The International Monetary 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 instruments, institutions and agreements that link together the world’s currency and money markets

The present system is characterised by a mix of fixed, floating and managed exchange rate policies

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

DEVELOPMENT OF THE INTERNATIONAL MONETARY SYSTEM Monetary System before 1945 No international central bank The Gold Standard Development of the International Monetary Fund (IMF) Monetary System Dropping the Gold Standard Currency Float Currency Arrangements Present

The Gold Standard 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

Example In USA, the dollar is convertible to gold at a rate of $ per ounce of gold In the UK the British pound was pegged to £ 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?

$ to the pound

The value of each individual currency in terms of gold and therefore its own fixed parity between currencies remained stable.

LIMITATIONS 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 Systems Gold Standard Gold 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 WORLD WAR II 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 assets, gold and sterling, there are assets, gold and sterling, there are now several. USA and France had become important trade partners Volume of trade did not grow in the 1920’s in proportion world’s GNP and declined 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 Agreement Establishment of a US dollar based International Monetary System and provided for 2 new institutions - The IMF - The World Bank

The 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 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 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 Fund 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 Fund 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 Reconstruction and Development Initially aided in post-war reconstruction, but since has supported general economic development

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

SPECIAL 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 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 CURRENCY REGIMES International monetary system currencies Currency boards Dollarization Fixed versus flexible exchange rates

What are the likely attributes of the “ideal currency”?

Some currency terminology Exchange rate Par value of a currency Devaluation of a currency Weakness/depreciation of a currency Soft/weak currency

Classification of currency arrangements Pegged to another currency Pegged to a composite basket of currencies Independently floating Managed floating

Currency Board System No Central Bank The 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 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