International International Financial SystemFinancial SystemThe Gold StandardThe Gold Standard

Gold StandardGold Standard1880-19141880-1914

Currencies valued in terms of their gold Currencies valued in terms of their gold equivalentequivalent

Mid 1870’s most major economies Mid 1870’s most major economies pegged to goldpegged to gold

All currencies linked together in a system All currencies linked together in a system of fixed exchange ratesof fixed exchange rates

Gold StandardGold StandardExampleExample

Currency A worth 0.10 ounce goldCurrency A worth 0.10 ounce gold Currency B worth 0.20 ounce goldCurrency B worth 0.20 ounce gold 1 unit of B worth twice as much as 1 unit 1 unit of B worth twice as much as 1 unit

of A.of A.

Gold StandardGold Standardpros and conspros and cons

To achieve long run price stabilityTo achieve long run price stability Prices may rise and fall with swings in gold Prices may rise and fall with swings in gold

outputoutput National money supplies constrained by growth National money supplies constrained by growth

of stock of goldof stock of gold As long as gold stock steady prices steadyAs long as gold stock steady prices steady Countries with balance of payments deficits Countries with balance of payments deficits

outflows of gold , moutflows of gold , mssreduce.reduce.

The Interwar PeriodThe Interwar Period1918-19391918-1939

WW 1 ended the gold standardWW 1 ended the gold standard Europe experienced rapid inflation Europe experienced rapid inflation USA little inflation so returned to gold USA little inflation so returned to gold

standard in 1919.standard in 1919. War ended Britain’s financial War ended Britain’s financial

preeminicencepreeminicence USA World’s dominent banker countryUSA World’s dominent banker country

Interwar PeriodInterwar Period

1930’s depression years.1930’s depression years. Trying to stimulate domestic economies Trying to stimulate domestic economies

by increasing exports country after by increasing exports country after country had to devalue.country had to devalue.

Period of competitive devaluations.Period of competitive devaluations. Run on US gold holdings at the end of Run on US gold holdings at the end of

1931.1931. USA abandoned the gold standard.USA abandoned the gold standard.

The Gold Exchange The Gold Exchange StandardStandard1944-19701944-1970

Desire to reform the international Desire to reform the international monetary system led to an international monetary system led to an international conference at Bretton Woods , New conference at Bretton Woods , New Hampshire.Hampshire.

US dollar key currency in the system.US dollar key currency in the system. 1$= 1/35 ounce gold.1$= 1/35 ounce gold. Primary architects Harry White of US and Primary architects Harry White of US and

Keynes of UK.Keynes of UK.

Bretton WoodsBretton Woods

For countries experiencing difficulty For countries experiencing difficulty maintaining their parity value new maintaining their parity value new institution created.institution created.

The International Monetary FundThe International Monetary Fund

International Monetary International Monetary FundFund

Headquartered in Washington D.CHeadquartered in Washington D.C Had 30 original member now 180.Had 30 original member now 180. Given the task of promoting the growth of world Given the task of promoting the growth of world

trade, setting rules for maintenance of fixed trade, setting rules for maintenance of fixed exchange rates.making loans to countries exchange rates.making loans to countries facing balance of payments difficulties.facing balance of payments difficulties.

Collecting and standardizing int economic data.Collecting and standardizing int economic data.

IMFIMF

oversees the international monetary system oversees the international monetary system promotes exchange stability and orderly promotes exchange stability and orderly

exchange relations among its member exchange relations among its member countries countries

assists all members--both industrial and assists all members--both industrial and developing countries--that find themselves in developing countries--that find themselves in temporary balance of payments difficulties by temporary balance of payments difficulties by providing short- to medium-term credits providing short- to medium-term credits

IMFIMF

supplements the currency reserves of its supplements the currency reserves of its members through the allocation of SDRs members through the allocation of SDRs (special drawing rights); to date SDR 21.4 (special drawing rights); to date SDR 21.4 billion has been issued to member countries in billion has been issued to member countries in proportion to their quotas proportion to their quotas

draws its financial resources principally from draws its financial resources principally from the quota subscriptions of its member countries the quota subscriptions of its member countries

has at its disposal fully paid-in quotas now has at its disposal fully paid-in quotas now totaling SDR 145 billion (about $215 billion) totaling SDR 145 billion (about $215 billion)

has a staff of 2,300 drawn from 182 member has a staff of 2,300 drawn from 182 member countries countries

World BankWorld Bank

seeks to promote the economic development of seeks to promote the economic development of the world's poorer countries the world's poorer countries

assists developing countries through long-term assists developing countries through long-term financing of development projects and financing of development projects and programs programs

provides to the poorest developing countries provides to the poorest developing countries whose per capita GNP is less than $865 a year whose per capita GNP is less than $865 a year special financial assistance through the special financial assistance through the International Development Association (IDA) International Development Association (IDA)

World BankWorld Bank

encourages private enterprises in developing encourages private enterprises in developing countries through its affiliate, the International countries through its affiliate, the International Finance Corporation (IFC) Finance Corporation (IFC)

acquires most of its financial resources by acquires most of its financial resources by borrowing on the international bond market borrowing on the international bond market

has an authorized capital of $184 billion, of has an authorized capital of $184 billion, of which members pay in about 10 percent which members pay in about 10 percent

has a staff of 7,000 drawn from 180 member has a staff of 7,000 drawn from 180 member countriescountries

   

1960’s1960’s

In 1960 USA ; dollar crises due to run large In 1960 USA ; dollar crises due to run large balance of payments deficitsbalance of payments deficits

By the late 1960’s foreign dollar liabilities of By the late 1960’s foreign dollar liabilities of USA much larger than the US gold stock.USA much larger than the US gold stock.

Pressures of this dollar glut terminated Nixon Pressures of this dollar glut terminated Nixon declared 1971 dollar incovertibledeclared 1971 dollar incovertible

Close to the Bretton Woods era fixed exchange Close to the Bretton Woods era fixed exchange rates and convertible currencies.rates and convertible currencies.

Transition YearsTransition Years1971-731971-73

Dec 1971 Smithsonian agreement dollar Dec 1971 Smithsonian agreement dollar devalued by about 8% , surplus devalued by about 8% , surplus countrie’s curriencies revalued upward.countrie’s curriencies revalued upward.

June 1972 countries like Germany and June 1972 countries like Germany and Switzerland experiencing large inflows of Switzerland experiencing large inflows of speculative capital.speculative capital.

They applied legal control to slow further They applied legal control to slow further movements of money.movements of money.

Transition YearsTransition Years

Dollar still inconvertible.Dollar still inconvertible. Speculative capital flows of 1972 further Speculative capital flows of 1972 further

devaluation of dollar.devaluation of dollar. An ounce of gold rose from $38 to $42.2 An ounce of gold rose from $38 to $42.2

still speculative capital flows from weak still speculative capital flows from weak to strong curr persisted.to strong curr persisted.

March 1973 major currencies began to March 1973 major currencies began to float.float.

Floating Exchange RatesFloating Exchange Rates1973-to the Present1973-to the Present

System best described as managed float.System best described as managed float. Exchange rate systems; Flexible Exchange rate systems; Flexible

(floating),Managed Floating, Fixed (floating),Managed Floating, Fixed Exchange Rate Systems. Exchange Rate Systems.

Exchange Rate SystemsExchange Rate SystemsFloating -FlexibleFloating -Flexible

Flexible (floating) ; Value of the currency Flexible (floating) ; Value of the currency determined by the market.determined by the market.

By the interactions of banks , firms other By the interactions of banks , firms other institutions.Seeking to buy , sell currency for institutions.Seeking to buy , sell currency for purposes of transactions clearing, hedging, purposes of transactions clearing, hedging, arbitrage and speculationarbitrage and speculation

Most OECD countries , US, Canada, Britain , Most OECD countries , US, Canada, Britain , Australia , European Monetary Union.Australia , European Monetary Union.

Managed FloatManaged Float

Hybrid of fixed exchange rate and flexible Hybrid of fixed exchange rate and flexible exchange rate system.exchange rate system.

Central Bank holds stocks of foreign Central Bank holds stocks of foreign currency.currency.

Intervenes in forex market by buying and Intervenes in forex market by buying and selling foreign currency to keep exch rate selling foreign currency to keep exch rate at desired implicit target values.at desired implicit target values.

Fixed (Pegged) Exchange Fixed (Pegged) Exchange RatesRates

Prior to 1970’s most countries operated Prior to 1970’s most countries operated under fixed exchange rate system.under fixed exchange rate system.

Exchange Rate of member countries Exchange Rate of member countries fixed against US dollar , with the dollar in fixed against US dollar , with the dollar in turn worth a fixed amount of gold.turn worth a fixed amount of gold.

Why exch rates kept fixed??????Why exch rates kept fixed??????

Fixed Exch RatesFixed Exch Rates

To facilitate tradeTo facilitate trade Reducing fluctuations in relative prices.Reducing fluctuations in relative prices. Reducing uncertaintyReducing uncertainty

Adjustable Pegged Adjustable Pegged Exchange RateExchange RateCrawling PegCrawling Peg

Central Bank fixes the value of the Central Bank fixes the value of the currency when it desirescurrency when it desires

Crawling peg ; Fixed exchange rate Crawling peg ; Fixed exchange rate system where fixed rate changes in a system where fixed rate changes in a pre-determined manner .pre-determined manner .

Floating Exchange RatesFloating Exchange RatesSDRSDR

SDR’s are special international reserve SDR’s are special international reserve assets created by IMF.assets created by IMF.

If trade is not heavily concentrated with If trade is not heavily concentrated with USA diversified across several countries.USA diversified across several countries.

More sensible to alter the currency value More sensible to alter the currency value to a weighted average of foreign to a weighted average of foreign currencies.currencies.

SDRSDR

Some countries choose to peg to the Some countries choose to peg to the SDR (special drawing rights)SDR (special drawing rights)

A basket peg is choosen.A basket peg is choosen. Basket of currencies consisting of yen, Basket of currencies consisting of yen,

euro , sterling , dollar.(today)euro , sterling , dollar.(today)

The Choice Of an The Choice Of an Exchange Rate SystemExchange Rate System

Country size in terms of economic activity Country size in terms of economic activity or GDP important for choosing floating or or GDP important for choosing floating or pegging exchange rates.pegging exchange rates.

Large countries more independent , Large countries more independent , foreign trade constitutes smaller part of foreign trade constitutes smaller part of GDP..GDP..

Choice Of Exchange Rate Choice Of Exchange Rate SystemSystem

Openess of economy ;Openess of economy ; the degree to which country depends on the degree to which country depends on

international trade.international trade. The greater the fraction of tradable goods The greater the fraction of tradable goods

in GDP the more open the economy will in GDP the more open the economy will be.be.

The more open economy tends to follow The more open economy tends to follow a pegged exchange rate.a pegged exchange rate.

Choice of Exc RateChoice of Exc Rate

Inflation rates ; Countries inflation experience Inflation rates ; Countries inflation experience above average tend to choose floating exch above average tend to choose floating exch rates.rates.

Where exch rate is adjusted at short intervals Where exch rate is adjusted at short intervals to compensate for inflation differentials.to compensate for inflation differentials.

Countries that trade with one single currency Countries that trade with one single currency pegs their exchange rate to that currency.pegs their exchange rate to that currency.

ConclusionConclusion

Peggers ; small size , open Peggers ; small size , open economy,Harmonious inflation rate, economy,Harmonious inflation rate, concentrated trade.concentrated trade.

Floaters; Large Size , Closed economy , Floaters; Large Size , Closed economy , Divergent inflation rate , diversified trade.Divergent inflation rate , diversified trade.