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INTERNATIONAL MONETARY SYSTEM
Prepared by Vipul S. Sutar
(IMCOST)
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International Monetary System - Vipul Sutar
INTRODUCTION
International Monetary System-
Complex system of international arrangements,
rules, institutions, policies in regard to ex-rates,
international payments, capital flows.
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International Monetary System - Vipul Sutar
HISTORY OF THE IMS
BIMETALLISM(pre-1875)
CLASSICAL GOLD STANDARD (1875-WWI)
INTERWAR PERIOD: (1915-1944 )
BRETTON WOODS SYSTEM: (1945-1972 )
FLEXIBLE EXCHANGE RATES: (1973-
PRESENT)
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International Monetary System - Vipul Sutar
BIMETALLISM(pre-1875)
Commodity money system using both silver and gold
(precious metals) for international payments (and for
domestic currency).
Eg. gold standard (British pound) or the silverstandard (German DM) and some on a bimetallic
(French franc). Pound/Franc ex-rate was determined
by the gold content of the two currencies. Franc/DM
was determined by the silver content of the twocurrencies. Pound (gold) / DM (silver) rate was
determined by their ex-rates against the Franc.
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Under a bimetallic standard the silver/gold ratio was
fixed at a legal rate. When the market rate for
silver/gold differed substantially from the legal rate,
one metal would be overvalued and one would beundervalued.
Eg. from 1837-1860 the legal silver/gold ratio was
16/1 and the market ratio was 15.5/1.
Gold was overvalued at the legal rate, silver was
undervalued.
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International Monetary System - Vipul Sutar
CLASSICAL GOLD STANDARD
(1875-WWI)
Gold Standard exists when most countries:
1. Use gold coins as the primary medium of exchange
2. Have a fixed ex-rate between ounce of gold and
currency
3. Allow unrestricted gold flows - gold can be
exported or imported freely.
4. Banknotes had to be backed with gold to assurefull convertibility to gold.
5. Domestic money stock had to rise and fall with
gold flows.
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Under a gold standard, ex-rates would be kept in line
by cross-country gold flows.
Example: suppose that the UK Pound is pegged to
gold at: 6 Pound/oz., and the franc is pegged at 12FF/oz, then the official ex-rate should be 2FF/Pound.
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Advantages of Gold Standard:
1. Ultimate hedge against inflation. Because of its fixed
supply, gold standard creates price level stability,
eliminates abuse by central bank/hyperinflation.
2. Automatic adjustment in Balance of payments due toprice-specie-flow mechanism.
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Disadvantages of Gold Standard:
1. Possible deflationary pressure. With a fixed supply of
gold (fixed money supply), output growth would lead
to deflation.
2. An international gold standard has no commitmentmechanism, or enforcement mechanism, to keep
countries on the gold standard if they decide to
abandon gold.
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INTERWAR PERIOD: 1915-1944
When WWI started, countries abandoned the gold
standard, suspended redemption of banknotes for
gold, and imposed ban on gold exports
Hyperinflation
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BRETTON WOODS SYSTEM: 1945-
1972
At the end of WWII, 44 countries nations met at
Bretton Woods, N.H. to develop a postwar IMS.
IMS established by Bretton Woods was a dollar-
based, gold-exchange standard of fixed exchangerates. The US dollar was pegged to gold at a fixed
price of $35/ounce, and then each currency had a
fixed ex-rate with the $.
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Advantages of Gold-Exchange
System/Bretton Woods in SR:
1. Easier to transfer dollars vs shipping gold overseas
under pure gold standard.
2. By holding $ instead of gold as reserves, foreign
central banks can earn interest vs. non-interestbearing gold.
3. Ex-rate stability reduced currency risk, provided a
stable IMS.
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International Monetary System - Vipul Sutar
BRETTON WOODS SYSTEM: 1945-
1972
In long run, Bretton Woods (gold-exchange system)
was unstable.
There was no way to devalue the $, and other
countries were not willing to revalue their ex-ratesupward.
Bretton Woods started to collapse in 1971
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FLEXIBLE EXCHANGE RATES:
1973-PRESENT
IMF members met in Jamaica in 1976 to agree to a new IMS
including:
a. Flexible ex-rates allowed, central banks could intervene in
currency markets. (Under fixed ex-rates, you lose control over
your monetary policy. Monetary policy must be committed to
maintaining the fixed ex-rate, and cannot be used to pursue
other macroeconomic goals)
b. Gold was abandoned as a reserve asset.
c. Developing countries were to get more assistance from IMF.
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International Monetary System - Vipul Sutar
Advantages of Flexible Ex-Rates:
a. Countries have control over monetary policyb. A true market value is established for currency,
fluctuates daily to reflect market forces of S and D.
c. Flexible ex-rates maintain BP equilibrium.Example: U.S. has trade deficit, M>X, excess dollars in
world currency markets, $ depreciates,
appreciates, US exports will go up, restore tradebalance.
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Disadvantages:
a. More Volatility.
b. Potential abuse by central bank, reckless monetary
expansion.
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European Monetary System
The single currency in Europe. (1 ECU = 1 Euro)
To qualify, countries had to meet certain economic
criteria:
1) Deficits/GDP less than 3%,
2) price level stability - low and stable inflation, etc.
Of the 15 countries in the European Union, three
countries decided not to join (UK, Denmark, andSweden).
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Euro:
1) The 12 countries fixed their ex-rates against each
other and against the Euro and
2) The Euro became a unit of account. For example,
3.35FF/DM. 6.55 FF/Euro. FF and DM will floatagainst the $, and Yen, but will be fixed against
each other and against the Euro.
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International Monetary System - Vipul Sutar
Main Advantages of Euro ():
1. Significant reduction in transaction costs for consumers,
businesses, governments.
European Saying: If you travel through all 15 countries and
exchange money in each country but don't spend it, you end
up with 1/2 of the original amount!
2. Elimination of currency risk, which will save companies
hedging costs
3. Promote corporate restructuring via M&A activity (mergers
and acquisitions), encourage optimal business location
decisions.
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Main Disadvantage of Euro:
Loss of control over domestic monetary policy and
exchange rate determination.
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Thank You