February 28, 2024

International Monetary System

International monetary systems 

  • The international monetary system refers to the institutional arrangements that countries adopt to govern exchange rates.
  • International monetary systems are 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.
  • International monetary system refers to the system prevailing in world foreign exchange markets through which international trade and capital movement are financed and exchange rates are determined.
  • The International Monetary System is part of the institutional framework that binds national economies, such a system permits producers to specialize in those goods for which they have a comparative advantage, and serves to seek profitable investment opportunities on a global basis.

Features that IMS should possess

  • Flow of international trade and investment according to comparative advantage.
  • Stability in foreign exchange and should be stable.
  • Promoting Balance of Payments adjustments to prevent disruptions associated with temporary or chronic imbalances.
  • Providing countries with sufficient liquidity to finance temporary balance of payments deficits.
  • Should at least try to avoid adding further uncertainty.
  • Allowing member countries to pursue independent monetary and fiscal policies.

 Stages in International Monetary System:-

  • Classic Gold Standard (1816 – 1914)
  • Interwar Period (1918 – 1939)
  • Bretton Woods System (1944 – 1971)
  • The Flexible Exchange Rate Regime: 1973-Present.

 Classic Gold Standard (1816 – 1914)

  • 22nd June 1816, Great Britain declared the gold currency as official national currency (Lord Liverpool’s Act). On 1st May 1821 the convertibility of Pound Sterling into gold was legally guaranteed.
  • Other countries pegged their currencies to the British Pound, which made it a reserve currency. This happened while the British more and more dominated international finance and trade relations.
  • At the end of the 19th century, the Pound was used for two thirds of world trade and most foreign exchange reserves were held in this currency.

Rules of the system:-

  • Each country defined the value of its currency in terms of gold.
  • Exchange rate between any two currencies was calculated as X currency per ounce of gold/ Y currency per ounce of gold.
  • These exchange rates were set by arbitrage depending on the transportation costs of gold.
  • Central banks are restricted in not being able to issue more currency than gold reserves.

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. During World War I countries had abandoned the gold standard and, except for the United States.

BRETTON WOODS (1945-1971)

  • 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 aimed at promoting full employment and social wellbeing.
  • Under the Bretton Woods system, the U.S. dollar was pegged to gold at $35 per ounce and other currencies were pegged to the U.S. dollar.
  • Each country was responsible for maintaining its exchange rate within ±1% of the adopted par
    value by buying or selling foreign reserves as necessary.
  • The Bretton Woods system was a dollar-based gold exchange standard.

Features of Bretton Woods System

  • The features of the Bretton Woods system can be described as a “gold-exchange” standard rather than a “gold-standard”. The key difference 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)
  • Other countries would have an “adjustable peg” basically, they were exchangeable at a fixed rate against the dollar, although the rate could be readjusted at certain times under certain conditions.
  • Each country was allowed to have a 1% band around which their currency was allowed to fluctuate around the fixed rate. Except on the rare occasions when the par value was allowed to be readjusted, countries would have to intervene to ensure that the currency stayed in the required band.
  • The IMF was created with the specific goal of being the multilateral body that monitored the implementation of the Bretton Woods agreement.

The Flexible Exchange Rate Regime: 1973-Present.

  • Flexible exchange rates were declared acceptable to the IMF members.
  • Central banks were allowed to intervene in the exchange rate markets to iron out unwarranted
    volatilities
  • Gold was abandoned as an international reserve asset.
  • Non-oil-exporting countries and less-developed countries were given greater access to IMF funds.

Current Exchange Rate Arrangements

  • Free Float

The largest number of countries,  about 48, allow market forces to determine their currency’s value.

  • Managed Float

About 25 countries combine government intervention with market forces to set exchange rates.

  • Pegged to another currency

Such as the U.S. dollar or euro (through franc or mark).

  • No national currency

Some countries do not bother printing their own, they just use the U.S. dollar. For example, Ecuador, Panama, and El Salvador have dollarized.

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