INTERNATIONAL MONETARY SYSTEM

Prepared by Vipul S. Sutar (IMCOST)

INTRODUCTION
International Monetary SystemComplex system of international arrangements, rules, institutions, policies in regard to ex-rates, international payments, capital flows.

International Monetary System - Vipul Sutar

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)

International Monetary System - Vipul Sutar

BIMETALLISM(pre-1875)
Commodity money system using both silver and gold
(precious metals) for international payments (and for domestic currency). Eg. gold standard (British pound) or the silver standard (German DM) and some on a bimetallic (French franc). Pound/Franc ex-rate was determined by the gold content of the two currencies. Franc/DM was determined by the silver content of the two currencies. Pound (gold) / DM (silver) rate was determined by their ex-rates against the Franc.
International Monetary System - Vipul Sutar

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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 market ratio was 15.5/1. Gold was overvalued at the legal rate, silver was undervalued.
International Monetary System - Vipul Sutar

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. 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.
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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.

International Monetary System - Vipul Sutar

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 due to price-specie-flow mechanism.

International Monetary System - Vipul Sutar

Disadvantages of Gold Standard:

1. Possible deflationary pressure. 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.

International Monetary System - Vipul Sutar

INTERWAR PERIOD: 1915-1944

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

International Monetary System - Vipul Sutar

BRETTON WOODS SYSTEM: 19451972

At the end of WWII, 44 countries nations met at

Bretton Woods, N.H. 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 $.

International Monetary System - Vipul Sutar

Advantages of Gold-Exchange System/Bretton Woods in SR:

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

International Monetary System - Vipul Sutar

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

International Monetary System - Vipul Sutar

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. (Under fixed ex-rates, you lose control over your monetary policy. Monetary policy must be committed to maintaining the fixed ex-rate, and cannot be used to pursue other macroeconomic goals) b. Gold was abandoned as a reserve asset. c. Developing countries were to get more assistance from IMF.

International Monetary System - Vipul Sutar

Advantages of Flexible Ex-Rates:

a. b.
Countries have control over monetary policy A true market value is established for currency, fluctuates daily to reflect market forces of S and D. c. Flexible ex-rates maintain BP equilibrium. Example: U.S. has trade deficit, M>X, excess dollars in world currency markets, $ depreciates, appreciates, US exports will go up, restore trade balance.

International Monetary System - Vipul Sutar

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

International Monetary System - Vipul Sutar

European Monetary System

The single currency in Europe. (1 ECU = 1 Euro) To qualify, countries had to meet certain economic criteria: 1) Deficits/GDP less than 3%, 2) price level stability - low and stable inflation, etc. Of the 15 countries in the European Union, three countries decided not to join (UK, Denmark, and Sweden).

International Monetary System - Vipul Sutar

Euro:
1) The 12 countries fixed their ex-rates against each other and against the Euro and 2) The Euro became a unit of account. For example, 3.35FF/DM. 6.55 FF/Euro. FF and DM will float against the $, and Yen, but will be fixed against each other and against the Euro.

International Monetary System - Vipul Sutar

Main Advantages of Euro ():

1. Significant reduction in transaction costs for consumers, businesses, governments. European Saying: If you travel through all 15 countries and exchange money in each country but don't spend it, you end up with 1/2 of the original amount! 2. Elimination of currency risk, which will save companies hedging costs 3. Promote corporate restructuring via M&A activity (mergers and acquisitions), encourage optimal business location decisions.

International Monetary System - Vipul Sutar

Main Disadvantage of Euro:

Loss of control over domestic monetary policy and
exchange rate determination.

International Monetary System - Vipul Sutar

Thank You

International Monetary System - Vipul Sutar