The Global Financial and Monetary Order

Group Member

•Sadia khan

•Rabeea bibi

•Bista faraz

•Zeenat bibi

•Anza zafar

Introduction

Presented by

Sadia khan

The International Monetary System

– The international monetary system refers to the institutional arrangements that countries adopt to govern exchange rates

– (i) the set of conventions,

– rules and policy instruments as well as

– (ii) the economic, institutional and political

– environment which determine the delivery

– of two fundamental global public goods: an

– international currency

– (or currencies) and

– external stability

Desirable objectives of the international monetary

– The desirable objectives of the international monetary system are.

– 1) exchange rate stability.– 2) being able to run an independent monetary (and more

broadly economic) national policy, for example a fiscal deficit when needed to boost economic growth.

– 3) enjoy freedom of capital flows, in order to have a more efficient financial system, international investment etc. As we shall see this third point is now being challenged.

Desirable objectives of the international monetary

Desirable objectives of IMS:– 1) exchange rate stability; – 2) independent monetary policy;– 3) free capital flows.

– The three objectives however are incompatible, only two are achievable at the same time.

– Under Bretton Woods there was 1 and 2, but not 3.

– Currently most countries, have 2 and 3, but not 1. – The Euro means that each EU member state enjoys

1 and 3, but not 2.

Floating exchange rate system

–A floating exchange rate system exists when a country allows the foreign exchange market to determine the relative value of a currency

– the U.S. dollar, the EU euro, the Japanese yen, and the British pound all float freely against each other

– their values are determined by market forces and fluctuate day to day

Fixed exchange rate system

–A fixed exchange rate system exists when countries fix their currencies against each other at some mutually agreed on exchange rate– European Monetary System (EMS) prior to 1999

Which Is Better – Fixed Rates Or Floating exchange Rates?

– fixed exchange rate system

1. Provides monetary discipline

– ensures that governments do not expand their money supplies at inflationary rates

1. Minimizes speculation

– causes uncertainty

1. Reduces uncertainty

– promotes growth of international trade and investment

Which Is Better – Fixed Rates Or Floating exchange Rates?

– Floating exchange rates provide

1. Monetary policy autonomy

– removing the obligation to maintain exchange rate parity restores monetary control to a government

1. Automatic trade balance adjustments

– under Bretton Woods, if a country developed a permanent deficit in its balance of trade that could not be corrected by domestic policy, the IMF would have to agree to a currency devaluation

CREATION OF THE BREETON WOODS SYSTEM

• The United Nations Monetary and Financial Conference was held in July 1944 at the Mount Washington Hotel in Bretton Woods, New Hampshire,

• It was an unprecedented cooperative effort for nations that had been setting up barriers between their economies for more than a decade.

• Those at Bretton Woods envisioned an international monetary system that would ensure exchange rate stability, prevent competitive devaluations, and promote economic growth.

The 730 delegates at Bretton Woods agreed to establish two new institutions.

The International Monetary Fund (IMF)

The World Bank

– In 1944, representatives from 44 countries met at Bretton Woods, New Hampshire, to design a new international monetary system that would facilitate postwar economic growth

– Under the new agreement – a fixed exchange rate system was established– all currencies were fixed to gold, but only the U.S. dollar was

directly convertible to gold– devaluations could not to be used for competitive purposes– a country could not devalue its currency by more than 10%

without IMF approval

CREATION OF THE BREETON WOODS SYSTEM

THE RISE AND DECLINE OF THE BREETON WOODS SYSTEM

Rabeea Bibi

The Breeton Woods system was based on four key elements:– The member states adopted fixed but adjustable exchange rates, with the US

dollar serving as an anchor currency. The dollar itself was linked to gold, and other currencies were allowed to fluctuate within 1 per cent of their fixed rate to the dollar.

– Although the removal of restrictions on capital movement was the ultimate goal, the Bretton Woods system allowed countries to retain capital controls initially to help them stabilise the system and adjust their domestic economy to it.A ‘scarce-currency’ clause was established that allowed restrictions of imports from countries that ran persistent payment surpluses and whose currencies became scarce within the Fund.

– The International Monetary Fund (IMF) and the World Bank were created as the main institutions supporting the new international monetary order.

What Institutions Were Established At Bretton Woods?

– The Bretton Woods agreement also established two multinational institutions

1. The International Monetary Fund (IMF) to maintain order in the international monetary system through a combination of discipline and flexibility

2. The World Bank to promote general economic development

– also called the International Bank for Reconstruction and Development (IBRD)

What Institutions Were Established At Bretton Woods?

1. The International Monetary Fund (IMF)

– fixed exchange rates stopped competitive devaluations and brought stability to the world trade environment

– fixed exchange rates imposed monetary discipline on countries, limiting price inflation

– in cases of fundamental disequilibrium, devaluations were permitted

– the IMF lent foreign currencies to members during short periods of balance-of-payments deficit, when a rapid tightening of monetary or fiscal policy would hurt domestic employment

What Institutions Were Established At Bretton Woods?

2. The World Bank

– Countries can borrow from the World Bank in two ways

1. Under the IBRD scheme, money is raised through bond sales in the international capital market

– borrowers pay a market rate of interest - the bank's cost of funds plus a margin for expenses.

1. Through the International Development Agency, an arm of the bank created in 1960

– IDA loans go only to the poorest countries

Why Did The Fixed Exchange Rate System Collapse?

– Bretton Woods worked well until the late 1960s

– It collapsed when huge increases in welfare programs and the Vietnam War were financed by increasing the money supply and causing significant inflation – other countries increased the value of their currencies relative to the U.S. dollar in

response to speculation the dollar would be devalued

– However, because the system relied on an economically well managed U.S., when the U.S. began to print money, run high trade deficits, and experience high inflation, the system was strained to the breaking point – the U.S. dollar came under speculative attack

THE RISE AND DECLINE OF THE BREETON WOODS SYSTEM

– The last two centuries have seen a succession of different international monetary systems.

– The era of the Gold Standard, which lasted from the 1870s to 1914, is widely credited with providing stability and confidence in the major currencies that formed part of the system.

–

– The Gold Standard was suspended during the the First World War, but following the end of the war there was a futile attempt to restore the Gold Standard at pre-war exchange rates.

– From the 1930s onwards, the economic dislocations of the war forced one country after another to abandon attempts to fix their currency to the Gold Standard.

RISE AND DECLINE

– The economic crisis of the inter-war years, which was one of the factors contributing to the outbreak of the Second World War. At the Bretton Woods conference in 1944, the United States and Britain played a pivotal role in designing a new framework for international monetary relations. Bretton Woods was to provide international stability while avoiding the shortcomings of previous monetary systems. The leading economic powers restored a system of fixed exchange rates and international cooperation linked with the promise of domestic autonomy in economic policy-making, which John Ruggie called the ‘compromise of embedded liberalism’.

Global monetary order after

Bretton Woods

Presented by:

Bista Faraz

Jamaica Agreement

– A new exchange rate system was established in 1976 at a meeting in Jamaica

– The rules that were agreed on then are still in place today

– Under the Jamaican agreement

– floating rates were declared acceptable

– gold was abandoned as a reserve asset

The post-Bretton Wood international monetary system– Fixed exchange rates broke down in 1971. What followed

were fluctuating exchange rates with no general rule on exchange rate adjustments.

The dollar remains the key reserve currency, although the system is based on some cooperation.

– The IMF act as regulator of the world international monetary system.

– National economies would be more independent of each other

Critics over floating exchange rate

– Threaten trade and undermine the long-term planning of

companies operating internationally.

– Governments might be tempted to use aggressive

devaluations(reduction in the official value of a currency in relation

to other currencies.) of their currency to boost export industries

– Flexible rates made currencies more volatile(uneasy),

– The fluctuations between the major currencies did not lead to

economic turmoil(disorder).

– USA continued leverage as the predominant economic power

– Frustrated by a lack of international cooperation, the European countries sought their own solution

– creating a separate monetary order for Europe

– Europe’s leading economies were more open to international trade than the USA and

– stability and predictability.

– These efforts supported by European Economic Community

‘European Snake’ in 1971

– limited the fluctuations of European currencies against each other to 4.5%.

– oil price rises and inflationary(prses rise) pressures, the Snake failed to live up to expectations.

– 1979 European Monetary System (EMS)

– policy oversight that was missing in the Snake

– interim step towards a full monetary union and single currency

– withdrawal in 1992 of Britain and Italy from the EMS underlined the weakness of its monetary disciplines.

1999 as European Monetary Union (EMU)

– EMS crisis gave the final inspiration to the creation of a full monetary union

– 1999 EMU established

– Euro replacing national currencies as the new single currency.

– EMU provided the ultimate solution to the inherent conflict between fixed rates and domestic autonomy.

1999 as European Monetary Union (EMU)

– It is an expansion of the EU single market,

– with common product regulations and

– free movement of goods, capital, labour and services.

– A common currency, the euro, has been introduced in the eurozone, which currently comprises 19 EU Member States

– single currency advantages:

– it lowers the costs of financial transactions,

– makes travel easier,

– strengthens the role of Europe at international level

Euro crises

– 2008 global financial crisis

– rapidly rising budget deficits

– Eurozone member states (Greece, Portugal, Ireland, Spain and Cyprus) were unable to repay or refinance their government debt

– 2010, the EU needed to set up a mechanism for supporting members of the Eurozone

– that experience difficulties in refinancing their public debt

– Euro crisis has thus brought into sharp focus the difficulty of sustaining a common currency system.

The IMF and international debt crises

Presented by :

Zeenat Mughal

What Has Happened To Exchange Rates Since 1973?

– Since 1973, exchange rates have been more volatile and less predictable than they were between 1945 and 1973 because of– the 1971 and 1979 oil crises– the loss of confidence in the dollar after U.S. inflation in 1977-

78– the rise in the dollar between 1980 and 1985– the partial collapse of the EMS in 1992– the 1997 Asian currency crisis– the decline in the dollar from 2001 to 2009

The IMF and international debt crises

The IMF’s original role was to provide short-term lending to countries with balance-of-payments problems but with the end of the Bretton Woods system this role was no longer central to the IMF’s mission.

With global financial liberalisation and greater capital flows to emerging economies in the developing world during the 1970s, the IMF shifted its focus to dealing with problems of indebtedness and long-term structural economic problems.

One of the key events of the 1980s that was to underline the importance of the IMF was the debt crisis that afflicted a number of developing countries.

– Today, the IMF focuses on lending money to countries in financial crisis

– There are three main types of financial crises:

1. Currency crisis

2. Banking crisis

3. Foreign debt crisis

Between the early 1970s and the mid-1980s, total debt by governments rose from around $100 billion to nearly $900 billion.

In the case of the developing countries that took on an ever growing debt burden in the 1980s, indebtedness became a key factor holding back their developmental efforts.

In Latin America – with some of the most heavily indebted countries of all, such as Mexico, Argentina and Brazil – the 1980s became known as the ‘lost decade’.

The debt crisis started in 1982, when the Mexican government nearly defaulted on its loan obligations. With a debt burden of $86 billion, Mexico’s debt crisis soon assumed international dimensions.

Heavily exposed creditor nations such as the United States could not afford to let indebted countries default, as this would threaten the stability of their own financial system.

The USA and European governments, private banks and the IMF responded by setting in motion a process of debt rescheduling that aimed at averting a global crisis while allowing for structural reforms to take place.

In this context, the IMF assumed the central role of negotiating rescheduling terms with debtor nations, leading the way for agreements between debtors and private banks.

The creditors thus acted like a cartel, and were able largely to impose their preferences on the affected developing countries.

The threat of international contagion effects should large debtor nations default, served to rein in the power of creditors and forced them to continue to supply capital to pull the international financial system back from collapse.

Managing Financial Crises

Presented by

Anza Zafar

– Financial crisis

– Financial crises seem to be endemic in the global financial system.

– Speculative bubbles, macroeconomic policy failures and volatile market reactions are a recurrent feature of the international economy.

– International financial system is prone to look like irrational market behavior and international contagion.

Asian crisis of 1997 – The Asian financial crisis, also called the "Asian Contagion," was a series

of currency devaluations and other events that spread through many Asian markets beginning in the summer of 1997.

– Asian crisis of 1997 exhibits some of the central features of financial crises, private capital was pouring into the region to the tune of $40 billion and $32 billion in 1995 and 1996 respectively.

– Much of this capital inflow, was short-term and could be reversed quickly if the economic climate worsened. This is indeed what happened from 1997 onwards, with net capital outflows from East Asia reaching $40 billion in 1998.

– The crisis was triggered by Thailand’s decision to end the currency peg of its national currency with the US dollar in response to speculative pressure from currency traders.

– The financial crisis quickly developed into a broader economic crisis in East Asia, with many countries seeing both an outflow of capital and a decline in economic prosperity, with often disastrous social consequences.

International Response to 1997Crisis

– The international response to the crisis was initially slow and insufficient.

– The IMF’s aid offers to Thailand and other affected countries failed to restore confidence or prevent the international contagion effect.

– Backed by the United States, the IMF prescribed a strong and bitter medicine: the troubled economies of East Asia had to cut back public spending, raise interest rates and increase the value of their currencies.

– These measures were meant to restore the credibility of macroeconomic policy in the region, but there was a high social cost.

– The role of the IMF in preventing, and managing, financial crises. The key questions in this debate concern, among other issues:

1.The conditionality of IMF aid

Conditions imposed by IMF loans often led to serious clashes with local governments and populations.

2. The problem of moral hazard

By offering aid before or during a financial crisis, the IMF may encourage countries to abandon economic prudence and rely on bailouts by international donors.

Financial Crisis of 2008

– A decade after the Asian crisis, another financial crisis hit the world economy in 2008.

The crisis started in 2007, Over many years of low interest rates, lax bank lending practices and inadequate regulation by governments, a speculative bubble had been building up in the real estate sector which finally burst in 2007.

– The risks to the global financial system became apparent in 2008 when Lehman Brothers, one of the world’s largest investment banks and heavily exposed to the subprime mortgage crisis, went bankrupt.

– The US government refused to bail out Lehman Brothers, but as panic started to spread in the worldwide market. The government authorized a large rescue package to support banks at risk and to inject a fiscal stimulus into the ailing US economy.

– By this time, the global dimensions of the crisis were all too visible, with ever more governments in the industrialized world stepping in to support the banking system and economic activity more generally.

– The global financial crisis signaled a wider malaise of global capitalism, indeed a fundamental crisis of capitalism as Marx and neo-Marxists had long predicted.

Cause of crisis– The main reason behind the events of 2007–08 was a weak regulatory system for

the banking system, which failed to detect the build-up of a speculative bubble in the housing market and allowed banks to take overly large risks that posed a wider systemic threat to the stability of the financial system.

– Confidence in the functioning of the market system was severely shaken, and governments around the world were called upon to step in and rescue the banking system. In the immediate aftermath of the crisis, the political pendulum seems to have swung back in favor of governments that came to the rescue of the global economy.

– However, the large-scale spending programmes combined with a fall in tax revenue due to the global recession has forced governments to cut back expenditure again in an effort to balance budgets and avoid a further loss of confidence in global financial markets. It is thus too early to tell how the global financial crisis will affect the role of the state in the global economy.

– Confidence in the functioning of the market system was severely shaken, and governments around the world were called upon to step in and rescue the banking system. In the immediate aftermath of the crisis, the political pendulum seems to have swung back in favor of governments that came to the rescue of the global economy.

– However, the large-scale spending programmes combined with a fall in tax revenue due to the global recession has forced governments to cut back expenditure again in an effort to balance budgets and avoid a further loss of confidence in global financial markets. It is thus too early to tell how the global financial crisis will affect the role of the state in the global economy.

Thank you