International Monetary System

2.  It is a set of internationally agreed rules, conventions
and supporting institutions that facilitate
international trade, cross border investment and
reallocation of capital between nations.

3. Gold Standard 1876-1913
Inter-war years 1914-1944
The Bretton Wood system 1945-1971
The Smithsonian Agreement 1971-1973
Post 1973

4.  Gold as a standard to determine value of a currency
 Each country’s government agreed to buy or sell gold
at its own fixed rate of demand
 Currency’s value to be backed by adequate reserves of
gold
 Free import and export of gold
 Two-way convertibility between gold and national
currencies
 Exchange rate determination

5. Eg:-
 Value of dollar in terms of gold $20.67/ounce of gold
 Value of pound in terms of gold £4.2474/ounce of gold
 $20.67/ounce of gold = $4.86656/£
£4.2474/ounce of gold

6.  Gold export point(upper limit)
 Gold import point(lower limit)
 Trade surpluses

7.  Gold is a scarce commodity
 Rigidity of the system
 Shifting the burden of BOP adjustments to domestic
variables

8.  Interrupted trade flows and disturbed stability of
exchange rates
 US became the leading creditor nation
 US returned to gold standard in 1919, UK in 1925 and
others by 1928
 Great mistake by UK to return at parity exchange rate
of $4.87/£
 In 1934, US devalued its currency at $35/ounce of gold
 Gold exchange standard

9.  Conference held in 1944 at Bretton woods, New
Hampshire
 Monetary units in terms of gold or dollars
 US dollar pegged to gold and other currencies pegged
to US dollar
 Fixed but adjustable rates(+1%)

10.  Creation of IMF and IBRD
 US dollar designated as reserve currency
 Currencies were to become convertible
 IMF subscription quotas were based on member’s size
and resources

11.  Lead to problem of lack of international liquidity.
 Any pressure to devalue the dollar would cause problems
throughout the world.
 Large amount of US dollars was held outside the USA
that it was more than the total gold holdings of the USA.
 Conditionality issue of IMF
 On 15th Aug 1971, President Nixon suspended the system
of convertibility of gold and dollar and decided for
floating exchange rate system.

12.  Most of the currencies were allowed to fluctuate from
August to December 1971
 US dollar fell in value in comparison to other
currencies
 Protective measures limited the international
commerce
 “Group of ten” entered into Smithsonian agreement on
December 18, 1971
 US dollar devalued to $38/ounce of gold
 Establishment of parity rates
 Wider band 2.25% from central rates and 9% against
any currency except dollar

13.  Currencies no longer backed by gold
 Flexible exchange rates accepted by IMF
 Central banks were allowed to intervene in the
exchange rate markets to iron out unwarranted
volatilities.
 Less-developed countries were given greater access to
IMF funds.

14. Within the flexible exchange rate regime there are 3
categories,
 Floating
 Independent floating system
 Managed floating systems
 Pegging
 Target Zone Arrangements

15.  Independent floating system does not involve
intervention and so termed as ‘clean floating’.
 The purpose of intervention is simply to moderate the
exchange rate and to prevent any undue fluctuation.
 But no attempt is undertaken to achieve/maintain a
particular rate.

16.  Involves direct or indirect intervention by the
monetary authorities of the country to stabilize the
exchange rate.
 Indirect intervention - The monetary authorities
stabilize the exchange rate through changing the
interest rates.
 Direct intervention - The monetary authorities
purchase and sell foreign currency in the domestic
market.
 Managed floating is also known as ‘dirty floating’.

17.  Periodic adjustment of fixed exchange rate to catch up
with market determined rates.
 Combine the advantages of fixed exchange rate with
flexibility of floating exchange rate.
 It fixes the exchange rate at a given level which is
responsive to changes in market conditions (i.e,) it is
allowed to crawl pegging.
 When exchange rate crosses limits, the monetary
policies push the exchange rate within the target zone.
 If economic indicators are being disturbed, the
monetary authorities let the exchange rate depreciate
or appreciate as the case may be.

18.  Target zone arrangement involves member countries
having fixed exchange rate among their currencies.
Alternatively, they may use a common currency

19.  Flow of international trade
 Investment according to comparative advantage
 Stability in foreign exchange
 Promoting Balance of Payments
 Providing countries with sufficient liquidity
 Plan for avoiding uncertainty
 Allowing member countries to pursue independent
monetary and fiscal policies

20.  Accelerating integration and globalization in financial
markets
 Increased Securitization
 Continued expansion of derivatives market
 Deregulation of financial markets
 Increase in cross border mergers and acquisitions and
MNCs
 Countries re-balancing their import export trade
 Negative interest rates in developed countries