International monetary system

International monetary system are set of internationally agreed rules, conventions and supporting institutions, that facilitate international trade cross border investment and generally the reallocation of capital between nation states.

International monetary system refer to the system prevailing in world foreign exchange markets through which international trade and capital movements are financially and exchange rate are determined.

IMS is part of institutional framework that binds national economic , such a  system permit producers to specialize in those goods for which they have a comparative advantage and serves to seek profitable investment opportunities on global basis.

Features of International monetary system:

-Flow of international trade and investment according to comparative advantage.

-Stability in foreign exchange  and should is stable.

-Promoting balance of payment adjustment to prevent disruptions associated with temporary or chronic imbalances.

-Should at least try avoid further uncertainty.

-Allowing member countries to pursue independent monetary and fiscal policies.

-Providing countries with sufficient liquidity to finance temporary balance of payment deficits.

Stage of international monetary

Classic gold standard ( 1816-1914)

Interwar Period (1918-1939)

Bretton woods system ( 1944 -1971)

Flexible exchange rate ( 1973 – since )

Classic gold standard :

• The first modern IMS was gold standard put afford in 1950.
• Participants – UK , France , Germany , USA and Japan in this system gold was used as a storage of wealth and medium of exchange in this system, each currency was linked to a weight of gold.
• The fundamental principle should set a par value for its currency term of gold and then try to maintain the value.
• Thus each country had to establish the rate at which its currency could be converted to the weight of gold.

The three features of gold standard:

The government of each country defines its national monetary units in term of gold.

1. Free import and export of gold.
2. Two way convertibility between gold and nation currency at a stable prices.

 

Advantages of Gold Standard:

 

• The gold standard dramatically reduced the risk in exchange rate because it established fixed exchange rate between currencies.
• The countries were forced to observe strict monetary policies.
• Gold standard would help a country correct its trade imbalance.

Decline of Gold standard :

• Money supply or financing the war activity is not easy.
• Gold volume could not grow fast enough.
• Exchange rate party was gathering disordered.
• The strained political relations impeded free flow of gold form one country to another.
• It was not practical for a country to subordinate their national currencies to gold.

 

Interwar Period (1918 – 1939) :

• The Gold standard as an IMS worked well until the beginning of world war first.
• War interrupted the trade the flow and disturbed the stability of exchange rate for currency of major countries.
• The role of great Britain as major creditor nation also came to and after world war first.
• The united began to assume the role of leading creditor nation.

 

The depression of 1930’s followed by world war second had vastly diminished.

• Commercial trade
• International exchange of currency
• Cross Border Lending and borrowing                                                     Revival of the system was necessary.

Bretton woods system (1944 – 1971) :

The depression of 1930’s followed by another war, had vastly diminished commercial trade the international exchange of currency and cross border landing and borrowing.

Revival of the system was necessary and the reconstruction of post war, financial system begin with the bretton woods agreement emerged from the international monetary and financial conference of the united and associated nation in July 1944 at Bretton woods , New Hampshire.

The principle of the new system, John Maynard Keynes and Harry Dexter White .

The term agreement were negotiated by 44 nation, lead by USA and Britain.

The main hope of creating a new financing system was to stabilize exchange rate.

Main characteristics of the IMS developed at bretton Woods can be summarized as follows:

• Fixed rates in terms of gold.
• A procedure for mutual international credits.
• Creation of IMF to supervise and ensure smooth functioning of the system.
• Devaluation of more than 5% had to be done with the permission to IMF.

 

Features of Bretton  wood system (1944-1971) :

 

• The features of Bretton woods system as a “ gold exchange” standard rather than a “gold –standard”. The key difference was the only currency that was backed by convertible into gold.
• Each country was allowed to have 1% band around which their currency was allowed to fluctuate around the fixed rate. Except on the rate occasions when the par value was readjusted, countries would have to intervene to ensure that the currency stayed in requied band.
• IMF was created with specific goal of being the multilateral body that monitored the implementation of the Bretton woods agreement.
• Its role was hold currencies reserve and gold reserve that were contributed by the member countries and land this money out of other nations that had difficulty meeting their obligations under this agreement.
• Currencies has to convertible; central bank has to exchange domestic currency for dollar upon request.
• Although the adjustable exchange rate system meant that countries that could no longer  sustain the fixed exchange rate vis-a-vis the dollar would be allowed to be devalue their currency , they could only do so with the consent pf the other countries and auspice of the IMF.

 

The Breakdown of Bretton woods systems:   

 

• The system of fixed exchange rate established at Bretton woods worked the late 1960’s.
• Any pressure to devalue the dollar would cause problems throughout the world.
• The tread balance of USA  became highly negative and very large amount of US dollars was held outside the USA; it became more than the  gold holding of USA.
• On 15 Aug. 1971, President Nixion suspended the system of convertibility of gold and dollar and decided for floating exchange rate system.
• The system dissolved between 1968 and 1973.
• By march 1973, the major currencies began to float against each other.

Flexible exchange rate regime since 1973 :

The collapse of Bretton woods system of exchange rate, the board of governors of the IMF appointed committee to suggest guidelines for evolving an exchange rate system that could be acceptable to the member countries.

Rate system are classified on the basis of the flexibility that the monetary authorities show towards fluctuations in the exchange rates and are divided into two categories:

1. System with A Fixed Exchange rate
2. System with A Flexible exchange rate (Floating system)

 

Fixed Exchange Rate System:

 

• In this system, a currency is pegged to a foreign currency, with fixed parity.
• A rate are maintained constant or they may fluctuate within a narrow range.
• When a currency trends towards crossing over the limits governments intervene to keep it within the band.
• A fixed peg regime exists when the exchange rate of home currency is fixed to anchor currency.
• This is the case with economies having currency boards or with no separate national currency of their own.

 

Flexible  Exchange Rate System:

 

• Floating exchange rate system involve market forces determining the exchange rate.

Its merits are:

1. Exchange rates are automatically adjusted to change in macro-economic variables.
2. Exchange rate is almost stable around the equilibrium in long run.
3. Currency remains insulated form the shocks emanating abroad.

 

Flexible Exchange Rate Regime Since 1973;

 

No country in world has adopted freely  floating exchange rate system.