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Monetary standard is the material representation or the value behind the money in
a monetary system, used for the definition of monetary unit.
In the 20th century, both silver and gold lost their former importance within
monetary systems, and monometallic system was abandoned by all nations.
It was set up in 1976 at the Conference in Kingston (Jamaica), when the gold lost
its role of monetary standard:
Under this system, the currency of the country is made of paper.
Generally, the currency system is managed by the CB of the country.
Today, almost all countries in the world have managed currency standard systems.
The paper currency standard system is a fiat system:
does not allow free convertibility of the currency into a metallic standard;
money is given value by government fiat (is intrinsically useless)
The value of the money is set by the supply and demand for money and by the
supply and demand for other goods and services in the country.
The value of the money depends on its purchasing power.
Advantages of paper currency system
Special Drawing Rights (SDR) parity – par values are expressed in SDRs.
3) Exchange rate
Exchange rate
It represents the price of one currency expressed in other currency (how much
one currency is worth in terms of the other).
Exchange rate quotation is stating the number of units of “term currency” (“price
currency”) that can be bought in terms of 1 “unit currency” (“base currency”).
Example: in a quotation that says the EUR/USD is 1.3 (1.3 USD per EUR),
the term currency is USD and the base currency is EUR.
There are two kinds of quotations:
Direct quotation – uses country’s home currency as the term currency:
1 foreign currency unit = x home currency units: in Bucharest, quotations
are: 1 USD = 4.2866 RON or 1 EUR = 4.5634 RON)
Indirect quotation – uses country’s home currency as the unit currency:
1 home currency unit = x foreign currency units: in London, quotations are:
1 GBP = 1.238950 USD, or 1 GBP = 1.172074 EUR)
Majority of countries use direct quotation.
Indirect quotations is specifically for the Anglo-Saxon countries (Great Britain,
Australia, New Zeeland) and the eurozone.
Types of exchange rates (I)
Depending on how exchange rates are set:
Official exchange rate – is set by the monetary authority; it can be:
a fixed exchange rate – is set by taking into account the par values of
currencies;
a free-floating exchange rate – is allowed to vary against that of other
currencies and is determined by the market forces of demand and supply.
a pegged exchange rate – is a fixed exchange rate but with a provision for the
devaluation of currency (with a fluctuation band).
Market exchange rate – is the price recorded on market depending on the demand
and supply.
Depending on the economic implications:
Single exchange rates – are applied by the developed countries for all
international transactions.
Multiple exchange rates – are used by the developing countries for diverse
transactions in order to favor or to discourage some transactions.
Types of exchange rates (II)
Depending on the bank’s position:
Selling exchange rate
Buying exchange rate
Direct quotation: banks buy foreign currency cheaply and sell it expensively
(in Bucharest, the selling exchange rate for EUR is 1 EUR = 4.5830 RON,
and the buying exchange rate is 1 EUR = 4.4830 RON).
Indirect quotation: the buying exchange rate of foreign currency results from
the selling exchange rate of domestic currency (in London, the selling
exchange rate for USD is 1 GBP = 1.237850 USD, and the buying exchange
rate is 1 GDP = 1.239250 USD).
Depending on the settlement date of transaction:
Spot exchange rate – refers to the current exchange rate.
Forward exchange rate – refers to an exchange rate that is quoted and traded
today for delivery and payment on a specific future date.
Types of exchange rates (III)
Depending on the influence of inflation rate:
Nominal exchange rate (e) – is the price in domestic currency of one unit of a
foreign currency.
Real exchange rate – is defined as RER = e*(Pf/Pd), where Pf is the foreign
price level and Pd is the domestic price level:
RER is nominal exchange rate multiplied by the price level ratio of the two
countries: the nominal exchange rate adjusted to inflation.
Example: if the price level in the US is higher than the price level in India,
then the real exchange rate of the rupee versus the dollar will be greater than
the nominal exchange rate.
RER describes how many of a good or service in one country can be traded for
one of that good or service in another country:
Example: a real exchange rate might state how many European bottles of
wine can be exchanged for one US bottle of wine.
Types of money (I)
During the time many types of money have circulated.
They can be classified according to some criteria.
Depending of the form of existence:
Cash money: banknotes and metallic money
Deposit money (bank money, scriptural money) – money placed into a
banking institution for safekeeping.
Depending on the intrinsic value:
Money with intrinsic value – its value is given by the content of precious
metal.
Fiduciary money – has fiat value lower than their intrinsic value.
Depending on the obligations assumed by the issuing institution:
Convertible money – is money convertible in precious metal (in the past) or
in other currency (in the present).
Nonconvertible money – circulates only in the domestic territory.
Types of money (II)
Depending on the ability to pay (payment capacity):
Legal money – is national money which can be used for payment in all
amounts, no matter how large they are.
Fractional money – is divisionary money, which can be used only for
payment in small amounts.
Depending on the issuing institution:
Money created by the public – it existed in the gold standard.
Money created by the government – refers to government securities issued
by government, especially in some critical periods (wars), in order to
finance its own increased expenditures and often imposed by law to be
used as money (to be legal tender).
Money created by banks: banknotes issued by central bank and scriptural
money created by commercial banks.
Money convertibility (I)
Convertibility represents the ability to exchange money for some other kind of
value (gold or other currencies):
Under the gold standard, banknotes were payable in gold coins.
Under the silver standard, banknotes were payable in silver coins.
Under the bimetallic standard, banknotes were payable in either gold or
silver coins at the option of the debtor (issuing bank).
Under the gold exchange standard, issuing banks were obliged to redeem
their currencies in gold bullion or in US Dollars, which in turn were
redeemable in gold bullion at the rate of $35/ounce.
The US abandoned the gold standard, and thus bullion convertibility, in
1971.
In a broad sense, convertibility represents the legal feature of a currency to be
freely exchanged on market in other currencies without restrictions regarding the
purpose, the solicitant, and the amount required for exchange.
Money convertibility (II)
The IMF statute groups the member countries’ currencies in:
Convertible currencies (Article VIII): Each member shall buy balances of its currency
held by another member if the latter, in requesting the purchase, shows that:
the balances to be bought have been recently acquired as a result of current
transactions; or
their conversion is needed for making payments for current transactions.
The buying member shall have the option to pay either in special drawing rights
(SDR), or in the currency of the member making the request.
Inconvertible currencies (Article XIV): currencies of the countries which maintain
restrictions on payments and transfers for current international transactions.
Freely usable currencies (Article XXX): a member’s currency that:
1) is widely used to make payments for international transactions, and 2) is widely
traded on the principal exchange markets:
U.S. dollar, euro, Japanese yen pound sterling and Chinese renminbi.
Types of convertibility
Depending on the types of operations allowed for convertibility:
Current account convertibility – refers to current transactions.
Capital account convertibility – refers to capital flows.
Depending on the solicitant:
Internal convertibility – only residents are accepted.
External convertibility – both residents and nonresidents are accepted.
Depending on the amount of exchange:
Limited convertibility – limited amount
Unlimited convertibility – any amount
Depending on the type of exchange rate used:
Official convertibility – is based on the fixed exchange rate.
Market convertibility – is based on the float exchange rate.
Convertibility in Romania