International Financial System• It refers to financial institutions and financialmarkets/facilitators of international trade,financial instruments (to minimise riskexposure), rules regulations, principles andprocedures of international trade.
International Monetary System• It is defined as a set of procedures, mechanisms,processes, institutions to establish that rate atwhich exchange rate is determined in respect toother currency.• The whole story of monetary and financial systemrevolves around Exchange Rate i.e. the rate atwhich currency is exchanged among differentcountries for settlement of payments arising fromtrading of goods and services.
Monetary System Before First World War:(1880-1914 Era of Gold Standard)• The oldest system of exchange rate wasknown as "Gold Species Standard“• The other version called "Gold BullionStandard", where the basis of moneyremained fixed gold but the authorities wereready to convert, at a fixed rate, the papercurrency issued by them into paper currencyof another country which is operating in Gold.
• The exchange rate between pair of twocurrencies was determined by respectiveexchange rates against Gold which was calledMint Parity.Monetary System Before First World War:(1880-1914 Era of Gold Standard)
Three rules of Mint Parity• The authorities must fix some once-for-allconversion rate of paper money issued by theminto gold.• There must be free flow of Gold betweencountries on Gold Standard.• The money supply should be tied with theamount of Gold reserves kept by authorities. Thegold standard was very rigid and during greatdepression (1929-32) it vanished completely.
The Gold Exchange Standard (1925-1931)• In 1925, US and England could hold goldreserve and other nations could hold bothgold and dollars/sterling as reserves.• The countries started devaluing theircurrencies in order to increase exports and de-motivate imports.• This was termed as "beggar-thy-neighbour "policy.
Bretton Woods System• Allied nations held a conference in NewHampshire, the outcome of which gave birth totwo new institutions namely the InternationalMonetary Fund (IMF) and the World Bank, (WB)and the system was known as Bretton WoodsSystem which prevailed during (1946-1971).• Bretton Woods, the place in New Hampshire,where more than 40 nations met to hold aconference.
The Bretton Woods Era (1946 to 1971)• In Bretton Woods modified form of GoldExchange Standard was set up with thefollowing characteristics– One US dollar conversion rate was fixed by the USA as onedollar = 35 ounce of Gold– Other members agreed to fix the parities of theircurrencies vis-à-vis dollar with respect to permissiblecentral parity with one per cent (± 1%) fluctuation oneither side.
Post Bretton Woods Period (1971-1991)• Two major events took place in 1973-74 whenoil prices were quadrupled by theOrganisational of Petroleum ExportingCountries (OPEC).• From 1977 to 1985, US dollar observedfluctuations in the oil prices which imposed onthe countries to adopt a much flexible regimei.e. a hybrid between fixed and floatingregimes.
Current Scenario of Exchange Regimes• Exchange arrangement with no separate legal tender• The members of a currency union share a commoncurrency.• Currency Board Agreement• There is a legislative commitment to exchangedomestic currency against a specified currency ata fixed rate.• Conventional fixed peg arrangement• Country pegs its currency to another, or to abasket of currencies not exceeding +/- 1• Up to 1999, thirty countries had pegged theircurrencies to a single currency
Current Scenario of Exchange Regimes• Pegged Exchange Rates Within Horizontal Bands• It is a middle way between a fixed peg and floatingpeg.• Crawl ing Peg• A currency is pegged to another currency or abasket of currencies but the peg is adjustedperiodically which may be pre-announced ordiscretion based or well specified criterion.• Crawling bands•The currency is maintained within a certainmargins around a central parity which crawls inresponse to certain indicators.
Current Scenario of Exchange Regimes• Managed float• In this regime, central bank interferes in theforeign exchange market by buying and sellingforeign currencies against home currencieswithout any commitment or pronouncement.• Independently floating• Here exchange rate is determined by marketforces and central bank only act as a catalyst toprevent excessive supply of foreign exchange andnot to drive it to a particular level.
The Era of Euro and EuropeanMonetary Union• As a failure of the Smithsonian agreement in1973, some countries of Europe met togetherto form a union which was basically anattempt to keep the member countriesexchange rate.• This was known as Snake in the Tunnel and in1979 the snake became the EuropeanMonetary System (EMS) with all EEC countriesjoining the club except Britain.
• The ECU was the sponsor of EURO commonlyshared by eleven member countries.• This was mainly an attempt to create a singleeconomic zone in Europe with completefreedom of resource mobility within the zone.• In November, 1999, central banks of EECfinalised the draft statute for a futureEuropean Central Bank.The Era of Euro and EuropeanMonetary Union
• The concept of European economic andmonetary union received shake when in 1992referendum, Denmark people (Danish) rejectedthe "Maastricht Theory" and Italy and Britainfaced political anger against it.• Debates were going on to resolve the conflictsand ultimately in Dec. 1996 "Growth & StabilityPact" was agreed upon in Dublin.• As a consequence of this agreement, EUROcame into existence on January 1, 1999 andtrading began on January 4, 1999.The Era of Euro and EuropeanMonetary Union
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