide means of payment acceptable between buyers and sellers of different nationality  Providing countries with sufficient liquidity to finance temporary balance of payments deficits.
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  History  since earlyhistory the coins of various issuers – generally kingdoms and empires – have been traded.  As multiple coins became common within a region, they were exchanged by money changers, the predecessors of today's forex, as famously discussed in the Biblical story of Jesus and Money changers.  The first form of International monetary system emerged in latter half of 19th century, i.e., Latin Monetary union(1865).Its monetary system rested on the use of bimetallic currencies that had international acceptability in member countries.
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  The Gold Standard In this system each currency was linked to the weight of the gold. Every country has to maintain adequate amount of gold as reserve in order to back its currency.  Under this a country has to determine a rate at which its currency can be converted to a weight of gold.  Exchange rate between any two currencies was calculated as X currency per ounce of gold/ Y currency per ounce of gold.
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  Gold Bullion Standard Direct link between gold and actual currency that a country could issue was eliminated.  Currency could either be in form of gold or paper, but the issuing authority would give a standing guarantee to redeem the currency it had issued in gold on demand at a price fixed.
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  Arguments in Favorof a Gold Standard  Price stability -By tying the money supply to the supply of gold, central banks are unable to expand the money supply.  Facilitates BOP adjustment automatically - The basic idea is that a country that runs a current account deficit needs to export money (gold) to the countries that run a surplus. Gold used to pay for imports reduces the money supply of importing nations, causing deflation, which makes them more competitive, while the importation of gold by net exporters serves to increase their money supply, causing inflation, making them less competitive
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  Arguments against GoldStandard  Tying currency values to gold ensures a stable overall price level only if the relative price of gold is stable → gold discovery in South America  An international payments system based on gold is problematic because central banks cannot increase their holdings of international reserves as their economies grow unless there are continual new gold discoveries.  The gold standard gives gold-producing countries power to influence the world economy
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  Interwar Period (1918– 1939)  The years between the world wars have been described as a period of de-globalization, as both international trade and capital flows shrank compared to the period before World War I.  The onset of the World Wars saw the end of the gold standard as countries, other than the U.S., stopped making their currencies convertible and started printing money to pay for war related expenses  Several attempts were made by Britain in order to restore Gold standards. For her it was perhaps the step to restore its preeminent pre war position in the international monetary arena. But she failed to put forward a realistic plan for this. Hence she also redeem the currency to gold.  The focus shifted from external cooperation to internal reconstruction and events like the Great Depression further illustrated the breakdown of the international monetary system.
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  Bretton Woods (1945-1971) British and American policy makers began to plan the post war international monetary system in the early 1940s.  The objective was to create an order that combined the benefits of an integrated and relatively liberal international system with the freedom for governments to pursue domestic policies.  The principal architects of the new system, John Maynard Keynes and Harry Dexter White, created a plan which was endorsed by the 42 countries attending the 1944 Bretton Woods conference  The plan involved nations agreeing to a system of fixed but adjustable exchange rates where the currencies were pegged against the dollar, with the dollar itself convertible into gold.  In effect this was a gold – dollar exchange standard. The key difference with Gold standard was that the dollar was the only currency that was backed by and convertible into gold. (The rate initially was $35 an ounce of gold)
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  Other agreements madeat Bretton  Each member to pay a quota into IMF pool – one quarter in gold and the rest in their own currency. It will be used for lending purpose  Creation of International Bank for Reconstruction and Development (IBRD)  Reation of International Monetary Fund (IMF) to promote consultations and collaboration on international monetary problems and countries with deficit balance of payments
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  Why did Brettonwoods collapse?  In the early post-war period, the U.S. government had to provide dollar reserves to all countries who wanted to intervene in their currency markets. Lead to problem of lack of international liquidity.  The increasing supply of dollars worldwide, made available through programs like the Marshall Plan, meant that the credibility of the gold backing of the dollar was in question. U.S. dollars held abroad grew rapidly and this represented a claim on U.S. gold stocks and cast some doubt on the U.S.’s ability to convert dollars into gold upon request.  Domestic U.S. policies, such as the growing expenditure associated with Vietnam.  Countries began to become growingly less keen on holding dollars and more keen on holding gold. In 1971, the U.S. government “closed the gold window” by decree of President Nixon.  Hence Bretton Wood system collapsed
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  The Floating ExchangeRate System  The collapse of Bretton Woods and Smithsonian Agreements coupled with oil crisis of 1970, the floating exchange rate system was adopted by leading industrialized countries.  Officially approved in April 1978.Under the system, the exchange rate would be determined by market forces without the intervention of government  Pure float, Managed float, Pegging
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