International monetary systems

From Wikipedia, the free encyclopedia Jump to: navigation, search For the exchange and bartering company, see International Monetary Systems Ltd. International monetary systems are sets of internationally agreed rules, conventions and supporting institutions that facilitate international trade, cross border investment and generally the reallocation of capital between nation states. They provide means of payment acceptable between buyers and sellers of different nationality, including deferred payment. To operate successfully, they need to inspire confidence, to provide sufficient liquidity for fluctuating levels of trade and to provide means by which global imbalances can be corrected. The systems can grow organically as the collective result of numerous individual agreements between international economic actors spread over several decades. Alternatively, they can arise from a single architectural vision as happened at Bretton Woods in 1944.

What is international liquidity?

It used to be that the term international liquidity meant the relative amount of resources available to a nations monetary authorities that could be used to settle a balance of payments deficit. In the days of the gold standard, this would mean access to gold that could be used to redeem a nations currency held by foreigners. After Bretton Woods and the advent of the dollar-gold exchange standard, liquidity came to mean access to dollars, either held as reserves or as credit lines, or the SDR system maintained by the International Monetary Fund.

Hotel Mount Washington, Bretton Woods, 1944 After 1971, with the abandonment of the dollar-gold exchange standard, as the world entered an era of managed exchange rates, some floating, some pegged, international liquidity came to mean the resources available to national monetary authorities to maintain the value of their currencies as required by their exchange management programs.

The Post World War I Monetary System After the World War I, countries permitted a great deal of exchange rate flexibility. The exchange rate at this period was characterised by instability resulting from external factors and domestic policy actions. However, in the middle of the decade, Britain (the financial centre of the world) attempted to restore the gold standard, adopting the old prewar par value of the pound. That par value greatly overvalued the pound and caused payments difficulties for Britain. With the tremendous decline in economic activity in the 1930's, payment difficulties emerged for many countries. Extensive attempts to restore some fixity in countries' exchange rates soon gave way to a series of competitive depreciations of currencies. Although single-country depreciation alone can stimulate employment and output in that country, when many countries depreciate their currencies in retaliatory fashion, the expected beneficial results are short-listed or do not occur at all. These various actions led to great reductions in the volume and value of international trade. The measures also most likely worsened the Great Depression and the low level of economic activity continued throughout most of the 1930's. The Post World War II Monetary System As World War II was drawing to a close, the historic United Nations Monetary and Financial Conference were held in Bretton Woods, New Hampshire in 1944. From this conference emerged two international institutions that still extremely prominent in the world economy- the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD), now known as the World Bank. The initial focus of the World Bank was to provide long-term loans for the rebuilding of Europe from the devastation of World War II, but since 1950s it has been concerned with providing long-term loans for projects and programs in developing countries, thus our efforts will be channelled to IMF. International Monetary Fund (IMF)

The IMF was the key institution in the functioning of Post World War II international monetary system known as the Bretton Woods System. In this context, the IMF had several objectives which include: 1. to seek stability in exchange rates; 2. to reconcile imbalance in balance of payments with national autonomy in macroeconomic policy; 3. to help preserve relatively free trade and payments in the world economy. To seek stability in exchange rates, the IMF called for a system of "pegged but adjustable exchange rates". This simply means that dollar as a "linchpin" which was defined by the United States as having the value of 1/35 of an ounce of gold will be used to define other currencies' values. By this, parity values were established by agreement, but variations of 1 percent above and below parity were permitted.These limits were to be maintained by central banks, which would buy dollar if the price fell to -1 percent and sell it if the price rise to the +1 percent ceiling. Also, the word "adjustment" in the phrase refers to the fact that if a country is experiencing prolonged BOP deficits or surplus at the pegged exchange rate, an IMF approved devaluation or upward revaluation of the currency's parity value could be undertaken. Also, IMF was to reconcile balance of payment deficits with national autonomy in macroeconomic policy through the use of loans to deficit countries. The rational behind these short-term loans (three to five years) was that a country's BOP deficit might be temporary because of the stage of the business cycle in which the country was located. If a loan could provide finance to the borrower until the payments imbalance reversed itself, then there would be no need for alteration of the deficit. In addition, an IMF loan might reduce the likelihood that the deficit country would impose tariffs and other restrictive measures on imports in order to conserve its foreign exchange reserve. Along the same line, fewer exchange controls on capital movement might be introduced. Hence, the availability of IMF loans not only could serve the purpose of giving more autonomy to domestic macro policy instruments but also contributed to a third objective of the IMF to help preserve relatively free trade and payment in world economy. The Bretton Woods system was at first commended by most economists until mid 1960's. Its success was that it helped Europe and Japan to recover from the World War II devastation and growth in world economy occured with no major setbacks or recessions. Despite this seeming success, some important problems emerged in the system. These problems can be broadly classified into three, namely 1. Liquidity Problem 2. Confidence Problem 3. Adjustment Problem The liquidity problem comes in as a result of growth in world trade without increase in reserve to finance BOP deficits. The framers of the Bretton Woods agreement envisioned that gold would be the primary international reserve asset, but the supply of gold in the world economy was growing at a rate of only 1 to 1.5 percent per year while trade in the 1960s was growing at a rate close to 7 percent per year. Hence, the fear was that reserves in the form of gold were not

increasing rapidly enough to deal with large BOP deficits. This led to danger of countries using trade and payments restrictions to reduce their deficits and these policies could reduce the gains from trade and the rate of world economic growth. Also, there was confidence problem which can also be related to the liquidity problem. Because the supply of gold held by central banks was growing relatively slowly, the US dollar and British pound which were considered the internationally acceptable currencies were held in largest amount by the central banks. Based on this, there was the fear that if US should attempt to devalue the dollar relatively to gold, then central banks would suffer a reduction in the value of their reserves in terms of gold. This would have brought the Bretton Woods system to a quick termination. The third problem of the Bretton Woods system was the adjustment problem. This had to do with the prolonged BOP deficit or surpluses of individual countries. This was particularly true for the US which ran deficits and West Germany which was on surpluses.There was no effective adjustment system to remove the imbalance. Following the devaluation of pound in1967, one of the official international reserves, from $2.80 to $2.40 per pound, a major development in the international monetary system occurred in 1970 with the introduction of the Special Drawing Rights (SDRs) assets by the IMF. Unlike gold and other international reserve assets, the SDR is a paper asset sometimes called "paper gold". It was defined as equal in value to 1/35 of an ounce of gold and thus equal to one US dollar. The SDR was divided among members of IMF in proportion to the share of their total IMF quotas. Also, the SDRs that a member country receives in an allocation add to international reserves and can be used to settle a BOP deficit in a fashion similar to any other type of international reserve asset. Another important feature of SDRs is that if a country receives a greater amount of SDR, that is to say, more than its allocation by the IMF, it receives interest on its excess holding. Likewise, when it receives lesser than the amount allocation to it, it pays interest on its shortfall. However, although SDR facility, as state Kreinin (1975:167), represented an important advance in the system, it also created a problem. That is to say, as an international reserve asset, there must be every need to make it equally attractive like gold and other convertible currencies. To avoid this problem, E.M. Bernstein proposed that participating countries should place their reserve assets in a single account called the Reserve Settlement Account (RSA) with the IMF. These deposits would be denominated in a Reserve Unit (RU), equal to one US dollar, with a guaranteed gold value. Reserve transactions between any two countries would go through this IMF account and would involve a proportionate use of their different reserve asset. At last, the Bretton Woods system was abandoned because of continuing US BOP deficits, escalating inflation and lagging economic growth, which led to drastic US measures in 1970s. In line with this, the United States announced in foreign central banks. This action amounted to an abandonment of Bretton Woods system, since the willingness of the US to buy and sell gold at $35 per ounce had been the linchpin of that system. In addition, the US temporarily frozen wages and prices (to help in the anti-inflation effort), imposed a temporarily 10 percent tariff surcharge on all imports (to help in reducing the BOP deficit) and instituted a tax credit for new productive investment (to stimulate economic growth), among other actions. From the standpoint of the

exchange rate system, the cessation of the willingness to buy and sell gold was the key policy change because it altered the nature of the existing system. Foreign central banks were faced with the decision of whether to continue buying and selling dollar at the previously established parity values or not. After this action, there was considerable turbulence in the international monetary system which led to the convention of the chief monetary officials of the leading industrial nations in Washington at Smithsonian institution in December 1971 to work out a new set of exchange rate arrangements. This meeting led to the Smithsonian Agreement, which established a new set of per values called "central rate". Countries agreed to permit variations of 2.25 percent on either side of the central rates, thus introducing greater exchange rate flexibility than had been allowed under the +1 percent variations of the Bretton Woods arrangements. Furthermore, the US changed the official price of gold from $35 to $38 per ounce. The Smithsonian Agreement generated optimism for the participating governments but as speculation against the dollar continued, Britain and other six countries of the European community began to float their currencies in 1972. In February 1973, the US dollar was again devalued against gold to $42.22 per ounce. Other currencies began floating either freely or in controlled fashion in 1973. In 1976, another important conference was held in Jamaica resulting to Jamaica Accords which were incorporated into the IMF's Articles of agreement. It recommended free exchange rate arrangement, abolition of official price of gold, enhancement of the SDR, and mandated the IMF to maintain surveillance of exchange rate behaviour. These changes officially went into effect on April 1, 1978. A true significant development in international monetary arrangements began in March 1979 with the inauguration of the European Monetary System (EMS). The first key feature of the EMS of the European community members was the creation of a new monetary unit, the European Currency Unit (ECU), in terms of which central rates for the currencies were defined. The value of the ECU was a weight average of EMS member currencies and the ECU was used as the unit of account for recording transactions among EMS central banks. The second feature of the EMS was that each currency was generally to be kept within 2.25 percent of the central rates against the other participating currencies, and a mechanism was put in place requiring central banks actions as exchange rate approached the limits of divergence permitted from the central rates. Third, the EMS participating currencies were to move as a unit in floating fashion against other currencies, including the US dollar. This set of exchange rates rules is known as the Exchange Rate Mechanism (ERM) of the EMS. Finally, the European Monetary Cooperation Fund (EMCF), a "bankers bank" similar to the IMF was established for receiving deposits of reserves from the EMS members and making loans to members with BOP difficulties. In December 1991, the members of the European Community extended the EMS and took a dramatic step toward future monetary union. The Maastricht Treaty laid out a plan for the establishment of a common currency called the Euro and a European central bank by, at the latest, January 1, 1999. The name "European Community" was later changed to "European Union". vote upvote downsharePrintflag Was this Hub ...?

Useful Funny Awesome Beautiful Interesting

Comments Follow (1) No comments yet. Submit a Comment