Essentials of a Sound Currency System:

It must maintain a reasonable stability of prices in the

country. A sound currency system must maintain stability of the external value of the currency. The system must be economical. The currency must be elastic and automatic. The currency system must be simple.

International Monetary system

This chapter serves to introduce the student to the institutional framework within which: International payments are made. The movement of capital is accommodated. Exchange rates are determined

Evolution of the International Monetary System Bimetallism: Before 1875 Classical Gold Standard: 1875-1914 Interwar Period: 1915-1944 Bretton Woods System: 1945-1972 The Flexible Exchange Rate Regime: 1973-Present.

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. Greshams Law implied that it would be the least valuable metal that would tend to circulate.

Classical Gold Standard: 1875-1914

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 countrys currencies would be determined by their relative gold contents.

Classical Gold Standard: 1875-1914

For example, if the dollar is pegged to gold at U.S.$30 = 1 ounce of gold, and the British pound is pegged to gold at 6 = 1 ounce of gold, it must be the case that the exchange rate is determined by the relative gold contents:$30 = 6 $5 = 1

Interwar Period: 1915-1944

The

gold standard as an international monetary system worked well until world war 1 interrupted trade flows and disturbed the stability of exchange rates for currencies of major countries. There was a widespread fluctuation in currencies in terms of gold standard in early 1920s. As countries began to recover from the war and stabilize their economies, they made several attempts to return to the gold standard.

 They made several attempts to return to the gold

standard, they were made to restore the gold standard, but participants lacked the political will to follow the rules of the game. U.K had experienced hyper inflation because of World war 1, it leads to imbalance in the exchange rates. The pounds overvaluation was not only the major problem of the restored gold standard, other problems included the failure of the other countries to act responsibly.

 The willingness and ability to rely on the gold standard

adjustment mechanism has been decreased over a period of time in many countries. Thus the inter-war period was characterized by halfhearted attempts and failure to restore the gold standard, economic and political instabilities, widely fluctuating exchange rates are the failure to regain the gold standard.

Bretton Woods System (1944 1973)

Named for a 1944 meeting of 44 nations at Bretton

Woods, New Hampshire. The purpose was to design a postwar international monetary system. The goal was exchange rate stability without the gold standard. The result was the creation of the IMF and the World Bank.

44 countries met to design a new system in 1944

Established:

International Monetary Fund (IMF) and World Bank

IMF: maintain order in monetary system World Bank: promote general economic

development
Fixed exchange rates pegged to the US

Dollar
US Dollar pegged to gold at $35 per ounce

 The result was the creation of the IMF and

the World Bank ( International bank for reconstruction and development ). The basic role of IMF would be to help countries with balance of payment and exchange rate problem while the world bank would help countries with post-war reconstruction and general economic development. Under the Bretton Woods system, the U.S. dollar was pegged to gold at $35 per ounce and other currencies were pegged to the U.S.

Bretton Woods System: 1945-1972

British pound German mark French franc

Par Value
U.S. dollar

Gold

Pegged at $35/oz.

 Role of the IMF, IMF maintained exchange rate

discipline

National governments had to manage inflation through their money supply flexibility Provides loans to help members states with temporary balance-of-payment deficit; Allows time to bring down inflation Excessive drawing from IMF funds came with IMF supervision of monetary and fiscal policies Allowed to 10% devaluations and more with IMF approval.

The Role of the world bank

World

Bank (IBRD) role (International Bank for Reconstruction & Development) Refinanced post-WWII reconstruction and development Provides 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.

 The Bretton Woods system was a

dollar-based gold exchange standard. The Bretton woods system worked without major changes from 1947 till 1971. During this period, the fixed exchange rates were maintained by official intervention in the foreign exchange markets.

The breakdown of Bretton woods system

The Bretton woods system worked without major

changes from 1947 till 1971. The system, however, suffered from a number of inherent structural problems. In the first place, there was much imbalance in the roles and responsibilities of the surplus and deficit nations. The countries with persistent deficit balance of payments had to undergo tight and stringent economic policy measure if they want to take help of IMF

 The basic problem was rigid approach adopted by the

IMF to the balance of payments disequilibria situation. U.S. high inflation rate. U.S.$ depreciated sharply.
US dollar was devalued and dealers started

speculating against it for further devaluation Bretton Woods fixed exchange rates abandoned in January 1972