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p e International
Monetary System |
 
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C apter Objective:

p is c apter serves to introduce t e student to t e

institutional framework wit in w ic :
‡International payments are made.
‡p e movement of capital is accommodated.
EUN / RESNICK
‡Exc ange rates are determined.
Second Edition
 C apter pwo Outline

[ Evolution of t e International Monetary System

[ Current Exc ange Rate Arrangements
[ European Monetary System
[ Euro and t e European Monetary Union
[ p e Mexican Peso Crisis
[ p e Asian Currency Crisis
[ Fixed versus Flexible Exc ange Rate Regimes

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 Evolution of t e
International Monetary System
[ ‰imetallism: ‰efore 1875
[ Classical Gold Standard: 1875-1914
[ Interwar Period: 1915-1944
[ ‰retton Woods System: 1945-1972
[ p e Flexible Exc ange Rate Regime: 1973-
Present

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 ‰imetallism: ‰efore 1875
[ A ³double standard´ in t e sense t at bot gold
and silver were used as money.
[ Some countries were on t e gold standard, some
on t e silver standard, some on bot .
[ ‰ot gold and silver were used as international
means of payment and t e exc ange rates among
currencies were determined by eit er t eir gold or
silver contents.
[ 
 implied t at it would be t e least
valuable metal t at would tend to circulate.
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 Classical Gold Standard:
1875-1914
[ uring t is period in most major countries:
Gold alone was assured of unrestricted coinage
p ere was two-way convertibility between gold and
national currencies at a stable ratio.
Gold could be freely exported or imported.
[ p e exc ange rate between two country¶s
currencies would be determined by t eir relative
gold contents.

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 Classical Gold Standard:
1875-1914
For example, if t e dollar is pegged to gold at
U.S.$30 = 1 ounce of gold, and t e ‰ritis pound
is pegged to gold at £6 = 1 ounce of gold, it must
be t e case t at t e exc ange rate is determined
by t e relative gold contents:

$30 = £6
$5 = £1

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 Classical Gold Standard:
1875-1914
[ Ñig ly stable exc ange rates under t e classical
gold standard provided an environment t at was
conducive to international trade and investment.
[ Misalignment of exc ange rates and international
imbalances of payment were automatically
corrected by t e 




  



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 Classical Gold Standard:
1875-1914
[ p ere are s ortcomings:
p e supply of newly minted gold is so restricted t at
t e growt of world trade and investment can be
ampered for t e lack of sufficient monetary reserves.
Even if t e world returned to a gold standard, any
national government could abandon t e standard.

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 Interwar Period: 1915-1944
[ Exc ange rates fluctuated as countries widely
used ³predatory´ depreciations of t eir currencies
as a means of gaining advantage in t e world
export market.
[ Attempts were made to restore t e gold standard,
but participants lacked t e political will to
³follow t e rules of t e game´.
[ p e result for international trade and investment
was profoundly detrimental.
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 ‰retton Woods System:
1945-1972
[ Named for a 1944 meeting of 44 nations at
‰retton Woods, New Ñamps ire.
[ p e purpose was to design a postwar international
monetary system.
[ p e goal was exc ange rate stability wit out t e
gold standard.
[ p e result was t e creation of t e IMF and t e
World ‰ank.

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 ‰retton Woods System:
1945-1972
[ Under t e ‰retton Woods system, t e U.S. dollar
was pegged to gold at $35 per ounce and ot er
currencies were pegged to t e U.S. dollar.
[ Eac country was responsible for maintaining its
exc ange rate wit in ±1% of t e adopted par
value by buying or selling foreign reserves as
necessary.
[ p e ‰retton Woods system was a dollar-based
gold exc ange standard.
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 p e Flexible Exc ange Rate Regime:
1973-Present.
[ Flexible exc ange rates were declared acceptable
to t e IMF members.
Central banks were allowed to intervene in t e
exc ange rate markets to iron out unwarranted
volatilities.
[ Gold was abandoned as an international reserve
asset.
[ Non-oil-exporting countries and less-developed
countries were given greater access to IMF funds.
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 Current Exc ange Rate Arrangements
[ Free Float
p e largest number of countries, about 48, allow market forces to
determine t eir currency¶s value.
[ Managed Float
About 25 countries combine government intervention wit market
forces to set exc ange rates.
[ Pegged to anot er currency
Suc as t e U.S. dollar or euro (t roug franc or mark).
[ No national currency
Some countries do not bot er printing t eir own, t ey just use t e
U.S. dollar. For example, Ecuador as recently dollarized.

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 European Monetary System
[ Eleven European countries maintain exc ange
rates among t eir currencies wit in narrow bands,
and jointly float against outside currencies.
[ Objectives:
po establis a zone of monetary stability in Europe.
po coordinate exc ange rate policies vis-à-vis non-
European currencies.
po pave t e way for t e European Monetary Union.

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 p e Euro
[ W at is t e euro?
[ W en will t e new European currency become a
reality?
[ W at value do various national currencies ave in
euro?

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 W at Is t e Euro?
[ p e euro is t e single currency of t e European
Monetary Union w ic was adopted by 11
Member States on 1 January 1999.
[ p ese member states are: ‰elgium, Germany,
Spain, France, Ireland, Italy, Luxemburg,
Finland, Austria, Portugal and t e Net erlands.

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 EURO CONVERSION RApES
 
   
  ‰elgian franc
  German mark
  Spanis peseta
  Frenc franc
 | Iris punt
 |
 Italian lira
  Luxembourg franc
 
utc gilder
 
 Austrian sc illing
 
 Portuguese escudo
 | Finnis markka

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 W at is t e subdivision of t e euro?
[ uring t e transitional period up to 31 ecember
2001, t e national currencies of t e member states
(Lira, eutsc e Mark, Peseta, Franc. . . ) will be
"non-decimal" subdivisions of t e euro.
[ p e euro itself is divided into 100 cents.

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 W at is t e official sign of t e euro?
[ p e sign for t e new single currency looks like an
³E´ wit two clearly marked, orizontal parallel
lines across it.

It was inspired by t e Greek letter epsilon, in reference to t e

cradle of European civilization and to t e first letter of t e
word 'Europe'.

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 W at are t e different denominations
of t e euro notes and coins ?
[ p ere will be 7 euro notes and 8 euro coins.
[ p e notes will be: 500, 200, 100, 50, 20, 10, and
5 euro.
[ p e coins will be: 2 euro, 1 euro, 50 euro cent, 20
euro cent, 10, euro cent, 5 euro cent, 2 euro cent,
and 1 euro cent.

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 Ñow will t e euro affect contracts
denominated in national currency?
[ All insurance and ot er legal contracts will continue in
force wit t e substitution of amounts denominated in
national currencies wit t eir equivalents in euro.
[ Euro values will be calculated according to t e fixed
conversion rates wit t e national currency unit adopted
on 1 January 1999.
[ Generally, t e conversion to t e euro will take place on 1
January 2002, unless bot parties to t e contract agree to
do so before and.

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 p e Mexican Peso Crisis
[ On 20 ecember, 1994, t e Mexican government
announced a plan to devalue t e peso against t e
dollar by 14 percent.
[ p is decision c anged currency trader¶s
expectations about t e future value of t e peso.
[ p ey stampeded for t e exits.
[ In t eir rus to get out t e peso fell by as muc as
40 percent.

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 p e Mexican Peso Crisis
[ p e Mexican Peso crisis is unique in t at it
represents t e first serious international financial
crisis touc ed off by cross-border flig t of
portfolio capital.
[ pwo lessons emerge:
It is essential to ave a multinational safety net in place
to safeguard t e world financial system from suc
crises.
An influx of foreign capital can lead to an overvaluation
in t e first place.
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 p e Asian Currency Crisis
[ p e Asian currency crisis turned out to be far
more serious t an t e Mexican peso crisis in
terms of t e extent of t e contagion and t e
severity of t e resultant economic and social
costs.
[ Many firms wit foreign currency bonds were
forced into bankruptcy.
[ p e region experienced a deep, widespread
recession.
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 Currency Crisis Explanations
[ In t eory, a currency¶s value mirrors t e fundamental
strengt of its underlying economy, relative to ot er
economies. |
 .
[ |
  , currency trader¶s expectations play a
muc more important role.
[ In today¶s environment, traders and lenders, using t e
most modern communications, act by fig t-or-flig t
instincts. For example, if t ey expect ot ers are about to
sell ‰razilian
 for U.S. dollars, t ey want to ³get to
t e exits first´.
[ p us, fears of depreciation become self-fulfilling
prop ecies.
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 Fixed versus Flexible
Exc ange Rate Regimes
[ Arguments in favor of flexible exc ange rates:
Easier external adjustments.
National policy autonomy.
[ Arguments against flexible exc ange rates:
Exc ange rate uncertainty may amper international
trade.
No safeguards to prevent crises.

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 End C apter pwo

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