Evolution of the International Monetary System

 

1. Gold Standard
2. Bretton Woods (1944-1973)
3. Role of IMF
4. SDR
5. Role of World Bank
6. Collapse of Bretton Wood

 

1. Gold Standard

–        Currencies pegged to the value of gold; convertibility guaranteed

–        The exchange rate between currencies was determined based on how much gold a unit of each currency would buy

–        By 1880 most countries were on the gold standard

–        Achieves balance of trade equilibrium for all countries (value of exports equals value of imports); flow of gold was used to make up differences

–        Abandoned in 1914; attempt to resume after WWI failed with Great Depression

2. Bretton Woods (1944 - 1973)

• 44 countries met to design a new system in 1944
• Established International Monetary Fund (IMF) and World Bank

–        IMF maintained order in monetary system

–        World Bank promoted general economic development

–        Fixed exchange rates pegged to the US Dollar

–        US Dollar pegged to gold at $35 per ounce

–        Countries maintained their currencies ± 1% of the fixed rate; government had to buy/sell their currency to maintain level

 

3. The Role of the IMF

1. Maintain Exchange rate discipline

•  National governments had to manage inflation through their money supply
• The need to maintain a fixed exchange rate puts a brake on competitive devaluations and brings stability to the world trade environment. 
• A fixed exchange rate regime imposes monetary discipline on countries, thereby curtailing price inflation. 

1.  Maintain Exchange rate flexibility

–        Provided loans to help members states with temporary balance-of-payment deficit;

Allowed time to bring down inflation

Relieved pressures to devalue

–        Excessive drawing from IMF funds came with IMF supervision of monetary and fiscal policies

–        Allowed up to 10% devaluations and more with IMF approval

 

4. Special Drawing Rights (SDR)

–        To help increase international reserves, The IMF created Special Drawing Right (SDR) in 1969.

–        SDRs are defined in terms of a basket of major currencies used in international trade and finance. At present, the currencies in the basket are the euro, the pound sterling, the Japanese yen and the United States dollar. Before the introduction of the euro in 1999, the Deutsche mark and the French franc were included in the basket.

–        SDRs are used as a unit of account by the IMF and several other international organizations. A few countries peg their currencies against SDRs, and it is also used to denominate some private international financial instruments

 

5. The Role of the World Bank

–        World Bank (IBRD-International Bank for Reconstruction and Development) role

–        Refinance post-WWII reconstruction and development

–        Provide low-interest long term loans to developing economies

The International Development Agency (IDA), an arm of the bank created in 1960

–        Raises funds from member states

–        Loans only to poorest countries

–        50 year repayment at 1% per year interest

 

6.Collapse of Bretton Woods

• Devaluation pressures on US dollar after 20 years - Huge balance of payment deficit & depletion of Gold reserves in US.

• Lyndon Johnson policies

–        Vietnam war financing

–        Welfare program financing

• Nixon ended gold convertibility of US dollar in 1971
• US dollar was devalued and dealers started speculating against it for further devaluation
• Bretton Woods fixed exchange rates abandoned in January 1972

 

After the Collapse of Bretton Wood

 

1. Jamaican Agreement 1976
2. Reasons for adopting Floating and Fixed rate system
3. Recent Activities by IMF
4. Implication of Forex on Business

 

1. Jamaica Agreement 1976

u        Floating rates declared acceptable

u        Gold abandoned as reserve asset;

–        IMF returned its gold reserves to its members at current prices

–        Proceeds were placed in a trust fund to help poor nations

–        IMF quotas – member country contributions – increased; membership now 182 countries

–        Less-developed, non-oil exporting countries given more access to IMF

u        IMF continued its role of helping countries cope with macroeconomic and exchange rate problems

 

2. Why country went for Floating Exchange Rates

1. Country gets Monetary policy autonomy and can take own decision
2. Trade balance adjustments helped

Why Country went for Fixed Exchange Rates

1. It brougth more Monetary discipline
2. Speculation on curreny was reduced
3. Uncertainty reduced
4. Trade balance adjustment effects on inflation controlled

 

3. Recent Activities by the IMF

1. Helping in solving Mexican crisis 1995
2. Managing Russian crisis1995
3. Solving Asian crisis 1997/1998

–        The investment boom

–        Excess capacity

–        The debt bomb

–        Expanding imports

–        The crisis

 

4. Implications of Forex for Business

1. Currency management

–        The monetary system is not perfect

–        Both speculative activity and government intervention affect the system

–        Companies must use risk management instruments

 

1. Business strategy

–        Minimize risk by placing assets in different parts of the world, e.g., production

–        Contract manufacturing

–        Manage company-government relations