HOW THE WORLD USES MONEY?

International Monetary System- The stock

markets of today and the way countries
maintain forex has not always been
same. From the early 19th century till World
War I, countries traded with each other using
one important stock.
What is that?
GOLD!
 Under this system, each nation defined
its currency in terms of Gold (eg. $1 was
equal to 1/20 of an ounce of gold while
the British pound was 5/20 of an ounce of
gold)
 Every country was willing to convert its
currency to Gold on demand. Thus those
countries which had high Gold reserves
started prospering. Lot of researchers
started to find ways to produce artificial
gold.
 Goods were traded between countries in
exchange for Gold. If a country imported
goods worth more than those it
imported, then it would have to pay the
remaining in the form of Gold.
 The GOLD standard worked very well till
World War I when most countries
stopped trading in gold due to which
currencies became inconvertible. After
the war, Gold exchange started again till
the great depression (1929- 1933)
 THE BRETTON WOODS SYSTEM
 Since exchange of gold stopped, nations were not able to do easy trade with
each other. Some countries tried to stabilize exchange agreements and funds
but all that failed with the coming of World War II.
 While the war was going on, in 1944, a conference was held in Bretton Woods,
USA in which 44 countries participated and proposed establishing-
IMF- to achieve exchange rate
stability
World Bank- to help in the
post-war reconstruction and
development of member countries
ITO- International Trade
Organization for world trade
(ITO did not work out, later came WTO)
 THE BRETTON WOODS SYSTEM HAD 2
AIMS-
(The maintenance of stable exchange rates and also a credit
mechanism supervised by IMF)
 This system was known as Pegged exchange rate system. Here each member country
was supposed to define the value of its currency in terms of gold or the US dollar or both.
 At the end of WWII, the US had over 74% of world’s monetary gold stock.
 The US promised that all US dollars in the hands of foreign central banks would get gold in
exchange at fixed price of $35 per ounce.
 Because of US financial dominance, almost every country came to accept US dollar as the
international money. As a result countries started accumulating dollars for reserves.
 THE DOLLAR WAS NOT MERELY AS GOOD AS
GOLD, IT WAS BETTER THAN GOLD BECAUSE
DOLLARS EARNED INTEREST WHILE GOLD DID
NOT!
 The designers of this system knew that you
cannot have a fixed system working smoothly
forever. But they hoped that changes would be
rare only when needed in emergency cases.
 The IMF provided credit facilities to member
countries suffering from payment problems. The
credit depended on the quota of the country i.e.
member’s contribution to the fund, its trades etc.
 The system started facing difficulties when the
US started finding it difficult in Gold for all dollars
from other countries. The US gold stock had
reduced from $25billion in 1949 to $10b in 1971.
 THE END WAS NEAR……
 In 1971, the central bank of Germany
alone had enough dollars to buy all the
gold reserves of US at the current $35
per ounce. This clearly showed that the
present system was on the brink of
collapse. The US could not continue
buying back dollars at the existing rate.
 Other countries also started losing
confidence in the dollar’s power to do
world business. MNCs started trying to
acquire other currencies instead of the
dollar. Thus on the one hand there was
a tremendous desire to sell dollars
everywhere, but on the other hand, the
traditional buyers of these dollars
(foreign central banks) were not willing
to buy them anymore.
 THE END.
 On August 15, 1971 the American President
Richard Nixon withdrew US commitment to
buy and sell gold at $35 per ounce. Thus the
IMF agreement became invalid. Foreign
governments now had 2 choices- either
continue maintaining existing exchange rates
(accumulating dollars without convertibility-
foolish) or to revalue the exchange rates.
 None of the countries wanted to revalue the
current rates. All the currencies (except the
french franc) started to float the way they
wished according to the dollar. Trade became
difficult and the world did not know how to
proceed further.
A NEW BEGINNING
 Since it was urgent to end this uncertain period, a
group of ten powerful countries got together and
signed the Smithsonian agreement.
agreement According to this
agreement the present exchange became $38 per
ounce of gold. Again fixed rates came back into the
picture with several countries appreciating their value
to the dollar.
 This deal too did not last long. In 1973, Nixon
announced a new rate of $42.2 for an ounce of gold.
The leading European countries reacted by bringing a
floating rate to the outside world and a fixed rate
among their own currencies.
 In 1976, the floating rate system

was finalized with the Jamaica

Agreement.
TODAY’S FOREX IS HERE!
 Since 1972 the world can be said to be
following varying levels of the floating
exchange rate system.
 The European countries that had fixed
a common fixed exchange rate among
themselves and floating rates among
others introduced a new arrangement
known as EMS (European Monetary
System) in 1979.
 Objectives of the EMS- Lasting
growth with stability, full employment,
higher living standards, lessening of
regional disparities. This was the first
step towards realizing the European
Union.
 A ECU (European Currency Unit) was
used to measure the value of each
currency with the others.
 EURO!
 In 1991, the leaders of member countries of the
European community came to an agreement for
a common European monetary policy. It was a 3
stage transition plan:
 Stage 1- The free internal market of EC would be
complete and obstacles to financial integration
removed.
 Stage 2- 1994, establishment of EMI (European
Monetary Institute) bringing closer coordination
of monetary policies and establishment of the
ECB (European Central Bank)
 Stage 3- Jan 1st , 1999 launch of a common
currency EURO by 11 of 15 members of the EU.

Only UK has kept away from all this.