International Monetary
Systems

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Development and Evolution of Internati
onal Financial Architecture

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 The use of money goes back to the earliest kind of
exchange and can be traced to settled societies 4000
years ago. But, none of these early uses of money
meant there were monetary economies, far less
international monetary arrangements; monetary
economies are much more recent and date to parts of
medieval Europe. International monetary relations
developed sometime after that, perhaps in the late
medieval and early modern period – 1400–1700.
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 But, there was no international monetary system (some
set of rules more or less formally agreed upon by
participants for effecting international payments) until
sometime after that again. It was really only after the
emergence of the nation state and national monies,
together with the great growth of international trade and
capital flows in the nineteenth century that we can begin
to talk about an international monetary system. It is
therefore common and sensible, when discussing the
international monetary system, to think in terms of the
years after the 1860s.
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 Such a system will have a set of exchange rate arrangements
and perhaps some other institutions that together facilitate the
smooth working of the international payment arrangements. A
good system will allow ready adjustment for balance-of-
payments disequilibria. Different sorts of arrangements of the
kinds implied have emerged at different times. Sometimes,
these have been consciously designed but more often they
have simply appeared as the outcome of the forces at work.
Thus for example, it is obviously a short step from the use of
commodity-based money to the acceptance of more formal
rules and to a metallic standard and then to an international
version.
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 The international monetary system refers to the operating
system of the financial environment, which consists of
financial institutions, multinational corporations, and
investors. The international monetary system provides
the institutional framework for determining the rules and
procedures for international payments, determination of
exchange rates, and movement of capital.
 The major stages of the evolution of the international
monetary system can be categorized into the following
stages.
 The era of bimetallism

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 Before 1870, the international monetary
system consisted of bimetallism, where both gold
and silver coins were used as the international
modes of payment. The exchange rates among
currencies were determined by their gold or silver
contents. Some countries were either on a gold or a
silver standard.
 Gold standard

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 The international gold standard prevailed from 1875
to 1914. In a gold standard system, gold alone is
assured of unrestricted coinage. There was a two-
way convertibility between gold and national
currencies at a stable ratio. No restrictions were in
place for the export and import of gold. The
exchange rate between two currencies was
determined by their gold content.
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 The gold standard ended in 1914 during World War I.
Great Britain, France, Germany, and many other countries
imposed embargoes on gold exports and suspended
redemption of bank notes in gold. The interwar period
was between World War I and World War II (1915-1944).
During this period the United States replaced Britain as
the dominant financial power of the world. The United
States returned to a gold standard in 1919. During the
intermittent period, many countries followed a policy of
sterilization of gold by matching inflows and outflows of
gold with changes in domestic money and credit.
 Gold exchange standard

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 The Bretton Woods System was established after World War II and was in
existence during the period 1945-1972. In 1944, representatives of 44
nations met at Bretton Woods, New Hampshire, and designed a new
postwar international monetary system. This system advocated the
adoption of an exchange standard that included both gold and foreign
exchanges. Under this system, each country established a par value in
relation to the US dollar, which was pegged to gold at $35 per ounce.
Under this system, the reserve currency country would aim to run a
balance of payments (BOPs) deficit to supply reserves. If such deficits
turned out to be very large then the reserve currency itself would witness
crisis. This condition was often coined the Triffin paradox (The Triffin
dilemma or Triffin paradox is the conflict of economic interests that arises
between short-term domestic and long-term international objectives for
countries whose currencies serve as global reserve currencies).
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 Eventually in the early 1970s, the gold exchange standard system collapsed because
of these reasons. From 1950 onward, the United States started facing trade deficit
problems. With development of the euro markets, there was a huge outflow of
dollars. The US government took several dollar defense measures, including the
imposition of the Interest Equalization Tax (IET) (Interest Equalization Tax was a
domestic tax measure implemented by U.S. President John F. Kennedy in July 1963.
It was meant to make it less profitable for U.S. investors to invest abroad by taxing
the purchase of foreign securities) on US purchases of foreign stock to prevent the
outflow of dollars.
 The international monetary fund created a new reserve asset called special drawing
rights (SDRs) (Special drawing rights (SDRs) are supplementary foreign exchange
reserve assets defined and maintained by the International Monetary Fund
(IMF). SDRs are units of account for the IMF, and not a currency per se. They
represent a claim to currency held by IMF member countries for which they may be
exchanged.) to ease the pressure on the dollar, which was the central reserve
currency.
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 Initially, the SDR were modeled to be the weighted average of 16
currencies of such countries whose shares in the world exports were more
than 1%. In 1981, the SDR were restructured to constitute only five major
currencies: the US dollar, German mark, Japanese yen, British pound, and
French franc. The SDR were also being used as a denomination currency
for international transactions. But the dollar-based gold exchange
standard could not be sustained in the context of rising inflation and
monetary expansion. In 1971 the Smithsonian Agreement signed by the
Group of Ten major countries made changes to the gold exchange
standard. The price of gold was raised to $38 per ounce. Other countries
revalued their currency by up to 10%. The band for exchange rate
fluctuation was increased to 2.25% from 1%. But the Smithsonian
agreement also proved to be ineffective and the Bretton Woods System
collapsed.
 Flexible exchange rate regime

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 European and Japanese currencies became free-floating
currencies in 1973. The flexible exchange rate regime
was formally ratified in 1976 by IMF members through
the Jamaica Agreement. The agreement stipulated that
central banks of respective countries could intervene in
the exchange markets to guard against unwarranted
fluctuations. Gold was also officially abandoned as the
international reserve asset. In 1985, the Plaza Accord
envisaged the depreciation of the dollar against most
major currencies to solve US trade deficit problems.
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 In general there are many flexible exchange rate systems. In a free-
floating or independent-floating currency, the exchange rate is
determined by the market, with foreign exchange intervention
occurring only to prevent undue fluctuations. For example,
Australia, the United Kingdom, Japan, and the United States have
free-floating currencies. In a managed-floating system, the central
monetary authority of countries influences the movement of the
exchange rate through active intervention in the forex market with
no preannounced path for the exchange rate. Examples include
China, India, Russia, and Singapore. In a fixed-peg arrangement, the
country pegs its currency at a fixed rate to a major currency or to a
basket of currencies. For example, many GCC countries such as UAE
and Saudi Arabia have pegged their currencies to the US dollar
 The International Monetary Fund

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 The International Monetary Fund (IMF) was
established in 1946 to “promote international
monetary cooperation, exchange stability and
orderly exchange arrangements; to foster economic
growth and high levels of employment; and to
provide temporary financial assistance to countries
to help ease balance of payments adjustment.” It
carries out these functions through loans,
monitoring, and technical assistance.
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 Since 1962, the IMF has provided emergency
assistance to its 188 member countries after they were
struck by natural disasters, and, in a great many cases,
when affected by complex emergencies. The assistance
provided by the IMF is designed to meet the country’s
immediate foreign-exchange financing needs, which
often arise because earnings from exports fall while
the need for imports increases (among other causes).
IMF assistance also helps the affected countries avoid
serious depletion of their external reserves.
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 In 1995, the IMF began to provide this type of emergency assistance to
countries facing post-conflict scenarios in order to enable them to
reestablish macroeconomic stability and to provide a foundation for
recovery, namely in the form of long-term sustainable growth. This
type of assistance is particularly important when a country must cover
costs associated with an “urgent balance of payments need, but is
unable to develop and implement a comprehensive economic program
because its capacity has been damaged by a conflict, but where
sufficient capacity for planning and policy implementation nevertheless
exists” (IMF 2005). The IMF maintains that their support must be part
of a comprehensive international effort to address the aftermath of a
conflict in order to be effective. Its emergency financing is provided to
assist the affected country and to gather support from other sources.
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 It is not uncommon for a country to severely exhaust its
monetary reserves in response to an emergency situation.
In the event of a natural disaster, funding is directed
toward local recovery efforts and any needed economic
adjustments. The IMF lends assistance only if a stable
governing body is in place that has the capacity for
planning and policy implementation and can ensure the
safety of IMF resources. After stability has been
sufficiently restored, increased financial assistance is
offered, which is used to develop the country in its post-
emergency status.
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 When a country requests emergency assistance, it
must submit a detailed plan for economic
reconstruction that will not create trade restrictions
or “intensify exchange.” If the country is already
working under an IMF loan, assistance may be in the
form of a reorganization of the existing arrangement.
It can also request emergency assistance under the
Rapid Financing Instrument (RFI)
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