INTERNATIONAL MONETARY FUNDS

International Monetary Fund

An organization of 187 member countries.
Their goal is to work with the Fund to stabilize the

global economy Ideally, these countries are willing to forfeit some of their sovereign authority if it is necessary to strengthen the global economy.

IMF - SERVICES
Surveying global economic conditions. Advising member countries on methods to improve

their economy. Providing short-term instability.

loans

to

avoid

currency

History of the IMF

The International Monetary Fund (IMF), like the

World Bank, was conceived at the Bretton Woods conference that sought to rebuild Europe after World War II. Unlike the Bank, its goal was to help countries maintain the value of their currencies without resorting to trade barriers and high interest rates. These were seen as a major cause of the Great Depression.

Great Depression
The Great Depression of 1929 was a worldwide

depression that lasted for 10 years. It started in the U.S. economy (Black Thursday) in October 24, 1929, when 12.9 million shares of stock were sold in one day, triple the normal amount. Over the next four days, prices fell 23%. This was known as the stock market crash of 1929. Unemployment raised from 3% to 25%

Bretton Woods system

It

was a remarkable achievement of global coordination. It established the U.S. dollar as the global currency, taking the world off of the gold standard. It created the World Bank and the International Monetary Fund (IMF) as the two global organizations to help monitor the new system. U.S. was the only country with the ability to print dollars, it established America as the major power behind these two organizations, and the global economy.

NEED for Bretton Woods System

Until World War I, most countries were on the gold standard. However, they went off so they could print the currency needed to pay for their war costs. This caused hyperinflation, as the supply of money overwhelmed the demand. The value of money fell so dramatically that, in some cases, people needed wheelbarrows full of cash just to buy a loaf of bread. After the war, countries returned to the safety of the gold standard. All went well until the Great Depression. After the 1929 stock market crash, investors switched to trading in currencies and commodities. This drove up the price of gold, resulting in people redeeming their dollars for gold. The Federal Reserve made things worse by defending the nation's gold reserve by raising interest rates. It's no wonder that, as World War II wound down, countries were ready to abandon a pure gold standard. The Bretton Woods system gave countries more flexibility than a strict adherence to the gold standard, but less volatility than no standard at all. A member country still retained the ability to alter its currency's value if needed to correct a "fundamental disequilibrium" in its current account balance.

Bretton Woods Agreement

Under the Bretton Woods agreement, countries promised that their

central banks would maintain fixed exchange rates between their currencies and the dollar. If their currency's value became too low relative to the dollar, they would buy up their currency in foreign exchange markets. This would decrease the supply, which would automatically raise the price. If their currency became too high, they'd print more of their currency, increasing the supply and automatically lowering its price. Members of the Bretton Woods system also agreed to avoid any trade warfare, such as lowering their currencies strictly to increase trade. However, they could regulate their currencies if foreign direct investment began to stream into their countries in such a way to destabilize their economies. They could also adjust their currency values to rebuild after a war.

Replacement the Gold Standard

Prior to Bretton Woods, the world had followed the gold

standard. This meant each country guaranteed that its currency would be redeemed by its value in gold. After Bretton Woods, each member agreed to redeem its currency for dollars, not gold. Why dollars? The U.S. held three-fourths of the world's supply of gold. The dollar's value was set at 1/35 of an ounce of gold, so in a way the world was still on somewhat of a gold standard. Hence, for all intents and purposes, the dollar had now become a substitute for gold. As a result, the value of the dollar began to increase relative to other currencies, since there was now more of a demand for it -- even though its worth in gold remained the same. This discrepancy in value planted the seed for the collapse of the Bretton Woods system three decades later

Role of the IMF and World Bank

The Bretton Woods system could not have been put into place without the IMF. That's because member countries needed a mechanism to bail them out if their currency values got too low. They'd need a kind of global central bank they could borrow from in case they needed to adjust their currency's value, and didn't have the funds themselves. Otherwise, they would just slap on trade barriers or raise interest rates. The Bretton Woods countries decided against giving the IMF the power of a global central bank, to print money as needed. Instead, they agreed to contribute to a fixed pool of national currencies and gold to be held by the IMF. Each member of the Bretton Woods system was then entitle to borrow what it needed, within the limits of its contributions. The IMF was also responsible for enforcing the Bretton Woods agreement. The World Bank, despite its name, was not the world's central bank. At the time of the Bretton Woods agreement, the World Bank was set up to lend to the European countries devastated by World War II. Now the purpose of the World Bank is to loan money to economic development projects in emerging market countries.

End of Bretton woods system

In 1971, the U.S. was suffering from massive stagflation -a deadly

combination of inflation and recession. This was partly a result of the dollar's role as a global currency. In response, President Nixon started to deflate the dollar's value in gold. The dollar was repriced to 1/38 of an ounce of gold, then 1/42 of an ounce. However, the plan backfired. It created a run on the U.S. gold reserves at Fort Knox as people redeemed their quickly devaluing dollars for gold. In 1973, Nixon unhooked the value of gold from altogether. Without price controls, gold quickly shot up to $120 per ounce in the free market. The Bretton woods system was over.

IMF vs WORLD BANK

World Bank lend money to developing countries for

specific projects that will fight poverty. The IMF only provides loans if it will help prevent a global economic crisis. Its overall goal is to prevent these crises through guidance to, and cooperation among, its members.

IMF BOARD
The finance minister or central bank leader of each

member countries. They meet annually, in conjunction with the World Bank. International Monetary and Financial Committee, (IMFC) meets twice a year to review the international monetary system and make recommendations. The day-to-day work of the IMF is carried out by the Executive Board, who appoints the IMF's Managing Director to a renewable five-year term.

EMERGING MARKET COUNTRIES

In 2011, the IMF was rocked by a scandal involving its

Executive Director, Dominique Strauss-Kahn. He was arrested while visiting New York on allegations. Although the charges were subsequently dropped, he resigned. Many emerging market IMF members argued that it was time for a representative from one of their countries be named director. The IMF had agreed to transfer 6% of voting power to emerging market countries in 2010.

EMERGING MARKET COUNTRIES

Singapore

Finance Minister Tharman Shanmugaratnam, Former Turkish Economic Minister Kemal Dervis and India's Montek Singh Ahluwalia, a former IMF director. However, France was allowed to replace Strauss-Kahn with its highly respected Finance Minister, Christine LaGarde.

IMF Advises Member Countries

Since the Mexican peso crisis of 199495 and the Asian

crisis of 199798, the IMF has taken a more active role to help countries prevent financial crises. It develops standards that countries should follow, such as providing adequate foreign exchange reserves in good times to help provide for increased spending during recessions. It reports on members countries' observance of these standards. It also issues member country reports that investors use to make well-informed decisions, improving the functioning of financial markets, and reducing potential financial shocks.

Importance of the IMF:

The importance of the IMF has increased since the 2008

global financial crisis. An IMF surveillance report warned about the economic crisis, but was ignored. As a result, the IMF has been called upon more and more to provide global economic surveillance. It's in the best position to do so because its requires members to subject their economic policies to IMF scrutiny. Member countries also committed to pursue policies that are conducive to reasonable price stability, and avoid manipulating exchange rates for unfair competitive advantage.

IMF - Short-term Loans

The Fund provides loans to help its members tackle

balance of payments problems, stabilize their economies, and restore sustainable growth. Most IMF borrowers were developing countries which have only limited access to international capital markets, partly because of their economic difficulties. Since IMF lending signals that a country's economic policies are on the right track, it reassures investors and can act as a catalyst for attracting funds from other sources. This shifted in 2011, when the eurozone crisis prompted the IMF to provide short-term loans to developed markets to bail out Greece.

Flexible Exchange Rate

A floating exchange rate or fluctuating exchange rate in which

a currency's value is allowed to fluctuate according to the foreign-exchange market. A currency that uses a floating exchange rate is known as a floating currency. In the modern world, most of the world's currencies are floating
the United States dollar, the euro, the Norwegian krone,

the Japanese yen,

the British pound, the Swiss franc, the Australian dollar.

Fixed to Flexible Currency

From 1946 to the early 1970s, the Bretton Woods system

made fixed currencies the norm; In 1971, the US decided no longer to uphold the dollar exchange at 1/35th of an ounce of gold, so that the currency was no longer fixed. After the 1973 Smithsonian Agreement, most of the world's currencies followed suit. However, some countries, such as most of the Gulf States, fixed their currency to the value of another currency, which has been more recently associated with slower rates of growth. When a currency floats, targets other than the exchange rate itself are used to administer monetary policy

Exchange-rate regime
An exchange-rate regime is the way an authority manages

its currency in relation to other currencies and the foreign exchange market. It is closely related to monetary policy and the two are generally dependent on many of the same factors. The basic types are a floating exchange rate, where the market dictates movements in the exchange rate; A pegged float, where a central bank keeps the rate from deviating too far from a target band or value; A fixed exchange rate, which ties the currency to another currency, mostly more widespread currencies such as the U.S. dollar or the euro or a basket of currencies.

Fixed exchange-rate
Fixed rates are those that have direct convertibility towards another currency. In case of a separate currency, also known as a currency board arrangement, the domestic currency is backed one to one by foreign reserves. A pegged currency with very small bands (< 1%) and countries that have adopted another country's currency and abandoned its own also fall under this category.

CURRENT EXCHANGE RATE REGIME

Floating rates are the most common exchange rate

regime today. For example, the dollar, euro, yen, and British pound all are floating currencies. However, since central banks frequently intervene to avoid excessive appreciation or depreciation, these regimes are often called managed float or a dirty float.

Hybrid exchange rate systems The current state of foreign exchange markets does not
allow for the rigid system of fixed exchange rates. At the same time, freely floating exchange rates expose a country to volatility in exchange rates. Hybrid exchange rate systems have evolved in order to combine the characteristics features of fixed and flexible exchange rate systems. They allow fluctuation of the exchange rates without completely exposing the currency to the flexibility of a free float.

Pegged float
Pegged floating currencies are pegged to some band or

value, either fixed or periodically adjusted.

Crawling bands the rate is allowed to fluctuate in a band

around a central value, which is adjusted periodically. This is done at a preannounced rate or in a controlled way following economic indicators. Crawling pegs the rate itself is fixed, and adjusted as above. Pegged with horizontal bands the rate is allowed to fluctuate in a fixed band (bigger than 1%) around a central rate.

Basket-of-currencies
Countries often have several important trading partners or are

apprehensive of a particular currency being too volatile over an extended period of time. They can thus choose to peg their currency to a weighted average of several currencies (also known as a currency basket) . For example, a composite currency may be created consisting of hundred rupees, 100 Japanese yen and one U.S. dollar the country creating this composite would then need to maintain reserves in one or more of these currencies to satisfy excess demand or supply of its currency in the foreign exchange market. A popular and widely used composite currency is the SDR, which is a composite currency created by the International Monetary Fund (IMF), consisting of a fixed quantity of U.S. dollars, euros, Japanese yen, and British pounds.

Special drawing rights

SDRs are supplementary foreign exchange reserve assets defined

and maintained by the International Monetary Fund (IMF). Not a currency, SDRs instead represent a claim to currency held by IMF member countries for which they may be exchanged. Created in 1969 to supplement a shortfall of preferred foreign exchange reserve assets, namely gold and the US dollar, the value of a SDR is defined by a weighted currency basket of four major currencies: the US dollar, the euro, the British pound, and the Japanese yen. As they can only be exchanged for Euros, Japanese yen, pounds sterling, or US dollars, SDRs may actually represent a potential claim on IMF member countries' nongold foreign exchange reserve assets, which are usually held in those currencies. An important future role, being the unit of account for the IMF has long been the main function of the SDR.

Currency boards
A currency board (also known as 'linked exchange rate system")effectively replaces the central bank through a legislation to fix the currency to that of another country. The domestic currency remains perpetually exchangeable for the reserve currency at the fixed exchange rate. As the anchor currency is now the basis for movements of the domestic currency, the interest rates and inflation in the domestic economy would be greatly influenced by those of the foreign economy to which the domestic currency is tied. The currency board needs to ensure the maintenance of adequate reserves of the anchor currency. It is a step away from officially adopting the anchor currency (termed as dollarization or euroization).

Dollarization/euroization
This is the most extreme and rigid manner of fixing exchange rates as it entails adopting the currency of another country in place of its own. The most prominent example is the eurozone, where 17 seventeen European Union (EU) member states have adopted the euro () as their common currency. Their exchange rates are effectively fixed to each other. There are similar examples of countries adopting the U.S. dollar as their domestic currency- British Virgin Islands, Caribbean Netherlands, East Timor, Ecuador, El Salvador, Marshall Islands, Federated States of Micronesia, Palau, Panama, Turks and Caicos Islands.