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The International Monetary The International Monetary SystemSystem

Budirman Bin Daud (805014)Noorina Binti Abd Hamid (805015)

Dayang Halimah Binti Mahali (803733 )Datu Zakariah Bin Datu Bistari (808744)

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OutlineOutline

1. Introduction2. The Gold Standard3. The Bretton Woods System4. The Collapse of the Fixed Exchange Rate

System5. The Floating Exchange Rate Regime6. The Fixed Versus Floating Exchange Rates7. Exchange Rate Regimes in Practice8. IMF Crisis Management

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IntroductionIntroduction

International Monetary System is the institutional arrangements that countries adopt to govern exchange rate or we can say is the rules and procedures by which different national currencies are exchange for each other in world trade. Such a system is necessary to define a common standard of value for the world’s currencies.

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Terms of Exchange RateTerms of Exchange Rate

1. Floating exchange rate : When a country allow the foreign exchange market to determine the relative value of a currency.

2. Pegged exchange rate : When a country fixes the value of its currency relative to a reference currency.

3. Dirty float : When a country tries to hold the value of its currency within some range against an important reference currency.

4. Fixed exchange rate : The values of a set of currencies are fixed against each other at some mutually agreed-on exchange rate.

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The Gold StandardThe Gold Standard

• The gold standard dates back to ancient times when gold coins were a medium of exchange, unit of account, and store of value. Some country pegging currencies to gold and guaranteeing convertibility.

• In the 1880s, most of the world’s trading nations followed the gold standard which the payment for imports was made in gold or silver.

• Later, as trade grew, payment was made in paper currency which was linked to gold at a fixed rate.

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The Gold StandardThe Gold Standard

• The Gold par value:U.S dollar$1.00 = 23.22 grains of pure gold$20.67 = 1 ounce of gold (480 grains = 1 ounce)

British pound£1.00 = 113 grains of pure gold

£4.25 = 1 ounce of gold

• From the gold par value of pounds and dollars, we can calculate the exchange rate for exchanging pounds in dollars: i.e £1.00 = $4.87 (*Currently £1.00 = $1.62)

• The great strength of the gold standard was that it contained a powerful mechanism for achieving balance-of-trade equilibrium (when the income a country’s residents earn from its exports is equal to the money its residents pay for imports) by all countries.

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The Period Between The The Period Between The Wars: 1918-1939Wars: 1918-1939

• The gold standard worked fairly well from the 1870s until the start of World War I in 1914.

• During the war, many governments financed their war expenditures by printing money, and in doing so, created inflation.

• People lost confidence in the system and started to demand gold for their currency putting pressure on countries' gold reserves, and forcing them to suspend gold convertibility.

• By 1939, the gold standard was dead.

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The Bretton Woods System

• In 1944, 44 countries met in New Hampshire • Countries agreed to peg their currencies to

US$ which was convertible to gold at $35/oz• Agreed not to engage in competitive

devaluations for trade purposes and defend their currencies

• Weak currencies could be devalued up to 10% w/o approval

• Created the IMF and World Bank

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The Role of the IMF

IMF maintained exchange rate – discipline

• National governments had to manage inflation through their money supply

– flexibility• Provides loans to help members states with

temporary balance-of-payment deficit; – Allows time to bring down inflation– Relieves pressures to devalue

• Excessive drawing from IMF funds came with IMF supervision of monetary and fiscal policies

– Allowed to 10% devaluations and more with IMF approval

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The Role of the World Bank

World Bank (IBRD) role (International Bank for Reconstruction & Development)– Refinanced post-WWII reconstruction and

development– Provides low-interest long term loans to

developing economies The International Development Agency (IDA),

an arm of the bank created in 1960– Raises funds from member states– Loans only to poorest countries– 50 year repayment at 1% per year interest

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The Collapse of the

Fixed Exchange Rate System • The system of fixed exchange rates established at

Bretton Woods worked well until the late 1960’s • The US dollar was only currency that could be

converted into gold• The US dollar served as the reference point for all

other currencies• Any pressure to devalue the dollar would cause

problems through out the world

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Factors that led to the collapse of the fixed exchange system include

• President Johnson financed both the Great Society and Vietnam by Printing money

• High inflation and high spending on imports• On 8 August 1971, President Nixon announces dollar

no longer convertible into gold• Countries agreed to revalue their currencies against

the dollar • On 19 March 1972, Japan and most of Europe floated

their currencies • In 1973, Bretton Woods fails because the key

currency (dollar) is under speculative attack

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The Floating Exchange Rate Regime

• In 1976, following the collapse of Bretton Woods, IMF members formalized a new exchange rate system at a meeting in Jamaica.

• The rules that were agreed on then, are still in place today.

• The Jamaica Agreement revised the IMF’s Articles of Agreement to reflect the new reality of floating exchange rates.

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The Jamaica Agreement

Under the Jamaican agreement:

• floating rates were declared acceptable• gold was abandoned as a reserve asset• total annual IMF quotas - the amount member

countries contribute to the IMF - were increased to $41 billion

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Exchange Rates Since 1973

• Since 1973, exchange rates have become more volatile and less predictable than they were between 1945 and 1973

• Volatility has increased because of:• The 1971 oil crisis• The loss of confidence in the dollar that followed the

rise of U.S. inflation in 1977 and 1978• The 1979 oil crisis• The unexpected rise in the dollar between 1980 and

1985• The partial collapse of the European Monetary

System in 1992• The 1997 Asian currency crisis

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FIXED VERSUS FLOATING EXCHANGE RATESFIXED VERSUS FLOATING EXCHANGE RATES

Disappointment with floating rates in recent years has led to renewed debate about the merits of a fixed exchange rate system.

The Case for Floating Exchange Rates The case for floating exchange rates has two main elements:• monetary policy autonomy• automatic trade balance adjustments

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Monetary Policy AutonomyMonetary Policy Autonomy

• Advocates of a floating exchange rate regime argue that removal of the obligation to maintain exchange rate parity restores monetary control to a government

• Under a fixed system, a country's ability to expand or contract its money supply as it sees fit is limited by the need to maintain exchange rate parity

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Trade Balance AdjustmentsTrade Balance Adjustments

• Under the Bretton Woods system, if a country developed a permanent deficit in its balance of trade that could not be corrected by domestic policy, the IMF would agree to a currency devaluation

• Critics of this system argue that the adjustment mechanism works much more smoothly under a floating exchange rate regime

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The Case for Fixed Exchange The Case for Fixed Exchange RateRate

The case for fixed exchange rates rests on arguments about monetary discipline, uncertainty, and the lack of connection between the trade balance and exchange rates.

Monetary Discipline • The need to maintain a fixed exchange rate parity ensures that governments do not expand their money supplies at inflationary rates

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Speculation • Critics of a floating exchange rate regime also argue that speculation can cause exchange rate fluctuations

Uncertainty • Speculation adds to the uncertainty surrounding future currency movements that characterizes floating exchange rate regimes

Trade Balance Adjustments• Advocates of floating exchange rates argue that floating rates help adjust trade imbalances

The Case for Fixed Exchange The Case for Fixed Exchange RateRate

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Who is Right?Who is Right?

• There is no real agreement as to which system is better

• We know that a fixed exchange rate regime modeled along the lines of the Bretton Woods system will not work

• A different kind of fixed exchange rate system might be more enduring and might foster the kind of stability that would facilitate more rapid growth in international trade and investment

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EXCHANGE RATE REGIMES IN PRACTICEEXCHANGE RATE REGIMES IN PRACTICE

• 19% of IMF members follow a free float policy

• 26% of IMF members follow a managed float system

• 22% of IMF members have no legal tender of their own

• The remaining countries use less flexible systems such as pegged arrangements, or adjustable pegs

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The Exchange Rate Policies of The Exchange Rate Policies of IMF Members, 2006IMF Members, 2006

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Pegged Exchange Rates• Under a pegged exchange rate regime a country will peg the

value of its currency to that of another major currency.• Pegged exchange rates are popular among the world’s smaller

nations. • There is some evidence that adopting a pegged exchange rate

regime does moderate inflationary pressures in a country.

Currency Boards• A country that introduces a currency board commits itself to

converting its domestic currency on demand into another currency at a fixed exchange rate.

• To make this commitment credible, the currency board holds reserves of foreign currency equal at the fixed exchange rate to at least 100% of the domestic currency issued.

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IMF ORIGINAL FUNCTIONS WAS TO PROVIDE A POOL OF MONEY, WHICH MEMBER CAN BORROW, SHORT TERM TO ADJUST THEIR BALANCE OF PAYMENTS AND EXCHANGE RATE

IMF Crisis ManagementIMF Crisis Management

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Currency Crisis - when a speculative attack on the exchange rate

Banking Crisis - Loss of confidence in the banking system

Foreign debt crisis – When a country cannot service its foreign debt obligations

3 Types of Crisis3 Types of Crisis

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1. High relatives price inflations rates2. Widening Current Account Deficit3. Excessive Expansion of Domestic

Borrowing4. Asset Price inflation ( sharp rise in

stock & property prices)

Effect of These CrisisEffect of These Crisis

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All IMF loan packages attached with conditions, including

1.Tighter Macroeconomic policies, which include cut in pubic spending

2.Higher interest rate3.Tight monetary control4.Deregulation of protected industries from

competitions5.Privatization of stated owned assets6.Better financial reporting from banking sectors.

Evaluation the IMF’s Policy Evaluation the IMF’s Policy PrescriptionsPrescriptions

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• “one-size-fits-all” refers to one rescue package that applied to all countries, inappropriate.

• “Moral Hazard” refers to borrower behaving recklessly because they know that they will be saved if things goes wrong.

• IMF have become too powerful for an institution that lacks accountability.

Inappropriate PoliciesInappropriate Policies

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• IMF were able to contains economic meltdown in several crisis for example The Asian economic crisis in 1997.

• But in several cases also the policies implemented seem to fail, e.g Turkey have received 18 aids since 1958

ConclusionsConclusions

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THANK YOU