International Monetary System Part I

8/3/2019 International Monetary System Part I

http://slidepdf.com/reader/full/international-monetary-system-part-i 1/42

The International

Monetary SystemPart I



Introduction

The international monetary system refers tothe institutional arrangements that countries

adopt to govern exchange rates



Introduction

International monetary systems are sets of

internationally agreed rules, conventionsand supporting institutions that facilitateinternational trade, cross border investmentand generally the reallocation of capital

between nation states



Introduction

It addresses to solve the problems relating to

international trade:

a. Liquidity

b. Adjustment

c. Stability



The problem of Liquidity

The problem of liquidity existed even in the

domestic transactions through barter

system Barter system was replaced by precious

metals as a medium of exchange and store

of value

Gold standard system of international

payments came into existence



The Gold Standard

The first moderninternationalmonetary systemwas the goldstandard

Put in effect in 1850

Participants – UK,France, Germany &USA

USAJapan



Gold Standard- I ( 1876-1913)

● In this system, each currency was linkedto a weight of gold

●Under gold standard, each country had toestablish the rate at which its currencycould be converted to a weight of gold

E.g. $ 20.67/ ounce ; Pound 4.247/ once



Gold Standard- I ( 1876-1913)

●Most of the countries used to declare par

value of their currency in terms of gold

●The problem was every country needed tomaintain adequate reserves of gold in

order to back its currency



The Gold Standard

● After World War I, the exchange rates were

allowed to fluctuate

● Since gold was convertible into currencies

of the major developed countries, central

banks of different countries either held goldor currencies of these developed countries



The System of Bretton Woods( 1944-71)

In July, 1944, 44 countries met in Bretton

Woods, New Hampshire, USA – a newInternational Monetary System was created

John Maynard Keynes of Britain and Harry

Dexter White of USA were the key movers



The Bretton Woods Agreement

Creation of International Monetary Fund (IMF)

to promote consultations and collaboration

on international monetary problems and

countries with deficit balance of payments

Establish a par value of currency with

approval of IMF Maintain exchange rate for its currency

within one percent of declared par value



The Bretton Woods Agreement

Each member to pay a quota into IMF pool –

one quarter in gold and the rest in their own

currency

The pool to be used for lending Dollar was to be convertible to gold till

international instrument was introduced

International Bank for Reconstruction andDevelopment (IBRD) was created to

rehabilitate war-torn countries and help

developing countries



The System of Bretton Woods( 1944-71)

So in effect this was a gold – dollar exchange

standard ( $35/ounce)- known as fixed

exchange rate system or adjustable peg Devaluation could not be resorted arbitrarily

When BOP problem became structural i.e.

repetitive, devaluation upto ten percent waspermitted by IMF

Thus each currency was tied to dollar directly

or indirectly



Collapse of theFixed Exchange System

The system of fixed exchange rates

established at Bretton Woods worked well

until the late 1960’s Any pressure to devalue the dollar would

cause problems throughout the world

The trade balance of the USA became highly

negative and a very large amount of USdollars was held outside the USA ; it was

more than the total gold holdings of the USA



Collapse of theFixed Exchange System

During end of sixties, European

governments wanted gold in return for the

dollar reserves they held

On 15th Aug. 1971, President Nixon

suspended the system of convertibility ofgold and dollar and decided for floating

exchange rate system



The end of the Bretton WoodsSystem (1972 –81)

The system dissolved between 1968 and

1973

By March 1973, the major currencies began

to float against each other



The end of the Bretton WoodsSystem (1972 –81)

IMF members have been free to choose any

form of exchange arrangement they wish

(except pegging their currency to gold): Allowing the currency to float freely

Pegging it to another currency or a basket

of currencies Adopting the currency of another country,

participating in a currency bloc, or

Forming part of a monetary union



Exchange Systems after 1973

• Exchange Rate systems are classified onthe basis of the flexibility that themonetary authorities show towardsfluctuations in the exchange rates and aredivided into two categories:

1. Systems with a fixed exchange rate( “f ixed peg” or “hard peg”) and

2. Systems with a flexible exchange rate( “Floating” systems)



Exchange Systems after 1973

• But as usual, between these two extremepositions there exists also an intermediaterange of different systems with limitedflexibility, usually referred to as “soft

pegs”



A fixed peg regime

A fixed peg regime exists when theexchange rate of the home currency is fixedto an anchor currency

This is the case with economies havingcurrency boards or with no separatenational currency of their own

Countries do not have a separate nationalcurrency, either when they have formallydollarized, or when the country is a memberof a currency union, for example Euro



Floating Exchange Rate System

● The collapse of Bretton Woods andSmithsonian Agreements coupled with oil

crisis of 1970, the floating exchange ratesystem was adopted by leadingindustrialised countries

● Officially approved in April 1978

● Under the system, the exchange ratewould be determined by market forceswithout the intervention of government



Floating Exchange Rate System

●No country in the world has adopted freelyfloating exchange rate system

●Floating exchange rate regimes consist ofindependent floating and managed floating

systems



Independent Floating systems

In Independent Floating systems theexchange rate is market determined andmonetary policy usually functions withoutexchange rate considerations

Foreign exchange interventions are rare

and meant to prevent undue fluctuations

But no attempt is undertaken toachieve/maintain a particular rate



Managed Floating systems

Managed Floating systems usually let themarket take its own course but the monetaryauthorities intervene in the market to “manage”

the exchange rate, if needed, to prevent highvolatilities and to stimulate growth, withoutcommitting to a particular exchange rate level

The monetary authorities do not specify their

opinion on “suitable” exchange rate level The IMF calls this practice a “Managed Floating

With No Predetermined Path for the ExchangeRate”



Intermediate Regimes ( Soft Pegs)

• Intermediate exchange rate regimes consist

of an array of differing systems allowing avarying degree of flexibility, such asconventional fixed exchange rate pegs,crawling pegs and exchange rate bands



Conventional fixed exchange ratepegs

In a Conventional Fixed Peg arrangement acurrency is pegged at a fixed rate to a majorcurrency or a basket of currencies, allowingthe exchange rate to fluctuate within anarrow margin of ±1 percent around a formal(or de facto ) central rate

The monetary authority intervenes in themarket, if the fluctuation is outside theselimits

(post-crisis Malaysia, fixing Ringgit againstUS dollar for a rate of RM 3,8 per $1)



Crawling Peg ( The Dirty Float)

● In this system an attempt is made tocombine the advantages of fixed exchange

rate with flexibility of floating exchange rate

● It fixes the exchange rate at a given levelwhich is responsive to changes in market

conditions i.e. it is allowed to crawl




In a Crawling Peg arrangement the currencyis adjusted periodically “in small amounts ata fixed rate or in response to changes inselective quantitative indicators (pastinflation differentials vis-à-vis major tradingpartners…)

A Crawling Band allows a periodicadjustment of the exchange rate band itself




● The upper and lower limits are decided forexchange rate depending demand and supplyof foreign exchange

● As the exchange rate crosses these limits,fiscal and monetary policies come into play topush the exchange rate within the target zone

● But in this case, these limits are sustained forsome time and if it is felt that economicindicators are being disturbed, the monetaryauthorities let the exchange rate depreciate or

appreciate as the case may be



Trends in Global Exchange Rate Regimes



Exchange Rate Regimes IMF Members, 2006



Exchange Rates Since 1973

• Since 1973, exchange rates have become morevolatile and less predictable than they werebetween 1945 and 1973, due to:

Oil crisis -1971 Loss of confidence in the dollar - 1977-78

Oil crisis – 1979, OPEC increases price of oil

Unexpected rise in the dollar - 1980-85

Rapid fall of the dollar - 1985-87 and 1993-95

Partial collapse of European Monetary System –

1992

Asian currency crisis - 1997



Exchange Rates Since 1973

● The merits of each continue to be debated

● There is no agreement as to which systemis better

● Many countries today are disappointedwith the floating exchange rate system



Implications For Managers

For managers, understanding theinternational monetary system is important

for:

Currency management

Business strategy

Corporate-government relations



Currency Management

Managers must recognize that the current

international monetary system is a managed

float system in which government

intervention can help drive the foreign

exchange market

Under the present system, speculativebuying and selling of currencies can create

volatile movements in exchange rates



Business Strategy

Managers need to recognize that while

exchange rate movements are difficult to

predict, their movement can have a majorimpact on the competitive position of

businesses

To contend with this situation, managers

need strategic flexibility e.g. dispersing

production to different locations



Corporate-Government Relations

Managers need to recognize that

businesses can influence government

policy towards the international monetarysystem

Companies should promote aninternational monetary system that

facilitates international growth and

development



Evolution of Indian Exchange Ratesystem

• 1931 – Rupee pegged to Pound Sterling – parity Rs. 1= shilling 1 and 6 pence

• 1944 – IMF asked nations to peg currencyto dollar or gold – chose gold – parity again with sterling –

BP 1 = Rs. 13.33

• 1949 – Pound was devalued 30.5% so was

Rupee but 36.5% in dollar terms




• 1967 – Pound again devalued by 14.3% butIndia did not – it delinked rupee from

pound and linked it to dollar• 1971 – Smithsonian Agreement – theinternational currencies wererealigned – India returned to sterling

peg – parity BP = Rs. 18.9677

The fluctuation of (+)/(-) 2.25% wasallowed




• Sept. 1975 – the sterling peg was replacedby a basket peg - The

fluctuation band widened to(+)/(-) 5%

• July 1991 – the rupee was devalued twice by18-20%

• 1991-92 Budget - partial convertibility oncurrent account




• 1992-93 Budget – the rupee was made fullyconvertible on current account and a

liberalized exchange rate managementsystem ( LERMS) was introduced

• Presently, FEDAI announces indicativerates on every business day . RBI hasdiscretion to enter the market to stabilisethe exchange rate



GOOD LUCK TO YOU

Documents

International Monetary System Part I