The InternationalThe InternationalMonetary SystemMonetary System

The structure within which foreign exchange rates are determined, international trade and capital flows are accomodated, and adjustments to the balance of payments made

- It also includes all the - It also includes all the instruments, institutions and instruments, institutions and agreements that link together agreements that link together

the world’s currency and the world’s currency and money marketsmoney markets

The present system is The present system is characterised by a mix of characterised by a mix of

fixed, floating and managed fixed, floating and managed exchange rate policiesexchange rate policies

Currencies of most nations are based on agreements in force between their government and the International Monetary Fund ( IMF )

DEVELOPMENT OF THE DEVELOPMENT OF THE INTERNATIONAL MONETARYINTERNATIONAL MONETARYSYSTEMSYSTEMMonetary System before 1945

No international central bankThe Gold Standard

Development of the International Monetary Fund (IMF)

Monetary System 1945 - 1973Dropping the Gold StandardCurrency Float

Currency Arrangements 1973 - Present

The Gold StandardThe Gold Standard1876-19131876-1913

The “ rules of the game” were clear and simple. Each country set the rate which its currency( paper or coin) could be converted to a weight of gold

ExampleExample

In USA, the dollar is convertible to gold at a rate of $ 20.67 per ounce of gold

In the UK the British pound was pegged to

£ 4.2474 per ounce of gold

As long as both currencies were freely convertible into gold, we can work out the dollar/pound exchange rate.

What is it?

$ 4.86656 to the pound

The value of each individual The value of each individual currency in terms of gold and currency in terms of gold and therefore its own fixed parity therefore its own fixed parity

between currencies remainedbetween currencies remainedstable.stable.

LIMITATIONSLIMITATIONS

Important to maintain adequate reserves of gold to back currency value

The rate at which a country could expand its money supply

Additional gold to be acquired by official authorities

Earlier Linkage SystemsEarlier Linkage Systems

Gold StandardGold Exchange Standard

( the system generally followed by the largest industrial countries at present)

European Monetary System (EMS) and its “special currency”, the European currency unit, the ECU

THE INTER-WAR YEARS AND THE INTER-WAR YEARS AND WORLD WAR II 1914-1944WORLD WAR II 1914-1944

During World War I and the early 1920’s, currencies were allowed to fluctuate over fairly wide ranges in terms of both gold and one another.

Unfortunately, such flexible exchange rates did not work in an equilibrim manner.

Instead of 2 international reserve Instead of 2 international reserve assets, gold and sterling, there are assets, gold and sterling, there are now several.now several.

USA and France had become importantUSA and France had become importanttrade partnerstrade partners

Volume of trade did not grow in the Volume of trade did not grow in the 1920’s in proportion world’s GNP and 1920’s in proportion world’s GNP and declined to a very low leveldeclined to a very low level

Foreign Exchange Markets, exchange rates and other institutional mechanisms were effectively suspended during the war

By the end of World War II, sterling dominance of international trade has gone and the era of the Gold Standard has passed

The Bretton-Woods The Bretton-Woods AgreementAgreement

Establishment of a US dollar based International Monetary System and provided for 2 new institutions

- The IMF

- The World Bank

The Bretton-Woods systemThe Bretton-Woods system

Each fund member would establish with the approval of the IMF, a par value for its currency, and would undertake to maintain exchange rates for its currency within 1 % of the declared par value

The Bretton-Woods systemThe Bretton-Woods system

Members would change their par value only after having secured IMF approval.

This approval would be granted only if there were evidence that the country was suffering from a fundamental disequilibrium in its balance of payments.

The Bretton-Woods systemThe Bretton-Woods system

Each IMF member country would pay into the IMF pool a quota, ¼ being in gold with the remainder in its own currency. The size of the quota was a function of each member’s size in the world economy.

The International Monetary The International Monetary FundFund

Key institution in the new monetary system and it remains so to-day

Established to render temporary assistance to member countries trying to defend their currencies against cyclical, seasonal or random occurences

The International Monetary The International Monetary FundFund

It also assist countries having structural trade problems if they take adequate steps to correct their problems

To carry out its tasks, the IMF was originally funded by each member subscribing to a quota based on post World War II patterns

The International Bank for The International Bank for Reconstruction and DevelopmentReconstruction and Development

Initially aided in post-war reconstruction, but since has supported general economic development

SPECIAL DRAWING RIGHTSSPECIAL DRAWING RIGHTS

The SDR is an international reserve asset created by the IMF in 1969 to supplement existing foreign exchange reserves.

SPECIAL DRAWING RIGHTSSPECIAL DRAWING RIGHTS

It serves as a unit of account for the IMF and other international and regional organisations.

It is also the base against which some countries peg the rate of exchange for their currencies.

SPECIAL DRAWING RIGHTSSPECIAL DRAWING RIGHTS

The SDR is a composite index of 5 key participant currencies.

Use the IMF website to find the current weights and valuation of the SDR

CONTEMPORARY CONTEMPORARY CURRENCY REGIMESCURRENCY REGIMES

International monetary system currencies

Currency boardsDollarizationFixed versus flexible exchange

rates

What are the likely attributes

of the “ideal currency”?

Some currency terminologySome currency terminology

Exchange ratePar value of a currencyDevaluation of a currencyWeakness/depreciation of a

currencySoft/weak currency

Classification of currency Classification of currency arrangementsarrangements

Pegged to another currencyPegged to a composite basket

of currenciesIndependently floatingManaged floating

Currency Board SystemCurrency Board System

No Central BankThe Board issues notes and coins that

are convertible on demand and at a fixed rate into a foreign reserve currency

The reserves of the board are high-quality, interest- bearing securities denominated in the reserve currency

Currency Board SystemCurrency Board System

Reserves = 100% or slightly more of notes and coins in circulation

Has no discretionary monetary policy. Market forces alone determine money supply

Example: Singapore, Hong Kong