Shibu lijack

Agenda

 Phases of Currency Evolution

 Gold Standard
 Bretton Woods
 Floating Exchange Rate
 Euro
 Feasibility
 Future of Dollar
 Various Option Explored
Phases of Currency Evolution
 The history of money consists of three phases:

• Actual valuable objects were bartered

Commodity
Money

• Paper notes are used to represent real commodities stored

Representative elsewhere
Money

• Paper notes are backed only by use of' "lawful force and
legal tender laws" of the government, in particular by its
Fiat Money acceptability for payments of debts to the government
Introduction

 Gold Standard refers to a

system in which a county’s
currency is backed up fully or
partly by Gold reserves, and
the currency issuing authority
stands ready to purchase and
sell gold at stipulated rates
Rules to adapt gold standard
 The following are the four essential rules which each country on Gold
Standard must abide by:

 The Monetary authority of each country must take steps to fix the gold
value of its own national currency

 There must be a free import and export of gold into, and out of, each
country which follows this system

 Each monetary authority must make arrangements for the domestic

supply of its own money such that the supply of money varies directly
in a more or less automatic manner with changes in stock of gold

 There must be perfect wage flexibility in every country, both upwards

and downwards
How to fix the value of gold in
terms of its own currency
 Gold Specie Standard: Under this system, a country’s legal tender money
consists of gold coins of a specified gold content. The price of such a gold
coin is the price of gold it contains

 Gold Bullion Standard: Under this system, gold coins need not be in
circulation, but currency is freely convertible into gold at statutory prices

 Gold Exchange Standard : Central Bank is ready to buy and sell the
currency of another country which is itself on gold bullion or gold specie
standard , at stipulated rates
Example
 When 2 countries are on Gold Standard , the first two rules ensure that the
rate of exchange between them will be automatically determined and will
remain fixed with slight fluctuations

 Let us suppose that in country A, an ounce of gold costs $ 20, while in

country B, it costs £ 5. We therefore can say that £1=$4

 If gold movements from one country to another involve no costs, exchange

rates remain absolutely fixed
Advantages
 The gold standard limits the power of governments to inflate prices through
excessive issuance of paper currency

 It may tend to reduce uncertainty in international trade by providing a fixed

pattern of international exchange rates

 Under the classical international gold standard, disturbances in price levels

in one country would be partly or wholly offset by an automatic balance-of-
payment adjustment mechanism called the "price specie flow mechanism"
Case
 The total amount of gold that has ever been mined has been estimated at
around 142,000 tons

 Assuming a gold price of US$1,000 per ounce, or $32,500 per kilogram,

the total value of all the gold ever mined would be around $4.5 trillion

 This is less than the value of circulating money in the U.S. alone, where
more than $8.3 trillion is in circulation or in deposit

 For example, instead of using the ratio of $1,000 per ounce, the ratio can
be defined as $2,000 per ounce effectively raising the value of gold to $8
trillion. However, this is specifically a disadvantage of return to the gold
standard and not the efficacy of the gold standard itself
Disadvantage

 It is difficult to manipulate a gold standard to tailor to an economy’s

demand for money, providing practical constraints against the measures
that central banks might otherwise use to respond to economic crises

 Monetary policy would essentially be determined by the rate of gold

production. Fluctuations in the amount of gold that is mined could cause
inflation if there is an increase, or deflation if there is a decrease

 Some have contended that the gold standard may be susceptible to

speculative attacks when a government's financial position appears weak.
For example, some believe the United States was forced to raise its
interest rates in the middle of the Great Depression to defend the credibility
of its currency
History
 The use of paper money, convertible into gold, to replace gold coins,
originated in China in the 9th century AD

 Gold standards replaced the use of gold coins as currency in the 17th-19th
centuries in Europe

 In 1844 the Bank Charter Act established that Bank of England notes, fully
backed by gold, were the legal standard. According to the strict
interpretation of the gold standard, this 1844 Act marks the establishment
of a full gold standard for British money

 Governments faced with the need to fund high levels of expenditure, but
with limited sources of tax revenue, suspended convertibility of currency
into gold on a number of occasions in the 19th century. The British
government suspended convertibility during the Napoleonic wars and the
US government during the US Civil War. In both cases, convertibility was
resumed after the war
Gold standard from peak to
crisis (1901–1932)
 As in previous major wars under its gold standard, the British government
suspended the convertibility of Bank of England notes to gold in 1914 to fund military
operations during World War I

 As had happened after previous major wars, the UK returned to the gold standard in
1925. Although a higher gold price and significant inflation had followed the wartime
suspension, Churchill followed tradition by resuming conversion payments at the
pre-war gold price

 For five years prior to 1925 the gold price was managed downward to the pre-war
level, causing deflation throughout those countries of the British Empire and
Commonwealth using the Pound Sterling

 In order to attract gold, Britain needed to increase the value of investing in its
domestic assets. They needed to increase the demand for the pound. By doing this,
Britain attracted gold from the stronger US, which decreased the US money supply
as well as depressed Britain’s own economy. Because of these price declines and
predictable depressionary effects, the British government finally abandoned the
standard September 21, 1931
Depression and World War II
 During the 1939–1942 period, the UK depleted much of its gold stock in
purchases of ammunitions and weapon on a "cash and carry" basis from
the U.S. and other nations. This depletion of the UK's reserve convinced
Winston Churchill of the impracticality of returning to a pre-war style gold
standard. To put it simply the war had bankrupted Britain

 Quite possibly because of this, the 1944 Bretton Woods Agreement

established the International Monetary Fund and an international monetary
system based on convertibility of the various national currencies into a U.S.
dollar that was in turn convertible into gold. It also prevented countries from
manipulating their currency's value to gain an edge in international trade
Interesting Analysis

 According to later analysis, the earliness with which a country left the gold
standard reliably predicted its economic recovery from the great depression

 For example, Great Britain and Scandinavia, which left the gold standard in
1931, recovered much earlier than France and Belgium, which remained
on gold much longer. Countries such as China, which had a silver
standard, almost avoided the depression entirely
Introduction

 After the Second World War, a system similar to a Gold Standard was
established by the Bretton Woods Agreements

 Representatives of most of the world's leading nations met at Bretton

Woods, New Hampshire, in 1944 to create a new international monetary
system

 Because the United States at the time accounted for over half of the
world's manufacturing capacity and held most of the world's gold, the
leaders decided to tie world currencies to the dollar, which, in turn, they
agreed should be convertible into gold at $35 per ounce
Main Reason for Choosing
Dollar
 Political Scenario
 The political basis for the Bretton Woods system was in the confluence
of several key conditions:

• They shared experiences of the Great Depression, the

concentration of power in a small number of states (further
enhanced by the exclusion of a number of important nations
because of the war)

• Presence of a dominant power willing and able to assume a

leadership role in global monetary affairs
Shift of Power

 One of the reasons Bretton Woods worked was that the US was clearly the
most powerful country at the table and so ultimately was able to impose its
will on the others, including an often-dismayed Britain

 At the time, one senior official at the Bank of England described the deal
reached at Bretton Woods as “the greatest blow to Britain next to the war”,
largely because it underlined the way in which financial power had moved
from the UK to the US
Rules of Bretton Woods

 Member countries could only change their par value with IMF approval,
which was contingent on IMF determination that its balance of payments
was in a "fundamental disequilibrium”

 Members were required to establish a parity of their national currencies in

terms of gold (a "peg") and to maintain exchange rates within plus or minus
1% of parity (a "band") by intervening in their foreign exchange markets
(that is, buying or selling foreign money)
International Monetary Fund

 Officially established on December 27,

1945, when the 29 participating countries
at the conference of Bretton Woods
signed its Articles of Agreement, the IMF
was to be the keeper of the rules and the
main instrument of public International
management

 The Fund commenced its financial

operations on March 1, 1947

 IMF approval was necessary for any

change in exchange rates in excess of
10%. It advised countries on policies
affecting the monetary system
Problems with Bretton woods 1

 For the Bretton Woods system to remain workable, it would either have to
alter the peg of the dollar to gold, or it would have to maintain the free
market price for gold near the $35 per ounce official price

 The greater the gap between free market gold prices and central bank gold
prices, the greater the temptation to deal with internal economic issues by
buying gold at the Bretton Woods price and selling it on the open market

 Gold's price spiked in response to events such as the Cuban Missile Crisis,
and other smaller events, to as high as $40/ounce
 Arbitrage Opportunity

 The attempt to maintain the peg collapsed in November 1968, and a new
policy program was attempted
Floating Bretton Woods
 This occurred from 1968–72. By 1968, the attempt to defend the dollar at a
fixed peg of $35/ounce, the policy of the administrations had become
increasingly untenable

 By the early 1970s, as the Vietnam War accelerated inflation, the United
States as a whole began running a trade deficit (for the first time in the
twentieth century). The crucial turning point was 1970, which saw U.S. gold
coverage deteriorate from 55% to 22%

 Gold was revalued and at the same time dollar was devalued at $38/ounce,
then $44.20/ounce

 In February 1973 the Bretton Woods currency exchange markets closed,

after a last-gasp devaluation of the dollar to $44/ounce, and reopened in
March in a floating currency regime
The Floating Exchange Rate
 The market determines a floating exchange rate. In other words, a currency
is worth whatever buyers are willing to pay for it

 This is determined by supply and demand, which is in turn driven by

foreign investment, import/export ratios, inflation, and a host of other
economic factors

 Floating exchange rates are considered more efficient, because the market
will automatically correct the rate to reflect inflation and other economic
forces

 The floating system isn't perfect, though. If a country's economy suffers

from instability, a floating system will discourage investment. Investors
could fall victim to wild swings in the exchange rates, as well as disastrous
inflation
 The Foreign Exchange Market, or
Forex, is the most prolific financial
market in the world. Each day, over
$1 trillion worth of currency changes
hands
 Euro

On January 1, 2002, the euro became the single currency of

12 member states of the European Union -- making it the
second largest currency in the world (the U.S. dollar being
the largest)

 This was, to date, the largest currency event in the history

of the world; sixteen national currencies have
since completely disappeared and were replaced by the euro
Advantage of Euro
 Elimination of exchange-rate fluctuations
 The euro eliminates the fluctuations of currency values across certain borders

 Transaction costs
 Tourists and others who cross several borders during the course of a trip had to
exchange their money as they entered each new country. The costs of all of
these exchanges added up significantly. With the euro, no exchanges are
necessary within the Euroland countries

 Increased trade across borders

 The price transparency, elimination of exchange-rate fluctuations, and the
elimination of exchange-transaction costs all contribute to an increase in trade
across borders of all the Euroland countries

 Increased cross-border employment

 With a single currency, it is less cumbersome for people to cross into the next
country to work, because their salary is paid in the same currency they use in
their own country
You Just Cant Ignore it….
Interesting Facts

 Nearly 65% of global central bank reserves are held in US dollars, while
around 25% are in Euros

 Nearly 60% of international financial transactions are denominated in US

dollars, making it a global medium of exchange

 The emergence of the Euro since 1999 has given the US dollar tough
competition. It has been estimated that since early 2007 the value of Euro
notes in circulation has risen to over € 600 billion
Option 1- Single World Currency
 Advantages
 Elimination of transaction costs related to trading currencies
 Do away with the need of maintaining forex reserves
 Do away with currency risk, benefiting foreign investors
 Eliminate the chance of currency failure, which would make foreign
investment decisions much easier in emerging economies
 Such a currency would in one go eliminate the problem of current
account deficits as there would be no need for foreign exchange

 Disadvantage
 Loss of national monetary policy – A single currency would imply a
single interest rate. Thus, a region or nation experiencing economic
depression will be unable to use the interest rate lever to boost the
economy
 Political barriers – Political differences between nations make it
extremely difficult for them to adopt a common currency
Option 2-One More world
Reserve Currency
 Statement-French President Nicolas Sarkozy said that the dollar can't
remain the world's only reserve currency, as the rise of emerging powers
such as China and Russia challenge the U.S.'s prominence

 Another currency can be Euro, reason being the second most floated
currency

 Contradiction-Sarkozy also said that he won't allow the euro to be the only
currency to bear the weight of foreign exchange market adjustments as has
happened in the pas
Option 3-Back to Gold Standard
 During 1879-1914 , the classical gold standard era , the average inflation in
most countries was 1 percent

 The period after Bretton woods 1 saw two major energy crisis, at least 4
recessions, one currency crisis, national bankruptcies and bouts of
hyperinflation

 But during the same period the Gross GDP rose 400 percent to $ 62 trillion
What if India were to adopt the
Gold Standard???
 Money Supply in India Rs 49,72,000 crore
 It must keep gold for that value. But can it find so much Gold?

 Total Reserves in the Country-Rs 32,39,000 crore

 RBI’s Gold Reserves- Rs 19,50,000 crore

 RBI’s Forex reserves- Rs 12,42,000 crore

 Conclusion
 Even If RBI maps up all the gold in the country, It wont be able to
support the current money stock. It either needs more gold or higher
value for the stock
 The yellow metal’s rightful place is in jewellery, not monetary policy

Source: Forbes India , August 28, 2009

Conclusion
 Force by any means that we are still the only solution, it doesn’t matter
even if destroy the world financial System( We stands for USA)

 The dollar will keep its status as the ``world currency'' for 15 to 20
years, said Stephen Roach, chairman of Morgan Stanley Asia Ltd.,
after Chinese officials signalled plans to diversify from the slumping
U.S. currency

 Chinese Vice Foreign Minister He Yafei said U.S. dollar would continue
to be the world's leading reserve currency for years to come."The U.S.
dollar is still the most important and major reserve currency of the day,
and we believe that that situation will continue for many years to
come,“(Why wont they say- Export Oriented Economy)