INTERNATIONAL

MONETARY SYSTEM

Why do economies need money? moneyas a unit of account

that is used as a medium of exchange in transactions. Without
money, individuals and businesses would have a harder time
obtaining (purchasing) or exchanging (selling) what they need,
want, or make. Money provides us with a universally accepted
medium of exchange.
Thousands of years ago, people had to barter if they wanted
to get something. That worked well if the two people each
wanted what the other had. Even today, bartering exists.
History shows that ancient Egypt and Mesopotamiabegan to
use a system based on the highly coveted coins of gold and
silver, also known asbullion, which is the purest form of the
precious metal. However, bartering remained the most
common form of exchange and trade.
Gold and silver coins gradually emerged in the use of trading,
although the level of pure gold and silver content impacted the
coins value. Only coins that consist of the pure precious metal
are bullions; all other coins are referred to simply ascoins.

An international monetary system can be regarded as

(i) the set of conventions, rules and policy instruments
(ii) the economic, institutional and political environment
which determine the delivery of two fundamental global
public goods: an international currency (or currencies)
and external stability.

Key Features
Different Currencies
International Flow Of Money
Institutional Framework
Determination of Exchange Rate
Political and Economic Policy
Regulatory Framework of International Monetary System

Important Constituents
Currency
Exchange Rate
Leading Institutions
Political and Economic Integration

Bimetallism
In 1791, most of the world's leading nations were on a

bimetallic standard in which both gold and silver served as the

basis for coinage (known as "specie").
Following the recommendations of Alexander Hamilton and
Thomas Jefferson, the U.S. Congress passed the Coinage Act of
1792, in which a gold eagle ($10) gold piece of 247.50 grains,
100 percent fine, a silver dollar of 371.25 grains, and subsidiary
silver coins including half-dollars, quarters, and dimes of
proportional weight became the money standard for the new
nation.

Bimetallism was intended to increase the supply of money,

stabilize prices, and facilitate setting exchange rates.

Some authors, such asAngela RedishorCharles Kindleberger
have argued that bimetallism was, by construction, unstable.
Changes in gold-silver exchange were, in their eyes, leading
to massive changes in the money supply.
Bimetallism was thus inherently flawed and the advent of
thegold standard was inevitable

The practical difficulties of having two metals as money led

one nation after another to abandon the effort, and to adopt

a system of monometallism, using gold to back the
currency.
The historical development of coinage in modern nations

has been from silver monometallism through a more or less

unsatisfactory experience with bimetallism, to the single
gold standard. Still, in the twentieth century, both metals
lost their former importance within monetary systems. Now,
monometallism in the form of thegold standard has been
abandoned by all nations.

GOLD STANDARD

 A gold standard is a monetary system in which the standard

economic unit of account is based on a fixed quantity of gold.

Three types can be distinguished: specie, exchange, and bullion.
In the gold specie standard the monetary unit is associated
with the value of circulating gold coins or the monetary unit has
the value of a certain circulating gold coin.
The gold bullion standard is a system in which gold coins do
not circulate, but the authorities agree to sell gold bullion on
demand at a fixed price in exchange for the circulating
currency.
The gold exchange standard usually does not involve the
circulation of gold coins. The main feature of the gold exchange
standard is that the government guarantees a fixed exchange
rate to the currency of another country that uses a gold
standard (specie or bullion), regardless of what type of notes or
coins are used as a means of exchange.
Most nations abandoned the gold standard as the basis of
their monetary

Origin
The gold specie standard arose from the widespread acceptance of

gold as currency.
Various commodities have been used as money and the use of
gold as money began thousands of years ago in Asia Minor.
In 1717, Sir Isaac Newton, the master of the Royal Mint,
established a new mint ratio between silver and gold that had the
effect of driving silver out of circulation and putting Britain on a
gold standard.
A formal gold specie standard was first established in 1821, when
Britain adopted it. The United Province of Canada in 1853,
Newfoundland in 1865, and the United States and Germany in
1873 adopted gold.
The gold specie standard came to an end in the United Kingdom
and the rest of the British Empire with the outbreak of World War I.

Three types of Gold Currency

Impact of World War I

By the end of 1913, the classical gold standard was at its peak

but World War I caused many countries to suspend or abandon

it.
In financing the war and abandoning gold, many of the
belligerents suffered drastic inflations.
Price levels doubled in the US and Britain and tripled in France.
Ultimately, the system could not deal quickly enough with the
large balance of payments deficits and surpluses as the system
was under the pressures of war and rapid technological change.
For example, Germany had gone off the gold standard in 1914,
and could not effectively return to it because War reparations
had cost it much of its gold reserves.

Gold Bullion replaces Gold

Specie as Standard
The gold specie standard ended in the United Kingdom and

the rest of the British Empire at the outbreak of World War I.

Treasury notes replaced the circulation of gold sovereigns
and gold half sovereigns.
The British Gold Standard Act 1925 both introduced the
gold bullion standard and simultaneously repealed the gold
specie standard. The new standard ended the circulation of
gold specie coins.
Many other countries followed Britain in returning to the
gold standard, this was followed by a period of relative
stability but also deflation.
This state of affairs lasted until the Great Depression
(19291939) forced countries off the gold standard.

William McKinley (25th US President) ran

for president on the basis of the gold
standard.

Great Depression
Some economic historians, blame the gold standard of the

1920s for prolonging the economic depression which started

in 1929 and lasted for about a decade.
Adherence to the gold standard prevented the Federal
Reserve from expanding the money supply to stimulate the
economy, fund insolvent banks and fund government
deficits that could "prime the pump" for an expansion.
The gold standard limited the flexibility of the central banks'
monetary policy by limiting their ability to expand the
money supply.
Once off the gold standard, it became free to engage in
such money creation.

Advantages
Long-term price stability
The gold standard provides fixed international

exchange rates between participating countries and

thus reduces uncertainty in international trade.
A gold standard does not allow some types of financial
repression.
It stands as a protector of property rights.

Disadvantages
The unequal distribution of gold deposits makes the gold standard
more advantageous for those countries that produce gold.
Some economists believe that the gold standard acts as a limit on
economic growth.
Although the gold standard brings long-run price stability, it is
historically associated with high short-run price volatility.
Deflation punishes debtors. Real debt burdens therefore rise,
causing borrowers to cut spending to service their debts or to
default. Lenders become wealthier, but may choose to save some
of the additional wealth, reducing GDP.
The money supply would essentially be determined by the rate of
gold production.
Devaluing a currency under a gold standard would generally
produce sharper changes than the smooth declines seen in fiat
currencies, depending on the method of devaluation.
Most economists favour a low, positive rate of inflation of around
2%.

THE BRETTON WOODS

SYSTEM

The more the markets grow, the lesser the control. The
lesser the control, the greater is the yearning to control
it.

 One such control measure was undertaken in 1944 when 44

nations came together to bring back order in a chaotic financial

world.
The gestation of the Bretton woods conference arose in the minds
of two men of different temper and background but equal brilliance
and arrogance. They were the British economist John Maynard
Keynes and Henry Dexter White of the US treasury.
The United Nations Monetary And Financial Conference
better known as the Bretton Woods Conference, established a
currency regime and two powerful institutions, the International
Monetary Fund and the World Bank.

Harry Dexter
White

John Maynard
Keynes

System
After World War I most countries wanted to return to the old financial security
and stable situation of pre-war times as soon as possible. Discussions about a
return to the gold standard began and by 1926 all leading economies had reestablished the system, according to which every nations circulating money had
to be backed by reserves of gold and foreign currencies to a certain extent. But
several mistakes in implementing the gold standard (mainly that a weakened
Great Britain had to take the leading part and that a number of main currencies
where over- or undervalued) led to a collapse of the economic and financial
relations, peaking in the Great Depression in 1929. Every single country tried to
increase the competitiveness of its export products in order to reduce its payment
balance deficit by deflating its currency.

This strategy only led to success as long as a country was deflating faster and
more strongly than all other nations. This fact resulted in an international
deflation competition that caused mass unemployment, bankruptcy of
enterprises, the failing of credit institutions, as well as hyper inflations in the
countries concerned.

In the 1930s several conferences dealing with the world monetary problems
caused by the
Great Depression had ended in failure. But after World War II the need for a
stabilising system that avoided the mistakes, which had been made earlier,
became evident. Plans were made for an innovative monetary system and a

The Conference

Bretton Woods refers to the international

monetary system adopted in July 1944 that
established rules for rebuilding the post-war
economic order.
The scenario discussed here is when World War is
still not over; despite of these 730 delegates from
44 Allied nations attended the conference at the
Mount Washington Hotel in Bretton Woods,
N.H., to create a new monetary structure for the
financial and commercial relations among the
worlds leading economies.
The goal was to avoid a replay of the economic
disasters of the 1930s.
John Maynard Keynes who stated: We, the
delegates of this Conference, Mr President,
have been trying to accomplish something
very difficult to accomplish.[...] It has been
our task to find a common measure, a
common standard, a common rule
acceptable to each and not irksome to any.

The Two ideas

The ideas of John Maynard Keynes and Harry Dexter White have been
described as very different from each other on several occasions but
in fact there are extraordinary similarities. According to the White
plan, a Bank for Reconstruction (today the World Bank) and an
International Stabilisation Fund should be established. The
Keynes plan called for the same.

The only difference was that Keynes wanted to vest the IMF with
possibilities to create money and with the authority to take actions on
a much larger scale. In case of balance of payments imbalances John
Maynard Keynes recommended that both sides, debtors and
creditors, should change their policies. Countries with payment
surpluses should increase their imports from the deficit countries and
thereby create a foreign trade equilibrium. Harry Dexter White, on
the other hand, saw an imbalance as a problem only of the deficit
country. Economists today agree that White was mistaken and Keynes

However, Keynes plan was never discussed seriously at

Bretton Woods and the participants agreed on the White plan.
The United States defined the value of its dollar in terms of
gold, so that one ounce of gold was equal to $ 35. All other
members had to define the value of their money according to
what was called the par value system in terms of U.S. dollars
or gold.

28g

$3

The dominant role of the

USA
The USA has been and still is the dominating power of the Bretton Woods
system. After World War II the United States was the country with the biggest
economic potential.
The U.S. dollar was the currency with the most purchasing power and it was
the only currency that was backed by gold.
Additionally, all European nations that had been involved in World War II
were highly in debt and transferred large amounts of gold into the United
States, a fact that contributed to the supremacy of the USA. Thus, the U.S.
dollar was strongly appreciated in the rest of the world and therefore
became the key currency of the Bretton Woods system.
The headquarters of the two main institutions (the IMF and the World Bank)
are situated in Washington D.C. The dominant role of the USA already
became apparent when the American ideas of the Bretton Woods system
gained more acceptance than those of Great Britain. The plans of the
British economist John Maynard Keynes were rejected and the model
of the American economist White was favoured.
Some delegates grumbled that the United States was using its new
superpower status to push its own interests like global free trade and
that it was slow to compromise. At one point, the British representative, the
economist John Maynard Keynes, wrote that the Americans plainly intend
to force their own conceptions through, regardless of the rest of

The Implied Bargain

The U.S.
becomes a global
hegemon due to
strength of the
dollar

U.S. is able to act

unilaterally to
secure its own
interests

US's allies acquiesce to this

hegemonic system because it
benefits their own economies

U.S. allows allies

use of the system
for their own benefit

Development at the Bretton

Woods
Under the agreement at Bretton Woods, countries were to
maintain an exchange rate in which the values of their
currencies could fluctuate only within a narrow range around
a fixed value based on gold. Gold's value was set in terms of
the U.S. dollar. Two organizations were set up to help govern
the international monetary system:
the International Monetary Fund which would address
temporary imbalances of payments
the International Bank for Reconstruction and
Development, which is now the chief agency of the World
Bank Group.

Purpose of IMF:
To promote international monetary cooperation by establishing a

global monitoring agency that supervises, consults, and

collaborates on monetary problems.
To facilitate world trade expansion and thereby contributes to the
promotion and maintenance of high levels of employment and real
income.
To ensures exchange rate stability to avoid competitive exchange
depreciation.
To eliminates foreign exchange restrictions.
To assist in creating systems of payment for multilateral trade.

Purpose of IBRD :
The World Bank comprises of two institutions:

theInternational Bank for Reconstruction and

Development(IBRD), and theInternational Development
Association(IDA).
To improve the living standards
To eliminate the worst forms of poverty.
To support the restructuring process of economies.
To provide capital for productive investments.
To encourages foreign direct investment by making
guarantees or accepting partnerships with investors.
To keep payments in developing countries balanced and
fosters international trade. It is active in more than 100
developing economies.
To offer financial services, analytical, advisory, and capacity
building.

Crisis of the system

In the 1960s and 1970s enduring imbalances of payments between

the Western industrialised countries weakened the system of

Bretton Woods.
However, in the 1960s they ran a very inflationary policy and
limited the convertibility of the U.S. dollar because the reserves
were insufficient to meet the demand for their currency. The other
member countries were not willing to accept the high inflation rates
that the par value system would have caused and the dollar
ended up being weak and unwanted, just as predicted by
Greshams law: Bad money drives out good money.
The system of Bretton Woods collapsed.

Relevance Today
For decades, the dollar has been the world's most widely used currency.

Many governments hold a large portion of their reserves in dollars. Crude

oil and many commodities are priced in dollars. Business deals around
the world are done in dollars. But the financial crisis has highlighted how
America's economic problems can wreak havoc on nations around the
world.
The world financial crisis, largely a result of excessive risk-taking and

faulty risk management practices in the financial markets, has

highlighted the immediate need for comprehensive reforms to the
existing global economic and financial structure.
The sub-loan crisis in the United States led to the collapse of the world

economy and has brought an immeasurable loss to the entire world.

Restructuring the anachronistic Bretton Woods system needs - re-

examining reserve currencies, dealing with growing public debt and the
symbiotic relationship of the state with finance capital, regulating stock
markets, hedge funds, and banks to avoid future disasters.

Zhou Xiaochuan, governor of

China's central bank, has proposed
creating as part of reform in the
international monetary system.
Create a currency made up of a
basket of global currencies and
controlled by the International
Monetary Fund. Call for a global
currency to replace the dominant
dollar.

Summary

In July of 1944, as World War II is coming to an end, all 44 allied

countries meet in Bretton Woods, New Hampshire for the purpose

of establishing a new international monetary system.
At Bretton Woods, countries agree that fixed exchange rates were
necessary for restarting world trade and global investment (both
of which had fallen dramatically).
It is also obvious that the US dollar would become the cornerstone
of any new international monetary system.
Key points of the Bretton Woods were:

Pegging the U.S. dollar to gold at $35 per ounce (with the USD the only
currency convertible into gold).

All other countries peg their currencies to the U.S. dollar.

Their par values are set in relation to the U.S. dollar

GBP = $2.80; JPY = 360 (1in 1949)
Countries agreed to support their exchange rates within + or
1% of these par values.
This is done through the buying or selling of foreign exchange
when market forces needed to be offset.
International Monetary Fund and the International Bank for
Reconstruction and Development were set up.

POST BRETTON
WOODS SYSTEM

The Seeds of Bretton

Woods Demise
In the 1960s, Bretton Woods begins to unravel.
President Lyndon Johnson tries to finance both his Great

Society programs at home and the American war in

Vietnam.
This produces a large US Federal budget deficit, which,
coupled with easy monetary policy, results in:
High inflation in the United States and
An increase in U.S. spending for cheaper imports
As a result, the United States balance of payments moves
from a surplus into a deficit.
Dollar is seen by the market as overvalued.
Foreigners become concerned about holding overvalued
U.S. dollars at a rate of $35 an ounce.
Markets are suggesting it should take more than $35 to
buy 1 oz of gold.

U.S. Balance of Payments: 1965 By the mid-1960, the U.S. balance of payment (e.g., trade

balance) started to deteriorate (a declining surplus).

By 1971, the U.S. merchandise trade balance moved into
deficit.

The Last Years of Bretton

Woods: 1970 -1973
By 1970, financial markets are reluctant to hold the overvalued

U.S. dollar.
Markets sell USD on foreign exchange markets.
This puts downward pressure on the exchange rate for dollars.
And upward pressure on the exchange rate for foreign
currencies.
Central banks engage in massive intervention in an attempt to
hold their Bretton Woods par values.
Central banks buy U.S. dollars as they are sold in markets.
As a result, foreign holdings of dollars increase dramatically and
eventually exceed U.S. gold holdings.
By 1971, gold coverage for U.S. dollars had dropped to 22%.
In August 1971, President Nixon suspends dollar convertibility
into gold.
In response, more dollars are sold on foreign exchange
markets pushing the dollar lower (and foreign currencies

Smithsonian Agreements,
December 1971
In December 1971, ten major counties meet in Washington,

D.C. with the aim of restoring stability to the international

monetary system.
Meeting concludes with the Smithsonian Agreements, whereby:
Key countries agree to revalue their currencies and in
essence set new par values against the US dollar (e.g., yen
+17%, mark +13.5%, pound and franc +9%)
The U.S. also agrees to raise the dollar price of gold from
$35 to $38 an ounce (represents a further devaluation of the
dollar).
It was also agreed that currencies could now fluctuate + or
2.25% around their new par values.

The Final Collapse of the Dollar,

February 1973
13 months after the Smithsonian Agreements, the dollar

comes under renewed attack for being overvalued.

In February 1973, markets sell off dollars again.
As before, central banks intervene and buy dollars.
On February, 12th, 1973 the dollar is devalued further to $42
per ounce.
But the price of gold on the London gold markets trades
at $70 per ounce.
Japan and Italy finally let their currencies float on
February 13th.
France and Germany continue to manage their currencies
in relation to the dollar.
In response to mounting speculative currency flows,
foreign exchange markets are closed on March 1, 1973,
and reopen on March 19, 1973.

The End of Bretton Woods

On March, 19, 1973, when foreign exchange markets

reopen, major countries announce that they are

floating their currencies:
On March 19, 1973, the list of countries floating their
currencies includes Japan, Canada, and those in
Western Europe.
The Bretton Woods fixed exchange rate system effectively
ends on this date.
Approximately 3 months later, by June 1973, the dollar
has floated down an average of 10% against the major
currencies of the world.

The Yen During Bretton Woods

JPY Exchange Rate: 1950 - 1970
361.4
361.2
361
360.8
360.6
360.4

Exchange Rate

360.2
360
359.8
359.6
359.4
359.2

Sterling During Bretton Woods

GBP Exchange Rate: 1950 - 1970
2.9
2.8
2.7
2.6

Exchange Rate

2.5
2.4
2.3
2.2
2.1

Yen Immediately After the Collapse

of Bretton Woods
1971 - 1980
400
350
300
250
200

Exchange Rate
150
100
50
0

Annual Data: % in USD

1971
1972
1973
1974
1975
1976
1977
1978
1979
1980

349.33 -2.96%
303.17 -13.21%
271.70 -10.38%
292.08
7.50%
296.79
1.61%
296.55 -0.08%
268.51 -9.46%
210.44 -21.63%
219.14
4.13%
226.74
3.47%

Sterling Immediately After the

Collapse of Bretton Woods
1971 - 1980
3

2.5
2
1.5

Exchange Rate
1
0.5
0

Annual Data: % in GBP

1971
1972
1973
1974
1975
1976
1977
1978
1979
1980

2.4336
1.41%
2.4975
2.62%
2.4497 -1.91%
2.3375 -4.58%
2.2124 -5.35%
1.7969 -18.78%
1.7443 -2.93%
1.9176
9.93%
2.1177 10.44%
2.3239
9.74%

The Yen After Bretton

Woods

Sterling After Bretton

Woods

Exchange Rate Regimes Today

Currently, current exchange rate regimes fall along a

spectrum as represented by national government

involvement in affecting (managing) their currencys
exchange rate.
Very Little (if any)
Involvement

Forex Market is
Determining
Exchange rate

Active
Involvement

Government is
Managing or
Pegging
Exchange rate

Where are we Today in

Terms of Exchange Rate
Regimes?
Mixed International Monetary System consisting of:
Floating exchange rate regimes:

Market forces determine the relative value of a currency.

Managed (dirty float) rate regimes:
Governments managing their currencys value with
regard to a reference currency.
Market moves these currencies, but governments are
managing the process and intervening when necessary.
Pegged exchange rate regimes:
Government fixes (links) the value of its currency relative
to a reference currency.
Fewer of these regimes than in the past.

Post Bretton Woods Summary

Since March 1973, the major currencies of the world have

operated under a floating exchange rate system.

While central banks of these major countries have
occasionally interviewed in support of their currencies, this
intervention has become less over the years.
The US last intervened in 1998.
In addition to the major currencies of the world, a growing
number of other developing country currencies have also
moved to a floating rate system.
Thus: more and more, market forces are driving currency
values.
The post Bretton Woods period has resulted exchange rates
become much more volatile and , perhaps, less predictable
then they were during previous fixed exchange rate eras.
This currency volatility complicates the management of
global companies.

Freely Floating Currencies by

Country or Region, IMF data, 2006
Albania
Congo, Dem. Rep.of
Indonesia
Uganda
Australia
Brazil
Canada
Chile
Iceland
Israel
Korea
Mexico
New Zealand

Norway
Philippines
Poland
South Africa
Sweden
Turkey
United Kingdom
Tanzania
Japan
Somalia
Switzerland
United States
Eurozone

Bibliography
www.google.co.in
www.googleimage.co.in
www.britannicaencylcopedia.com
Link to the history of foreign exchange regime changes of

many countries.
intl.econ.cuhk.edu.hk/exchange rate regime/
Quarterly report on U.S. Intervention in foreign exchange
markets
www.ny.frb.org/markets/foreignex

THANK
YOU