2. Introduction to International Monetory Developments (1)

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Introduction to International

Monetory Developments



What is money?



Fixed Exchange Rate

• Exchange rate between 2 countries is Fixed

• Government or central bank ties the official exchange rate to

another country's currency (or the price of gold).

• The purpose of a fixed exchange rate system is to maintain a

country's currency value within a very narrow band.

• Also known as pegged exchange rate.



• Gold Standard

• Rate can vary fractionally

– BOP deficit

– BOP Surplus



Benefits of Fixed Exchange Rate

• Promotion of International Trade

• Promotion of International Investment

•

Prevention of Speculation• Long Term Planning

• Poor Economies



Limitations of Fixed Exchange Rate

• Gold is Scarce/Limited

• No automatic balance of payments

adjustment

• Large holdings of foreign exchange reserves

required

– Opportunity cost



Floating/Flexible Exchange Rate

• Exchange rates are determined by conditions

of demand and supply

• Rates are free to fluctuate

• Global and International economic factors

determine the rate



Benefits of Floating rates

• Automatic adjustment of BOP

• Less intervention needed by Central

Bank/Govt

• Better Liquidity

• Free Trade

•

Independence of Policy



Limitations of Floating rates

• Speculation

• Uncertainty

•

Lack of investment• Lack of discipline in economic management

• Adverse Effect on Economic Structure



Gold Standard

• Value of currency was kept equal to the value

of a fixed weight of Gold

• Gold Standard took 3 forms over period:

– Gold Currency Standard

– Gold Bullion Standard

– Gold Exchange Standard



• Gold Currency Standard

– Gold coins of definite weight and fineness were

circulated as standard unit of currency

– Other metal coins like nickel and silver were also

circulated

– Can be used as industrial or commercial purpose

– Free flow of Gold between countries, norestrictions



• Gold Bullion Standard (GBS) [1815 onwards]

– Limitations of Gold Currency Standard depletedgold reserves as deficit was paid by exporting gold

– Under GBS, paper currency replaced gold coins – Paper currency was expressed as a definite

quantity of gold

– Gold acted reserve for the currency in circulation

– World War I phase [ July 1914-Nov 1918]



• Gold Bullion Standard (GBS) [1815-1914]



• Gold Exchange Standard [1926 onwards]

– Nations consisted of paper currency and coins

– Not expressed in terms of gold but in terms of

foreign currency

– Gold coins were not circulated and gold wasn’t

kept as reserve for circulation

– World War II Phase [1939-1945]



• Gold Exchange Standard [1926 onwards]

– Example:

• A "gold exchange standard" is one where the nation

doesn't have an independent peg to gold bullion.• The currency is pegged to another international, gold-

linked currency, such as the British pound or U.S. dollar.

• If the British pound is pegged to gold and your currency

is pegged to the British pound, then your currency isalso pegged to gold.



Bretton Woods System

• World War II

• Bretton Woods Agreements – 730 delegates from all 44 Allied Nations on July 1944

in Bretton Woods, New Hampshire, US

– Setting up system of rules, institutions and proceduresto regulate international monetory system

– Establishment of IMF, IBRD• IMF would deal with int. monitory issues like reserve

currency, BOP deficit, exchange rate equilibrium• IBRD purpose was to finance the reconstruction of nations

devastated by WW2

• Fight poverty and development with capital financing



• Adoption of monitory policy that maintained exchangerate by tying its currency to U.S.

• Reserve will be in Pound, Dollar or gold

• Exchange rate was Fixed

• On August 15, 1971, the United States unilaterallyterminated convertibility of the dollar to gold

• Dollar became fully ‘Fiat Currency’

• Purpose:

1. Pool of international reserves2. Removal of BOP deficit

3. Maintenance of exchange rates



Failure of Bretton Woods System

1. Defective Economic Policies of US

– Dollar shortage to Dollar Glut/excess/abundance

– US spent lavishly in Viet-Nam war and the same

was the situation in case of space-raceexpenditure

– US deficits in budget increased

– Supply of dollars increased heavily and confidencein dollars decreased



2. Increase in Price of Gold

– Because of depreciating Dollar, rate went from

35$ to 200$ per ounce

– Speculators started purchasing Gold instead of Dollar

– France Govt. started accumulating Gold in

anticipation of failure of BWS



3. Insufficient Sources of IMF

– The components of BWS i-e gold, dollar and pound had

to face certain complications

–Deficits of under-developed countries went worst whilethose of developed countries went on improving

– Under-developed countries demanded for more

resources to meet their deficits

–IMF could not fulfill because of Insufficient Funds



4. Fixed Exchange Rate

– Value of each currency in dollar or in pound

remained fixed

– Deficits of the poor countries went on increasingrather decreasing

– Poor countries had to pay heavy interest



The End

2. Introduction to International Monetory Developments (1)

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