INTERNATIONAL MONETARY SYSTEM

INTRODUCTION
International Monetary SystemComplex system of international arrangements,

rules, institutions, policies in regard to ex-rates, international payments, capital flows.

HISTORY OF THE IMS

BIMETALLISM(pre-1875) CLASSICAL GOLD STANDARD (1875-WWI) INTERWAR PERIOD: (1915-1944 ) BRETTON WOODS SYSTEM: (1945-1972 ) FLEXIBLE EXCHANGE RATES: (1973PRESENT)

BIMETALLISM(pre-1875)
Commodity money system using both silver and gold
(precious metals) for international payments (and for domestic currency).

Continue
Under a bimetallic standard the silver/gold ratio was
fixed at a legal rate. When the market rate for silver/gold differed substantially from the legal rate, one metal would be overvalued and one would be undervalued. Eg. from 1837-1860 the legal silver/gold ratio was 16/1 and the spot market ratio was 15.5/1. Gold was overvalued at the legal rate, silver was undervalued.

CLASSICAL GOLD STANDARD (1875-WWI)

Gold Standard exists when most countries: 1. Use gold coins as the primary medium of exchange 2. Have a fixed ex-rate between ounce of gold and currency 3. Allow unrestricted gold flows - gold can be exported or imported freely, just like currency. 4. Banknotes had to be backed with gold to assure full convertibility to gold. 5. Domestic money stock had to rise and fall with gold flows.

Continue
Under a gold standard, ex-rates would be kept in line

by cross-country gold flows. Example: suppose that the UK Pound is pegged to gold at: 6 Pound/oz., and the franc is pegged at 12 FF/oz, then the official ex-rate should be 2FF/Pound.

Advantages of Gold Standard:

1. Ultimate hedge against inflation. Because of its fixed supply, gold standard creates price level stability, eliminates abuse by central bank/hyperinflation. 2. Automatic adjustment in Balance of payments. Ie, exports and imports will be backed up accordingly.

Disadvantages of Gold Standard:

1. Possible deflationary pressure for countries. With a fixed supply of gold (fixed money supply), output growth would lead to deflation. 2. An international gold standard has no commitment mechanism, or enforcement mechanism, to keep countries on the gold standard if they decide to abandon gold.

INTERWAR PERIOD: 1915-1944

When WWI started, countries abandoned the gold
standard, suspended redemption of banknotes for gold, and imposed ban on gold exports. Immediate effect was Hyperinflation

BRETTON WOODS SYSTEM: 19451972

At the end of WWII, 44 countries nations met at

Bretton Woods, New Hampshire, to develop a postwar IMS. IMS established by Bretton Woods was a dollarbased, gold-exchange standard of fixed exchange rates. The US dollar was pegged to gold at a fixed price of $35/ounce, and then each currency had a fixed ex-rate with the $.

Bretton Woods System: 1945-1972

British pound

German mark

French franc

Par Value

U.S. dollar

Pegged at $36/oz.

Gold

In short..

US $ was key currency valued at $1 = 1/35 oz. of

gold. All currencies are linked (pegged) to that price in fixed exchange rate system. In effect, rather than holding gold as a reserve asset, other countries hold US dollars (which are backed by gold)

Advantages of Gold-Exchange System/Bretton Woods System:

1. Easier to transfer dollars v/s gold overseas under pure gold standard. 2. By holding $ instead of gold as reserves, foreign central banks can earn more interest bearing gold. 3. Ex-rate stability reduced currency risk, provided a stable IMS.

BRETTON WOODS SYSTEM: 19451972

In long run, Bretton Woods (gold-exchange system)

was unstable. There was no way to devalue the $, and other countries were not willing to revalue their ex-rates upward. Bretton Woods started to collapse in 1971

FLEXIBLE EXCHANGE RATES: 1973-PRESENT

IMF members met in Jamaica in 1976 to agree to a new IMS including:

a. Flexible ex-rates allowed, central banks could intervene in currency markets. b. Gold was abandoned as a reserve asset. c. Developing countries were to get more assistance from IMF.

Advantages of Flexible Ex-Rates:

a. b.
Countries have control over monetary policy A true market value is established for currency, which fluctuates daily to reflect market forces of Supply and Demand. c. Flexible ex-rates maintain BOP equilibrium. Example: U.S. has trade deficit. As a result of excess dollars in world currency markets, $ depreciates, here, US can restore trade balance by maintaining more exports.

Disadvantages:
a. More Volatility. b. Potential abuse by central bank, reckless monetary expansion.

End