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World Financial Architecture

World Financial Architecture

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Published by Sukumar Nandi

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Published by: Sukumar Nandi on Mar 29, 2008
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World Financial Architecture and AlternativeMonetary RegimesSukumar NandiIndian Institute of Management Lucknow
"Money, I consider is a device which facilitates the working of markets." 
[ Sir John Hicks ,1989, p. 2.]"
 As science joins with technology to reduce man's ignorance and appeasehis wants at appalling speed, human institutions lag behind, the victim of memory, convention and obsolete education in man's life cycle. We see theconsequence of this lag …. At the nerve center of national sovereignties:international economic arrangements".
[ Robert Mundell, 1968 ]
The world has seen a number of financial systems depending on the level of integration of the world economy and the level of technology. Recent history hasdocumented the gold standard, gold exchange standard, dollar standard and the recentflexible exchange rate system. Each system evolved depending on the need of the timeand the will of the leading nations of the world who were able to carry the 'burden' of the world currency. But the major characteristics of the financial system determine thedynamics of the money supply of the countries who are the partners of trade and thecommon world system. We need to know about the different financial system that prevailed in the world to understand the evolution of world money. A better understanding of the world monetary system would help understand how the domesticmoney supply in member countries was affected by the change in the world financial
system. Though we are aware today that the domestic financial system can not be fullyinsulated from the global phenomenon, the situation in the immediate post-war periodwas not much different in the Group-of-ten countries
The level of economic integrationamong these countries made them inter-dependent.Sometimes a distinction is drawn between a monetary system and a monetaryorder and as Professor Robert Mundell put it :"A system is an aggregation of diverse entities united by regular interactionaccording to some forms of control. When we speak of international monetary system weare concerned with the mechanisms governing the interactions between trading nations,and in particular the money and credit instruments of national communities in foreignexchange, capital, and commodity markets. The control is exerted through policies at thenational level interacting with one another in that loose form of supervision that we callco-operation.An order , as distinct from a system , represents a framework and setting in whichthe system operates. It is a framework of laws, conventions, regulations, and mores thatestablish the setting of the system and the understanding of the environment by the participants in it. A monetary order is to a monetary system somewhat like a constitutionis to a political or electoral system. We can think of the monetary system as the modusoperandi of the monetary order." [ Mundell, 1972, p.92.].The distinction Professor Mundell makes between a monetary system and a monetaryorder is important in the sense that the chronological order that is followed here willfacilitate the understanding of the working of the world financial architecture and itsimpact on the domestic monetary policies of the member countries.
The classical gold standard emerged as a true international standard by 1880when majority of independent countries agreed to switch from bimetallism, silver monometallism and paper to the gold as the basis of their currencies. The key rule
1.The group of ten were Belgium, Canada, France, West Germany, Italy, Japan ,Netherlands, Sweden,United Kingdom and the United States.
was maintenance of gold convertibility at the established par. When the countriesadhered to the fixed price of gold vis-a vis their currencies and maintained it, itamounted to a fixed exchange rate. According to recent evidence, the exchange ratesthroughout the period 1880- 1914 were characterized by high degree of fixity of themain countries, and violations of gold-parity points and devaluation was rare. Thestability in the price of gold and the ease of the supply of gold compared to worlddemand did facilitate this situation. The period was an ideal example of classical full-employment equilibrium situation in the industrial world with real income changing verylittle and so the increase in the demand for monetary gold was small enough to be met byavailable production and supply.According to established literature, a time- consistent credible commitmentmechanism is necessary for an international monetary arrangement to be effectiveamong the countries. The adherence to the gold convertibility rule provided such amechanism. Also, apart from the reputation of the domestic gold standard and theconstitutional provisions regarding the same, some other mechanism like improvedaccess to international capital market, the operation of the rules of the game, and thehegemonic power of England might have enforced the countries to adhere to theinternational gold standard rules.The main countries at the time realized that gold standard did provide theimproved access to the international capital markets and for this the support for theregime increased. Also countries believed that gold convertibility would be a signal tocreditors of sound government finance. Again this had been the case for both developingand developed countries seeking access to long- term capital, such as Austria-Hungaryand Latin America. Also Japan used short -term loans to finance Russo-Japanese war during 1905-06. The example of England being on the gold standard was an addedattraction for other countries to be on the same standard. In fact England had been thecenter of the world monetary system because of her economic might and politicalinfluence .The fixed relation of British pound with gold assured the countries to stick tothe gold standard.

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