INTERNATIONAL MONETARY SYSTEM

INTRODUCTION

International Trade - BarterBond issues to finance infrastructure projects in developing countries (19th

century)Gold Standard (1879 - 1934)Bretton Woods (1944 - 1971)1960s: Decline of U.S Economy1971: Devaluation of DollarManaged / Dirty float

America,Germany first to free capital flows Britain, 1979, Japan, 1980 (mostly) France, Italy removed restrictions in 1990 Currency Board in Hong Kong Dollarisation Creeping peg in Brazil The Euro The rise of China Is the dollar losing its importance?

Forex MarketsPlayers : Individuals, corporate banks, central

banks and securities firms95 % of trading between banksMore than 97 % or trading is speculativeTrading almost around the clockDealing roomReuter’s screen Society for Worldwide Interbank Financial

Telecommunication, Sophisticated electronics technology.

GLOBAL FOREX TRADING

• Auckland Zurich• Sydney Paris• Tokyo London• Singapore New York• Frankfurt

• Peak trading during European waking hours• New York most active when Europe is open• During afternoon, New York becomes more volatile• Worst time to trade - after New York closes but Sydney has not

opened

Currencies : ISO CodesCurrency Code Currency Code

Aus $ AUH Italian Lira ITL Aus SchillingATS Japanese Yen JPYBelgian Franc BEF New Zealand Dollar NZDSterling GBP Norway Krone NOKCan $ CAD Portugese Escudo PTEDan Kr DKK Saudi Riyal SARDeutsche Mark DEM Singapore $ SGDDutch Guilder NLG Spanish Peseta ESPFrench Franc FRF Swedish Kroner SEKHongkong Dollar HKD Swiss Franc CHFIrish Punt IEP US Dollar USD

Note: Reuters uses ISO Codes

COUNTRY’S CHOICE OF EXCHANGE RATE SYSTEM

Openness :Relatively closed economies may find it difficult to correct external imbalances using domestic policies. They would prefer flexible exchange rates. On the other hand, open economies would prefer fixed exchange rates.

Size :Small countries tend to prefer fixed exchange rates. Economic policy can be tailored to meet the needs of the economy as a whole. In a diversified large economy, flexible rates are preferable.

Export dependence on a few commodities

Fixed exchange rate preferable. Otherwise disruptive effect on economy

Capital A/C Convertibility

Heavy inflows and outflows of capital create considerable difficulties in maintaining fixed exchange rate

Exchange Rate regimes(Q1, 1998)

Fixed : 35.7%Managed floating : 29.7%Independently floating : 25.3%Others : 9.3%

A NEW FINANCIAL ARCHITECTURE

1994- Mexican Peso crisis1997- Asian currency crisis1998- Brazil/RussiaBasic issues

* weak financial systems* poor supervision and regulation* too much short term borrowing* false security of stable exchange rates* once crisis struck, contagion effects because of interconnected financial markets

Basic objectives of policy makerscontinuing national sovereigntyglobally regulated financial marketsbenefits of global capital markets

Ideas being suggestedreintroduction of capital controlscreation of global central bankworld currencyglobal financial regulatorremove IMF due to moral hazard

Practical suggestions• improve disclosure norms• put pressure for introducing bankruptcy lawsFloating exchange rates can overshoot but allow country to retain

independence as far as monetary policies are concerned . This freedom is however more limited than it looks prima facie.

Fixed rates mean subservience to monetary policies of another country

Emerging scenario- Two groups of countries• Flexible exchange rates , relatively low level of integration into global

capital markets• Fixed exchange rates- Tightly integrated into global capital markets,

foreign ownership, Euro or dollar zones

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