International monetary System and types of exchange rate systems.

1. WORKSHOP ON FOREIGN TRADE
DOCUMENTATION AND TRADE
FINANCE
Course Instructor : Sneha Sharma

2. INTERNATIONAL
MONETARY SYSTEM

3. INTERNATIONAL MONETARY SYSTEM
It is a system that sets rules and
procedures by which different
national currencies are exchanged for
each other in world trade.

4. INTERNATIONAL MONETARY SYSTEM
 It
is often used interchangeably with terms such as
―international monetary and financial system‖ and
―international financial architecture.
 The
objective of the IMS is

to contribute to stable and high global growth,

while fostering price and financial stability.

5. INTERNATIONAL MONETARY SYSTEM

The IMS regulates key dimensions of the balance
of payments (IMF, 2009c; 2010a).

It consists of four elements:
exchange arrangements and exchange rates;
 international payments and transfers relating to current
international transactions;
 international capital movements; and
 international reserves.

The essential purpose of the IMS is to facilitate the exchange of
goods, services and capital among countries.

6. INTERNATIONAL
MONETARY SYSTEM WAS
DIVIDED INTO MANY
PHASES

7. TIMELINE OF IMS
The Gold Standard
The Collapse of Gold Standard
The Bretton Woods Era
The End of the Bretton Woods System
Post Bretton Woods System & the Floating Rate Era

8. THE GOLD STANDARD
Buying and selling of paper currency in
exchange for gold
• Adopted by UK in 1821
• Upshot
• It created a fixed exchange rate system because
each country tied the value of its currency.
• Difficulty: Transacting in gold was expensive.

9. STERLING BASED GOLD STANDARD
 From

the
1821 until the end of 1918,
most
important
currency
in
international commerce was the British
pound sterling

because of the United Kingdom‘s large territory
due to dominant economic and military power.

11. THE COLLAPSE OF GOLD STANDARD

During World War 1, the sterling-based gold
standard unraveled

Normal commercial transactions between the Allies
(France, Russia, and the United Kingdom) and the Central
Powers (Austria-Hungary, Germany, and the Ottoman
Empire) ceased.

The economic pressures of war caused country after
country to suspend their pledges to buy or sell gold at their
currencies' par values.

12. POST-WAR CONFERENCES & READAPTATION OF GOLD STANDARD

After the war

Conferences at Brussels (1920) and Genoa
(1922) yielded general agreements among the
major economic powers to return to the prewar
gold standard.

Most countries, including the United States, the
United Kingdom, and France, readopted the gold
standard in the 1920s

13. IMPLEMENTATION OF FLOATING RATE
SYSTEM BY BANK OF ENGLAND
 The
standard of gold
standard was
doomed by economic stresses triggered by
the worldwide Great Depression.

The Bank of England, the United Kingdom's
central bank, was unable to maintain its new
pledges under the gold standard.

14. IMPLEMENTATION OF FLOATING RATE
SYSTEM BY BANK OF ENGLAND
 On
September 21, 1931 The Bank of
England
allowed
the pound to float, meaning that the
pound's value would be determined by the forces
of supply and demand and the Bank of England
would no longer guarantee to redeem British
paper currency for gold at par value.

15. COMPETITIVE DEVALUATION OF CURRENCIES &
INCREASED TARIFF RATE
 After
the United Kingdom abandoned the
gold standard,

a
"sterling
area‖
emerged
as
some
countries, primarily members of the British
Commonwealth, pegged their currencies to the
pound and relied on sterling balances held in
London as their international reserves.

16. COMPETITIVE DEVALUATION OF CURRENCIES &
INCREASED TARIFF RATE
 Other
countries tied the value of their currencies
to the U.S. dollar or the French franc.

Some
countries
Kingdom,
(United
Belgium,
States,
France,
Latvia,
United
the
Netherlands, Switzerland & Italy) were deliberately &
artificially devaluating their official value of currencies
to make their goods cheaper in the international
markets, which is stimulating its exports and reducing
its imports.

17. COMPETITIVE DEVALUATION OF CURRENCIES &
INCREASED TARIFF RATE

But, none were getting the benefit due to
competitive devaluation at almost same percentage
that is each currency's value relative to the other
remains the same.

Most countries also raised the tariffs they imposed on
imported goods in the hope of protecting domestic jobs in
import-competing industries.

Nations adversely affected by trade barriers of any kind are
quite likely to impose retaliatory or reciprocal tariffs.

18. BEGGAR-THY-NEIGHBOR POLICIES

An international trading policy that utilizes currency
devaluations and protective barriers to alleviate a
nation's economic difficulties at the expense of
other countries.

19. BEGGAR-THY-NEIGHBOR POLICIES

The policy name is derived from its resulting
impact, making a beggar out of neighboring
nations.

The goal of a Beggar-Thy-Neighbor strategy is to
increase the demand for your nation's exports, while
reducing your reliance on imports.

This
is
often
executed
by
devaluing
the
nation's
currency, which will make exports to other nations cheaper.

20. EFFECT OF BEGGAR-THY-NEIGHBOR POLICIES
(WORLD WAR II)
 As
more and more countries adopted
beggar-thy-neighbor policies like

devaluation of currencies and increasing the tariff
rate on imported goods,

international trade contracted that hurt employment in
each country's export industries.

More ominously, this international economic conflict was
soon replaced by international military conflict that was the
outbreak of World War II in 1939.

21. THE BRETTON WOODS ERA
Lecture 2nd

22. POST-WAR SITUATION

World War II created

inflation, unemployment and an instable political
situation.

Every country was struggling to rebuild their wartorn economy.

23. BRETTON WOODS CONFERENCE

To construct the postwar international monetary
system

representatives of 44 countries met at a resort in
Bretton Woods, New Hampshire in 1944.

24. DECISIONS & OUTCOME OF THE BRETTON
WOODS CONFERENCE

The Bretton Woods Conference has presented the
world two historic agreements. These are as
follows:
Agreement of conferees to renew the gold standard on
a modified basis.
 Agreement to create two new international organizations
to assist the rebuilding of the world economy and the
international monetary system. These were:

International Bank for Reconstruction and Development
(IBRD)
 International Monetary Fund (IMF)


25. A DOLLAR-BASED GOLD STANDARD

IMF and the World Bank provided the institutional
framework for the postwar international monetary
system.

All countries agreed to peg the value of their currencies
to gold.

However, only the United States pledged to redeem its
currency for gold at the request of a foreign central bank.

Thus the U.S. dollar became the key-stone of the Bretton
Woods system.

26. A DOLLAR-BASED GOLD STANDARD

Countries had faith in the U.S. economy and so were
willing to accept U.S. dollars to settle their transactions.
As the British pound sterling had been in the nineteenth century, the
U.S. dollar became the preferred vehicle for settling most international
transactions.

27. THE EFFECT OF THE BRETTON WOODS
CONFERENCE
 Under
the Bretton Woods Agreement each
country pledged to maintain the value of its
currency within ±1% of its par value.

If the market value of its currency fell outside that
range, a country was obligated to intervene in the
foreign-exchange market to bring the value back
within ±1% of par value.

28. THE EFFECT OF THE BRETTON WOODS
CONFERENCE

This
stability
in
exchange
international businesses.
rates
benefited

29. BRETTON WOODS SYSTEM AS ADJUSTABLE
PEG

The Bretton Woods system is often described as using
an adjustable peg

because currencies were pegged to gold but the pegs
themselves could be altered under certain conditions.

30. BRETTON WOODS SYSTEM AS ADJUSTABLE
PEG

The arrangement of Bretton Woods System worked well
as long as pessimism about a country‘s economy was
temporary.

But, if a country suffered from structural macroeconomic
problems, major difficulties could arise.

31. THE END OF THE BRETTON WOODS
SYSTEM

32. SHORTCOMING OF DOLLAR-BASED GOLD
STANDARD UNDER BRETTON WOODS SYSTEM &
TRIFFIN PARADOX

Ironically, the reliance of the Bretton Woods system
on the dollar ultimately led to the system‗s undoing.

Because the supply of gold did not expand in the
short run,

the only source of the liquidity needed to expand
international trade was the U.S. dollar.

33. SHORTCOMING OF DOLLAR-BASED GOLD
STANDARD UNDER BRETTON WOODS SYSTEM
& TRIFFIN PARADOX

Under the Bretton Woods system, the expansion of
international liquidity depended on foreigners‗ willingness to
continually increase their holdings of dollars.
 Foreigners
were perfectly happy to hold dollars as long as they
trusted the integrity of the U.S. currency, and during the 1950s and
1960s the number of dollars held by foreigners rose steadily.

34. SHORTCOMING OF DOLLAR-BASED GOLD STANDARD
UNDER BRETTON WOODS SYSTEM & TRIFFIN
PARADOX
 As
foreign
dollar
holdings
increased, however,

people began to question the ability of the
United States to live up to its Bretton Woods
obligation.

This led to the Triffin paradox, named after Robert Triffin,who
first identified the problem.

35. SHORTCOMING OF DOLLAR-BASED GOLD
STANDARD UNDER BRETTON WOODS SYSTEM
& TRIFFIN PARADOX

The paradox arose because foreigners needed to
increase their holdings of dollars to finance
expansion of international trade.
 But
the more dollars they owned, the less faith they had in the
ability of the United States to redeem those dollars for gold.

36. SHORTCOMING OF DOLLAR-BASED GOLD STANDARD
UNDER BRETTON WOODS SYSTEM & TRIFFIN
PARADOX

The less faith foreigners had in the United States, the
more they wanted to rid themselves of dollars and get
gold in return

But if they did this, international trade and the international
monetary system might collapse because the United States didn't
have enough gold to redeem all the dollars held by foreigners.

37. SHORTCOMING OF DOLLAR-BASED GOLD
STANDARD UNDER BRETTON WOODS SYSTEM
& TRIFFIN PARADOX

The shortcomings are listed below in brief



Limited gold.
Liquidity problem.
Foreigners‘ behavior of continuous increasing in dollar
holding.
Foreigners‘ less faith on United States.

38. AGREEMENT TO CREATE SPECIAL DRAWING
RIGHTS (SDRS)

To inject more liquidity into the international monetary
system while reducing the demands placed on the dollar as a
reserve currency,

IMF members created the special drawing rights in 1967.

SDR is a credit granted by the IMF that can be used to settle
official transactions among central banks.

Thus SDRs are sometimes called "paper gold―.

39. AGREEMENT TO CREATE SPECIAL DRAWING
RIGHTS (SDRS)

As
of
1993,
approximately
21.4
billion
SDRs, representing about 2% of the world‗s total
reserves, had been distributed to IMF members in
proportion to their IMF quotas.

The value of an SDR is a function of the current value of five
different currencies from which it is comprised.

They include the U.S. dollar, the Japanese yen, the United
Kingdom pound sterling, and the respective euro values of
Germany and France.

40. AGREEMENT TO CREATE SPECIAL DRAWING
RIGHTS (SDRS)

An SDR's value is currently calculated daily as a weighted
average of the market value of five major currencies
 U.S.
dollar,
 German
 French
mark,
franc,
 Japanese
 pound
 with
yen,
sterling
the weights revised every five years.

41. OUTCOME OF CREATING SDRS

SDRs solved the liquidity problem for the
international monetary system, but it failed to
solve the problem related to the glut of dollars held
by foreigners & faith.

By mid 1971, the Bretton Woods system was tottering, the
victim of fears about the dollar's instability.

In the first seven months of 1971, the United States sold
one third of its gold reserves.

42. OUTCOME OF CREATING SDRS

It became clear to the marketplace that the United
States did not have sufficient gold on hand to meet the
demands of those who still wanted to exchange their
dollars for gold.

The Bretton Woods system officially ended when in a
dramatic address on August 15, 1971, President
Richard M. Nixon announced that the United States
would no longer redeem gold at $35 per ounce.

43. POST BRETTON WOODS SYSTEM & THE
FLOATING RATE ERA

After President Nixon's speech, most foreign
currencies began to float, their values being
determined by supply and demand in the foreignexchange market.

The value of the U.S. dollar fell relative to most of the
world's major currencies.

44. POST BRETTON WOODS SYSTEM & THE
FLOATING RATE ERA

At
the
Smithsonian
Conference,
held
in
Washington, D.C. in December 1971, central
bank representatives from the Group of Ten
countries agreed to restore the fixed exchange-rate
system but with restructured rates of exchange
between the major trading currencies.

45. FLOATING EXCHANGE RATE

46. FLOATING EXCHANGE RATES

After abandoning gold convertibility IMF had to agree on a
system of floating exchange rates.

According to which the gold standard became obsolete and
the values of various currencies were to be determined by the
market.

In the late 20th cent., the Japanese yen and the German
Deutschmark
strengthened
and
became
important in international financial markets
increasingly

47. FLOATING EXCHANGE RATES

The U.S. dollar although still the most important
national currency weakened with respect to them
and diminished in importance.

The euro was introduced in financial markets in
1999 as replacement for the currencies (including
the Deutschmark) of 11 countries belonging to the
European Union (EU); it began circulating in 2002
in 12 EU nations.

48. TYPES OF EXCHANGE RATES

49. CLASSIFYING ER REGIMES
HARD PEGS
INTERMEDIATE
FLOATING
• Currency union
• Basket peg
• Managed float
• Dollarization
• Crawling peg
• Free float
• Currency board
• Band

50. HARD PEGS
Dollarization
Currency union
• Use another country‘s currency as
sole legal tender
• E.g. Ecuador, El
Salvador, Panama
• Share same currency with other
union members
• E.g. Euro area
Currency board
• Legally commit to exchange domestic currency for specified foreign
currency at fixed rate
• E.g. Hong Kong(1983), Estonia(1992), Lithuania
(1994), Bulgaria(1997), Bosnia and Herzegovina, Argentina (until 2001)

51. DOLLARIZATION
Dollarization: Country gives up completely its monetary
autonomy by adopting another country‘s currency.
- Mostly small and very open economies
- Countries recently adopted: e.g. Ecuador (2000), El
Salvador (2001), Guatemala (2001)

Advantages


Credibility in the regime is maximized
Disadvantages

Limited flexibility for economic policy when facing adverse
external shocks

52. CURRENCY UNION (CU)
Substitute a single currency for several national
currencies
- Efficiency gains: reduces transaction costs of trade
within CU countries
- Boost the volume of trade
- More synchronization of business cycles inside the
CU
- A gradual loss of monetary policy autonomy

Fiscal policy is constrained by the convergence criteria

53. CURRENCY BOARD

Strict fixed ER


Advantages


e.g. Hong Kong(1983), Estonia(1992), Lithuania
(1994), Bulgaria(1997)
High credibility because the institutional constraints are
difficult to change
Disadvantages

Limited flexibility for economic policy when facing
adverse external shocks

54. INTERMEDIATE REGIMES
Conventional (soft) peg
Band
• Single currency peg (e.g.
Malaysia, Nepal, Namibia)
• Pegged exchange rate within
horizontal bands (>±1%)
• E.g. Denmark ( 2.25%), Tonga
( 5%), Hungary ( 15%)
Crawling peg
Crawling band
• Backward or forward looking
• E.g. Bolivia
• Symmetric or asymmetric
• E.g. Belarus ( 5%), Israel
( 22%)

55. CONVENTIONAL (FIXED) PEG
Soft fixed Exchange Rate, Central Bank not obliged
to maintain the parity indefinitely
 Advantages

Provides macroeconomic discipline by maintaining
tradable goods prices in line with foreign prices
 Built-in escape clause ―devaluation‖ provides some
flexibility


Disadvantages
If weak institutional constraints, the system is subject to
speculative attacks
 Realignments can be disruptive especially when
dollarized debts are high


56. CRAWLING PEG

Nominal ER is adjusted periodically according to a
set of indicators, and it is not allowed to fluctuate
beyond a narrow range


– backward-looking or forward-looking adjustments
Adjustment can be pre-announced.
Advantages
For high inflation countries, crawling helps avoid RER
overvaluation
 Pre-announcement helps guide public expectations


Disadvantages

If backward-looking adjustment, there is a risk of
creating inflationary inertia

57. CRAWLING BAND

A band system where the ER central parity crawls
over time—asymmetric or symmetric band

Choice of ER bands
Central rate: single currency or basket?
 Whether the central rate is fixed , crawling, or realigned
irregular depends on the inflation differential and
permanent shocks to RER
 Width of band
 Rules governing the CB‘s FOREX intervention inside
the bands


58. FLOATING
Managed floating
• No preannounced path for the exchange rate
• Management by sterilized intervention or interest rate (monetary)
policy
• E.g. Thailand, Indonesia, Mongolia, Singapore, Brazil
Independently floating
• E.g. U.S., Japan,

59. MANAGED FLOATING

with a feedback rule—


indirect intervention using interest rates and liquidity
positions, dirty floating—sporadic CB interventions in
the FOREX market
Advantages
Adjustments in NER absorb foreign and domestic
shocks, but high international reserves required
 Dampens excessive fluctuations of ER


Disadvantages
Lack of transparency on CB intervention may create too
much uncertainty
 Effects of intervention are typically short-lived and may
be destabilizing


60. INDEPENDENT /FREE FLOAT

No need for reserves but higher nominal ER
volatility may distort resource allocation