International monetary system

its a presentation about the international monetary system and its history

1. International Monetary System Suresh Thengumpallil

2. What is money? A current medium of exchange in the form of coins and banknotes; coins and banknotes collectively Any good that is widely accepted in exchange of goods and services, as well as payment of debts.

3. Three functions of money : Medium of exchange – money used for buying and selling goods and services Unit of account – common standard for measuring relative worth of goods and services Store of value – convenient way to store wealth

4. International Monetary System International monetary systems are sets of internationally agreed rules, conventions and supporting institutions, that facilitate international trade, cross border investment and generally there allocation of capital between nation states . International monetary system refers to the system prevailing in world foreign exchange markets through which international trade and capital movement are financed and exchange rates are determined.

5. Features that IMS should possess Efficient and unrestricted flow of international trade and investment. Stability in foreign exchange aspects. Promoting Balance of Payments adjustments to prevent disruptions associated. Providing countries with sufficient liquidity to finance temporary balance of payments deficits. Should at least try avoid adding further uncertainty. Allowing member countries to pursue independent monetary and fiscal policies.

6. Requirements of good international monetary system Adjustment : a good system must be able to adjust imbalances in balance of payments quickly and at a relatively lower cost; Stability and Confidence : the system must be able to keep exchange rates relatively fixed and people must have confidence in the stability of the system; Liquidity : the system must be able to provide enough reserve assets for a nation to correct its balance of payments deficits without making the nation run into deflation or inflation.

7. STAGES IN INTERNATIONAL MONETARY SYSTEM 1. Bimetallism: Before 1875 2. Classical Gold Standard : 1875-1914 3. Interwar Period: 1915-1944 4. Bretton Woods System: 1945-1972 4. The Flexible Exchange Rate Regime: 1973-Present

8. Bimetallism: Before 1875 A “double standard” in the sense that both gold and silver were used as money. Some countries were on the gold standard, some on the silver standard, some on both. Both gold and silver were used as international means of payment and the exchange rates among currencies were determined by either their gold or silver contents. Gresham’s Law implied that it would be the least valuable metal that would tend to circulate.

9. Gresham’s Law Gresham's law  is an economic principle that states: "if coins containing metal of different value have the same value as legal tender, the coins composed of the cheaper metal will be used for payment, while those made of more expensive metal will be hoarded or exported and thus tend to disappear from circulation.” It is commonly stated as : " “Bad” (abundant) money drives out “Good” (scarce) money”

10. Gresham’s Law Contd … The law was named in 1860 by Henry Dunning Macleod, after Sir Thomas Gresham (1519–1579), who was an English financier during the Tudor dynasty. However, there are numerous predecessors. The law had been stated earlier by Nicolaus Copernicus; for this reason, it is occasionally known as the  Copernicus Law .

11. Image of first United States gold coin - the 1795 Gold Eagle .

12. C lassical Gold Standard (18 75 – 1914)

13. During this period in most major countries: Gold alone was assured of unrestricted coinage There was two-way convertibility between gold and national currencies at a stable ratio. Gold could be freely exported or imported. The exchange rate between two country’s currencies would be determined by their relative gold contents. Gold Standard

14. Rules of the system Each country defined the value of its currency in terms of gold. Exchange rate between any two currencies was calculated as X currency per ounce of gold/ Y currency per ounce of gold. These exchange rates were set by arbitrage depending on the transportation costs of gold. Central banks are restricted in not being able to issue more currency than gold reserves.

15. Class i cal Gold Stand a rd : Exchange rate determination For exa m ple, if t h e do l lar is peg g ed to g o ld at U.S.$30 = 1 o u nce of g ol d , and the Briti s h pou n d is pegged to g o ld at £6 = 1 o u nce of g ol d , it m ust be the case that the exchange rate is determined by the relative gold contents $ 3 = £6 $5 = £1

16. Classical Gold Standard: Highly stable exchange rates under the classical gold standard provided an environment that was favorable to international trade and investment Misalignment of exchange rates and international imbalances of payment were automatically corrected by the price-specie-flow mechanism .

17. Price-Specie-Flow Mechanism Suppose Great Britain exported more to France than France imported from Great Britain. Net export of goods from Great Britain to France will be accompanied by a net flow of gold from France to Great Britain. This flow of gold will lead to a lower price level in France and, at the same time, a higher price level in Britain. The resultant change in relative price levels will slow exports from Great Britain and encourage exports from France.

18. Arguments in Favor of a Gold Standard Price Stability. By tying the money supply to the supply of gold, central banks are unable to expand the money supply. Facilitates BOP adjustment automatically price-specie-flow mechanism

19. Arguments against Gold Standard The growth of output and the growth of gold supplies are closely linked. Volatility in the supply of gold could cause adverse shocks to the economy, In practice monetary authorities may not be forced to strictly tie their hands in limiting the creation of money. Countries with respectable monetary policy makers cannot use monetary policy to fight domestic issues like unemployment.

20. Interwar Period ( 1915-1944 )

21. Int e rwar Perio d : 19 1 5 - 1944 Exchange r a tes fl u ctuated as count r ies widely used “ p redato r y” depreciatio n s of t h eir currencies as a m e ans of g aining advantage in the world exp o rt m arket. Atte m pts were m ade to resto r e the g o ld standar d , but partici p ants lacked the p o litical will to “f o llow the ru l es of t h e ga m e” The world economy characterized by tremendous instability and eventually economic breakdown, what is known as the Great Depression (1930 – 39)

22. Int e rwar Perio d : 19 1 5 - 1944 International Economic Disintegration Many countries suffered during the Great Depression. Major economic harm was done by restrictions on international trade and payments. These beggar-thy-neighbor policies provoked foreign retaliation and led to the disintegration of the world economy. All countries’ situations could have been bettered through international cooperation Bretton Woods agreement

23. Bretton Woods System: 1945-1972

24. Bretton Woo d s System: 19 4 5- 1 9 72 Na m ed f or a 1944 m eeting of 44 n ations at Bretton Wo o ds, N e w Ha m ps h ire. The pur p ose w as to desi g n a po s twar inter n ational m onetary sys t e m . The goal was exchan g e rate stabi l ity with o ut the go l d stan d ard.

25. Resulted in ; The result was the creation of the IMF and the World Bank IMF : maintain order in monetary system World Bank : promote general economic development In discussion : ITO

26. Features of Bretton Woo d s System Under t h e Bretton W o ods sy s te m , t h e U . S. d o llar was pegged to gold at $35 per o u nce a nd o ther currencies w e re p egged to the U.S. d o llar. Ea c h cou n try was res p on s ible for maintaining its exchange rate fixed : within ±1% of the adop t ed par value by bu y ing or selli n g fo r eign reserves as necessary. The Br e tton Wo o ds sys t em was a dolla r - based go l d exchange stan d ard.

27. Brett o n Woo d s System:1 9 4 5 -1 9 72 Par value / pegged exchange rate system Ger m an m ark Brit i sh pound French franc Par V alue U.S. dollar Pegged at $3 5 /oz. Gold

28. The Demise of the Bretton Woods System In the early post-war period, the U.S. government had to provide dollar reserves to all countries who wanted to intervene in their currency markets. The increasing supply of dollars worldwide, made available through programs like the Marshall Plan, meant that the credibility of the gold backing of the dollar was in question. U.S . dollars held abroad grew rapidly and this represented a claim on U.S. gold stocks and cast some doubt on the U.S.’s ability to convert dollars into gold upon request.

29. The Demise of the Bretton Woods System Domestic U.S. policies, such as the growing expenditure associated with Vietnam resulted in more printing of dollars to finance expenditure and forced foreign governments to run up holdings of dollar reserves. The dollar was overvalued in the 1960s In 1971, the U.S. government “closed the gold window” by decree of President Nixon.

30. The Demise of the Bretton Woods System The world moved from a gold standard to a dollar standard from Bretton Woods to the Smithsonian Agreement . Growing increase in the amount of dollars printed further eroded faith in the system and the dollars role as a reserve currency. By 1973, the world had moved to search for a new financial system: one that no longer relied on a worldwide system of pegged exchange rates.

31. Smithsonian Agreement An agreement reached by a group of 10 countries (G10) in 1971 that effectively ended the fixed exchange rate system established under the Bretton Woods Agreement. The Smithsonian Agreement reestablished an international system of fixed exchange rates without the backing of silver or gold, and allowed for the devaluation of the U.S. dollar. This agreement was the first time in which currency exchange rates were negotiated.

32. Concepts… Snake in the tunnel Nixon Shock

33. The Flexible Ex c ha n ge Rate Regime: 19 7 3 - Pr e sent

34. The Flexible Ex c ha n ge Rate Regime Flexi b le exchange rates were d ecl a red ac c eptable to the IMF m e m bers. Central banks were a l lowed to interv e ne in the exchange rate m arke t s to iron out unwarran t ed volat i lit i es. Gold was aban d oned as an internati o nal reserve asset . The currencies are no longer backed by gold

35. Curr e nt Ex c ha n ge Rate Ar r an g ements Free Float The largest number of cou n tries, abo u t 48, allow m arket forces to deter m ine their cur r ency’s value. Managed Float Ab o ut 25 co u ntries co m bine go v ern m ent intervention with m arket fo r ces to set exchange rates. Pegged to another curr e ncy Such as t he U.S. dollar or e uro etc.. No national cur r ency So m e c ou n tries do n o t bot h er printing their ow n , they just use the U.S. d o ll a r. For exa m ple, Ecuador, Pana m a, and have d o llarize d .

36. “give a man a fish and you feed him for a day; teach a man to fish and you feed him for a lifetime”