International Monetary System

The Gold Standard

The earliest form of International Monetary system In use for 4 decades before the onset of World War I

The principles Domestic currency system (coins or paper) – fully repayable in

Gold Gold could be freely imported or exported in unlimited quantities

between countries The exchange rates were fixed on the basis of their gold parity at

fixed par values

The Gold Standard

The mechanism The flow of Gold from trade deficit countries to trade surplus Gold losing countries experienced reduction in money supply, money

income & fall in prices Gold receiving countries experienced increase in money supplies,

income & prices These conditions made goods & services flow from trade deficit

countries to surplus ones.

Thus gold standard system automatically restored equilibrium

The Gold Standard The breakdown

World War I rudely shattered the economic order Because of hyper Inflation – gold payments were suspended Consequently convertibility of currencies broke down It was expected that freely fluctuating exchange rates would restore

competitive price and cost system which would automatically restore stability However, it stimulated speculation in hot currencies

Over valuation of Pound Sterling Undervaluation of French & Belgium Francs Collapse of German Mark

Due to war – free trade & flexible exchange rate gave way to restrictions & exchange control

And the world went into complete disarray leading to collapse of the gold standard

What Happened Next… Restoration attempts were not very successful.

And in 1931 with Britain going off gold standard – it finally collapsed

Emergence of currency blocs Formal & Informal arrangements between members 4 prominent blocs

Sterling area, French Bloc, COMECON (Soviet Bloc), Dollar area It was a chaotic monetary system

With multiple exchange rates Exchange rate fluctuations were frequent Import restrictions & exchange controls were widespread Competitive devaluation had become order of the day.

All this lead to serious economic erosion of super powers – USA, UK, & France

The order was finally restored with establishment of IMF.

International Monetary Fund IMF – came into existence in 1945 & started functioning in 1947

Started with 7 members and had 180 members in 2000.

It combined the characteristics of both Gold standard;

Gold remained the universally accepted medium payment.

Fluctuating exchange rate Dollar & Pound Sterling emerged as reserve currencies supplementing Gold

as internationally acceptable assets.

Exchange rates were fixed in Gold and also linked to Dollar or Pound With fixation of exchange rates – convertibility of currencies was

restored.

International Monetary Fund

IMF also restored multilateral payment system with following conditions.

No country is supposed to impose new exchange controls without IMF’sapproval.

To ensure flexibility in exchange rates within prescribed limits – the members were not permitted to vary spot exchange rates more

than 1 % beyond upper & lower limits.

To deal with short run payment difficulties a member will be allowed to borrow 25% of the quota in a year – though total borrowing can be 125% of the quota across 5 years.

To overcome fundamental disequilibrium – IMF may permit devaluation of currency by 10%. Beyond that only through negotiations

International Monetary Fund

With the establishment of IMF:

Within 5 years multilateral payment system was fully restored By 1958 most major currencies had become convertible, restrictions

on payment had disappeared and a free payment system was

universally established

International Monetary Fund

Purpose of IMF To promote international monetary cooperation

To facilitate expansion and balanced growth of international trade

To maintain exchange rate stability

To assist members in establishment of multilateral system of payments and elimination of foreign exchange restrictions

To give confidence to members by making fund’s resources available to them to correct balance of payments

To shorten the duration and lessen the degree of disequilibrium in the international balance of payments of members

Collapse of IMF System

In 1960s – there was serious inadequacy of international liquidity

Shortage of gold & foreign exchange reserves to remove in deficit in BOP because world trade was growing faster than world reserves

For instance during 1950-71 world trade grew at 8 % per annum – where as Reserve increased by 2-3% per annum during this period

The smaller stock of gold and fixed exchange rate system created instability.

Led to severe BOP Deficit in USA

Special Drawing Rights

This necessitated the search for a new kind of reserve asset to supplement gold stock & create additional international liquidity

SDR

Special Drawing Rights

SDR – is a kind of ‘reserve asset’ – created through amendmentof IMF system.

It is nick-named ‘paper gold’ – since it performs the functions of gold in international payment system

It is not A paper currency Nor a coin Nor a credit note Nor a treasury bill

SDRs are simply entries in SDR-account of participating countries.

Though SDRs figure in the published reserves of a nation.

Special Drawing Rights

SDRs serve as ‘means of payment’ between the participating

nations for the purpose of legitimate purchase of foreign exchanges

and for making up for the deficit in balance of payment.

In SDR transactions participating nations are not required to transfer

their currency or any other asset against SDRs received in allocation.

They are simply credited to the participants’ accounts and are then available for use.

SDRs are defined in terms of a basket of major currencies used in international trade and finance. The amounts of each currency making up one SDR are chosen in accordance with the relative importance of the currency in international trade and finance

Special Drawing Rights

3 ways to transact in SDRs Receive foreign exchange from a participant designated by the fund Through mutual agreements between the participants to redeem

their own currency held by another nation For transaction with the Fund’s General Account.

SDR Quota

Quota subscriptions generate most of the IMF's financial resources. Each member country of the IMF is assigned a quota, based broadly

on its relative size in the world economy. A member's quota determines its maximum financial commitment to

the IMF and its voting power, and has a bearing on its access to IMF financing. Total quotas at end-March 2008 were SDR 217.3 billion (about $357.3 billion).

Special Drawing Rights

What are the functions of quotas?

Subscriptions. A member's quota subscription determines the maximum amount of financial resources the member is obliged to provide to the IMF.

A member must pay its subscription in full upon joining the Fund: up to 25 percent must be paid in SDRs or widely accepted currencies (such as the U.S. dollar, the euro, the yen, or the pound sterling), while the rest is paid in the member's own currency.

Access to financing.

The amount of financing a member can obtain from the IMF (its access limit) is based on its quota, a member can borrow up to 100 percent of its quota annually and 300 percent cumulatively.

Composition of SDR

• The largest member of the IMF is the United States, with a quota of SDR 37.1 billion (about $61.0 billion),• The smallest member is Palau, with a quota of SDR 3.1 million (about $5.1 million).

The Present IMF System

The present IMF is on MANAGED FLOATING SYSYTEM

It allows member nations the choice of foreign exchange as long as it does not injure the interest of their trade partners.

Most of the nations pegged their currencies to the US Dollar, SDR and basket of currencies.

Trade Agreements

Need for Trade Agreements Helps in overcoming trade barriers

Promotes trade amongst member countries

Increases efficiency – through economies of scale (spreading fixed cost over larger regional markets)

Increased economic growth from foreign direct investment

Promotes regional infant industries through protected regional market

Increased security of market access for smaller countries.

Improves members bargaining strength in multilateral trade negotiations.

Strengthens political ties and managing migration flows.

Trade Agreements

Trade Agreements

Bi-lateral Regional Multi-lateral

Trade Agreements

Bi-Lateral Agreement

Trade agreements between two countries.

Regional Trade Agreements (RTAs) :

Trade agreements between group of countries – may or may not belong to same geographical region

Multi-lateral Agreements

Trade agreements between multiple countries – GATT/WTO

Multilateral Trade GATT ( General Agreement of Trade and Tariff)

Formed in 1948 to liberalize Trade.

Till 1994 this was the forum for negotiating lower customs duty rates and reducing other trade barriers.

Provided a framework for trade expansion vis-à-vis removing barriers on free movement of goods and services.

‘Rounds’ the West, negotiated trade deals with themselves in mind.

The developing world were forgotten as backward and without any clout.

GATT v/s WTO

GATT WTOIt is Adhoc and provisional. Its agreement are permanent.

It had contracting parties. It has members.

It allowed existing domestic legislation to continue even if it violated the agreement.

WTO does not permit it.

It was less powerful, dispute system settlement system was slow and less efficient and its ruling could be blocked.

WTO is more powerful, mechanism faster and more efficient and difficult to block the rulings.

WTO IMPACT

GATT / GATS TRIMS TRIPS

Liberalisation of trade in

goods and services

Liberalisation of international investment

Provides monopoly power to owners of intellectual

Multilateral Trade

The WTO (World Trade Organisation) is an international organization dealing with the rules of trade between countries.

The WTO can be said to be made up of different entities:

Laws governing international commerce and are contracts by which governments agree to trade policies that would be beneficial to all the WTO member nations.

Countries can negotiate these agreements, settle disputes arising from the agreements and help other countries join the negotiations .

WTO is GATT plus – GATS (General agreement on trade in services) and TRIPS (Trade related intellectual property rights).

Helping countries, especially developing countries, develop and review national trade policies.

Regional Trade Agreements

RTA focus – not only true for India but it is a global reality

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“What should be India’s focus – bilateral/ regional or

multilateral trade agreement?”

Multilateral Trade Overwhelming dominance of developed countries in the WTO.

The developing countries have not gained any meaningful increase in market access in the key areas where they have comparative advantage (textiles and agriculture).

Liberalization of services or trade has occurred only in sectors which are of primary interest to developed countries like IT, ITES, automobile and some manufactured goods.

Declining industrial tariff and removal of all quantitative restrictions has the potential to harm the industrial sector of developing countries.

Free trade is more suitable to the advanced countries which have already established their industrial base.

Bilateral/ Regional Trade Help the developing countries to expand market access without

compromising on national policies and interests

Lead to lower dependence on developed country markets and help in resisting the pressures of economic superpowers

Helps to forge and foster stronger alliances at the multilateral trade negotiations.

Allows infant industry protection

Thus, India is : Focussing on BLT/RTAs first. So that it can balance differences and

build capabilities at par with developed countries and then move towards a multilateral trade regime.

Some of the recent alignments Free trade area (FTA) agreements with Sri Lanka and Thailand Advance stages of free trade area agreement with Singapore Signed a framework agreement for a free trade area with the

members of the Association of South East Asian Nations (ASEAN) An agreement to create a South Asian Free Trade Area (SAFTA). Approached distant trading partners such as South Africa and Brazil