INTERNATIONAL

MONETARY
SYSTEM

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NEED FOR INTERNATIONAL
MONETARY SYSTEM
 A firm with the worldwide transactions in goods, services and finance
need an efficient multilateral financial system for efficient operation.

 A Global monetary and financial organization that facilitate transfer

of funds

 Conversion of national currencies into one another

 Acquisition and Liquidation of financial assets

 International credit creation

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INTERNATIONAL MONETARY
SYSTEM
 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.

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 International monetary system is a set of internationally agreed
rules, conventions and supporting institutions, that facilitate
international trade, cross border investment and allocation of
capital between nation states.

 International monetary system refers to the system prevailing

in world’s foreign exchange markets through which
international trade and capital movement are financed and
exchange rates are determined.

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STAGES OF EVOLUTION OF
INTERNATIONAL MONETARY SYSTEM
 Gold Standard (1875 – 1914)

 Interwar Period (1914 – 1944)

 Bretton Woods System (1944 – 1971)

 Present International Monetary System (1971 onwards)

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CLASSIC GOLD STANDARDS
 This is the oldest system which was in operation till the beginning of the
first world war.

 In this system, the central bank of the country, standing ready to convert on
demand, unlimited amounts of paper currency into gold and vice versa, at a
fixed conversion ratio.

 Thus, a pound sterling note can be exchanged for x ounce of gold and while
a dollar note can be converted into y ounce of gold on demand.

 June 1816, Great Britain declared the gold currency as official national
currency. On 1st May 1821 the convertibility of Pound Sterling into gold6
was legally guaranteed.
 Other countries pegged their currencies to the British Pound, which made
it a reserve currency. This happened while the British dominated
international finance and trade relations.

 At the end of the 19th century, the Pound was used for two thirds of world
trade and most foreign exchange reserves were held in this currency.

 From the 1870s to the outbreak of World War I in 1914, the world
benefited from a well integrated financial order, sometimes known as the
First age of Globalization. Money unions were operating which
effectively allowed members to accept each others currency as legal
tender.

 In the absence of shared membership of union, transactions were

facilitated by widespread participation in the gold standard, by both
independent nations and their colonies. 7
ARGUMENTS IN FAVOR OF A GOLD
STANDARD
 Price Stability:
 By tying the money supply to the supply of gold, central banks were
unable to expand the money supply.

 Facilitates BOP adjustment automatically

 The basic idea is that a country that runs a current account deficit
needs to export money (gold) to the countries that run a surplus.
 The surplus of gold reduces the deficit country’s money supply and
increases the surplus country’s money supply.

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ARGUMENTS AGAINST GOLD
STANDARD
 The growth of output and the growth of gold supplies needs to be closely
linked. For example, if the supply of gold increased faster than the supply
of goods then there would be inflationary pressure. Conversely, if output
increased faster than supply of gold then there would be deflationary
pressure.

 Volatility in the supply of gold could cause adverse shocks to the economy,
rapid changes in the supply of gold would cause rapid changes in the
supply of money and cause wild fluctuations in prices that could prove
quite disruptive

  In practice monetary authorities may not be forced to strictly tie their9
hands in limiting the creation of money.
INTERWAR PERIOD
 The years between the world wars have been described as a
period of de-globalization, as both international trade and
capital flows shrank compared to the period before World War
I.

 During World War I countries had abandoned the gold

standard and, except for the United States.

 The onset of the World Wars saw the end of the gold standard
as countries, other than the U.S., stopped making their
currencies convertible and started printing money to pay for
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war related expenses.
 After the war, with high rates of inflation and a large stock of
outstanding money, a return to the old gold standard was only
possible through a deep recession inducing monetary
contraction as practiced by the British after WW I.

 The focus shifted from external cooperation to internal

reconstruction and events like the Great Depression further
illustrated the breakdown of the international monetary
system, bringing bad policy moves such as a deep monetary
contraction in the face of a recession.

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CONDITIONS PRIOR TO
BRETTON WOODS
SYSTEM
 Prior to WW I major national currencies were on a system of
fixed exchange rates under the international gold standards.
This system had been abandoned during WW I

 There were fluctuating exchange rates from the end of the War
to 1925. But it collapsed with the happening of the Great
Depression.

 Many countries resorted to protectionism and competitive

devaluation. But depression disappeared during WW II
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THE SYSTEM OF
BRETTON WOODS (1944 -
71)
 A conference was held at Bretton Woods in Newhapshire, USA, in
July, 1944 in order to put in place a new international monetary
system.

 The principal architects of the new system, John Maynard Keynes

(UK) and Harry Dexter White (US).

 The major objectives of this conference was:

 To review the existing rules
 To devise a system to encourage international monetary co-operation
 To establish an international institution to ensure good functioning of the
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system
CHARACTERISTICS OF INTERNATIONAL
MONETARY SYSTEM DEVELOPED AT BRETTON
WOODS CONFERENCE

 Fixed rate in terms of gold (i.e. a system of gold standard), but only the
US dollar was convertible into gold (The rate initially was $35 an
ounce of gold)

 A procedure for mutual international credits

 Creation of International Monetary Fund (IMF) and International Bank

for Reconstruction and Development (IBRD) also know as World bank
to supervise and ensure smooth functioning of the system.

 Devaluation or Revaluation of more than +/- 5% had to be done with

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the permission of the IMF.
THE DEMISE OF THE BRETTON
WOODS SYSTEM
 In the early post-war period, the U.S. government had to
provide dollar reserves to all countries who wanted to
intervene in their currency markets, that lead to problem of
lack of international liquidity.

 The increasing supply of dollars worldwide, made available

through programs like the Marshall Plan, meant that the
credibility of the gold backing of the dollar was in question.

 U.S. dollars held abroad grew rapidly and this represented a

claim on U.S. gold stocks and cast some doubt on the U.S.’s
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ability to convert dollars into gold upon request.
 Domestic U.S. policies, such as the growing expenditure associated with Vietnam
resulted in more printing of dollars to finance expenditure and forced foreign
governments to run up holdings of dollar reserves.

 Although they pursue this for a while a few countries began to become growingly
less keen on holding dollars and more keen on holding gold.

 In 1971, the U.S. government “closed the gold window” by decree of President
Nixon.

 The world moved from a gold standard to a dollar standard from Bretton Woods to
the Smithsonian Agreement. Growing amount of dollars eroded faith in the system
and the dollars role as a reserve currency.

 By 1973, the world had moved to search for a new financial system: one that no
longer relied on a worldwide system of pegged exchange rates. 16
EXCHANGE RATE REGIMES SINCE 1973:
FLEXIBLE EXCHANGE RATE SYSTEM
 Managed float system

 Free float system

 Crawling Peg system

 Currency Board Arrangement

 Target zone arrangements

 • In this regime, central bank interferes in the foreign exchange market by
buying and selling foreign currencies against home currencies without any
commitment or pronouncement.
Managed float • Also known as dirty floating.
system • India, Russia, Egypt, Singapore

• Here exchange rate is determined by market forces and central bank only
act as a catalyst to prevent excessive supply of foreign exchange and not to
drive it to a particular level.
Free float • Also known as Independent or clean float system
system • USA, UK, Japan, Switzerland, Australia, Canada

• Here currency is pegged to another currency or a basket of currencies but

the peg is adjusted periodically which may be pre-announced or discretion
based or well specified criterion.
Crawling Peg • Iraq, Lebanon, Saudi Arabia, Qatar
system

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 • In this regime, there is a legislative commitment to exchange
domestic currency against a specified currency at a fixed
rate.
Currency Board • Hongkong
Arrangement

• The members of a currency union share a common currency.

Economic and Monetary Unit (EMU) who have adopted
common currency and countries which have adopted
currency of other country.
Target zone
• European Monetary System
arrangements

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EUROPEAN MONETARY SYSTEM
 The treaty was signed at Paris 1951 to establish European Coal and Steel
Community (ECSC) was the first step towards the unification of Europe.

 In 1978, the European council decided to establish a European Monetary

System.

 The primary objective of the EMS is to promote and enhance monetary

stability in European community.

 Its other objectives include working towards the improvement the general
and economic situation of countries of the European union in terms of
Growth, full employment, standard of living, reduction of regional
disparities etc. 20
6 western European nations agreed to maintain the parity
values within a band of +/-1.125%. This system was known as
snake.

“Snake in the tunnel” was replaced by EMS in 1979

ECU was established in 1979

The EMS was based on parity grid. The parity grid experienced
a serious damage.

September 1993 the band for fluctuation was widened to +/-15%

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 European union members met at Maastricht and signed the
Maastricht treaty in 1992

 Member countries agreed to replace their individual currencies

by a common currency by January 1, 1999

 The European Central Bank (ECB) was establish in 1998 and it

works in conjunction with the national central banks to achieve
price stability.

 In January 2002 the Euro notes and coins were issued and by
the end of February 2002 local currencies were completely
replaced by Euros. 22
INTERNATIONAL MONETARY
FUND
 The IMF had 44 countries as its members in 1944 at the
time of Bretton woods conference.

 The International Monetary Fund (IMF) is an organization

of 190 countries, working to foster global monetary
cooperation, secure financial stability, facilitate international
trade, promote high employment and sustainable economic
growth, and reduce poverty around the world.

 Created in 1944, the IMF is governed by and accountable to

the 190 countries that make up its near-global membership. 23
OBJECTIVES OF THE IMF
 To avoid competitive devaluation and exchange control.

 Establish and maintain currency convertibility with

stable exchange rates.

 Develop multilateral trade and payments

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ORGANIZATIONAL STRUCTURE
 The IMF, organizational structure is set out in its Articles
of Agreement, which entered into force in December
1945.

 The articles provide for a Board of Governors, an

Executive Board, a Managing Director and a staff of
International civil servants.

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RESOURCES OF IMF
 The capital of the IMF is constituted by the totality of the
subscription of member states, known as quotas.

 Most resources for IMF loans are provided by member countries,

primarily through their payment of quotas.

 Quota subscriptions are a central component of the IMF’s financial

resources. Each member country of the IMF is assigned a quota,
based broadly on its relative position in the world economy.

 These quotas are determined as per the economic importance of

each country reflected/measured in terms of national income,
exports etc.
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SPECIAL DRAWING RIGHTS
 Payment method: 25% Special Drawing Rights and 75% in own currency.

 The SDR serves as the unit of account of the IMF and some other international
organizations. The SDR is an international reserve asset, created by the IMF in
1969 to supplement its member countries’ official reserves.

 After the collapse of the Bretton Woods system, the SDR was redefined as a basket
of currencies.

 Currency Weights determined in the October 1, 2016.

U.S. dollar 0.58252

Euro 0.38671
Chinese yuan 1.0174
Japanese yen 11.900 27
Pound sterling 0.085946
FUNCTIONS OF IMF
 Surveillance
Gathering data and assessing economic policies of countries

 Technical Assistance and training

Strengthening human skills and institutional capacity of countries

 Financial Assistance
Lending to countries to support reforms

 IMF has four credit lending lines:

 Flexible Credit lines (FCL)
 Precautionary lending lines (PLL)
 Standby Arrangements 28
 Extended Fund Facility
WORLD BANK
 The World Bank is an international financial institution that provides loans to
developing countries for capital programs.

 The World Bank's official goal is the reduction of poverty.

 The World Bank is a lending institution that funds essential infrastructural

requirement, globally.

 The World Bank differs from the World Bank Group, in that the World Bank
comprises only two institutions: the International Bank for Reconstruction and
Development (IBRD) and the International Development Association (IDA) 29
FUNCTIONS
 The Bank Group uses financial resources and extensive
experience to help poor nations reduce poverty, increase
economic growth, and improve the quality of life.

 World Bank provides technical and financial assistance to

underdeveloped nations for development schemes like
building roads, schools, hospitals, etc. The main aim is to
eliminate poverty from the world

 Current global challenges include the financial crisis, high

food prices, and climate change.
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WORKING GROUPS
OF WORLD BANK

 International Bank for Reconstruction and Development (IBRD):

 It lends to governments of middle-income and creditworthy low-
income countries

 International Development Association (IDA):

 It provides interest-free loans called credits and grants to
governments of the poorest countries.

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 International Finance Corporation (IFC):
 It provides loans, equity and technical assistance to stimulate
private sector investment in developing countries

 Multilateral Investment Guarantee Agency (MIGA):

 It provides guarantees against losses caused by non-commercial
risks to investors in developing countries

 International Centre for Settlement of Investment Disputes

(ICSID):
 It provides international facilities for conciliation and arbitration
of investment disputes.

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