International Monetary System

International
Monetary
System

PRESENTED BY:- Group-3

Members
•Shashank Gupta-068
•Pawan Singh-066
International Monetary System
Preface
 Increased Volatility of currency affects the earnings of MNC’s,
Banks and Cross Border investor’s

 There are large and unexpected fluctuations in the value of

currency hence a setup called Bretton Woods was formed in 1944
to reduce this riskiness of international business

 The main feature of Bretton Woods was the relatively fixed

exchange rate of individual currency in the terms of USD $ and
convertibility of $ into gold

 In 1971 Bretton Woods fell prey to international financial turmoil

and was replaced by the present regime of rapidly fluctuating
exchange rates which resulted in both problems and opportunities
for MNC’s
 International Monetary System
INTERNATIONAL MONETARY SYSTEM
The International Monetary System refers to set of policies,
institutions, practices, regulations & mechanism that determine
the rate at which one currency would be exchange for another.

There are primarily 5 market mechanisms to establish exchange rate

with each having its share of merits & demerits –

•Free float
•Managed float
•Target zone arrangement
•Fixed rate system
•Hybrid system
 International Monetary System
 All countries like to have economic stability & prefer a stable
exchange rate, however fixing exchange rate often leads to
currency crises if the monetary policy is inconsistent with it

 Countries are less vulnerable to economic shocks if they allow

their currency to float freely but that may exhibit excessive
volatility which hurts trade & economic growth

 The trade off between different mechanism depend upon the

importance of the underlying benefits & trade offs associated with
them
 International Monetary System
Free Float
 Free market exchange rates are determined by interaction of
currency supply & demand which is in turn influenced by price
level changes interest differential & economic growth

 The exchange rate fluctuates randomly as market participants

arises & react to new information, for example – Government
policies or acts of God & nature

 This is also called clean float as the exchange rates are free flowing
without any manipulation
International Monetary System
Managed float
 Intervention by Government’s in the foreign change market in
order to reduce economic uncertainty associated with free/ clean
float

 This is triggered by the fear that a sudden change in the currency

appreciates or inflation of it depreciates

 Central banks of countries intervene to smooth as out exchange

rate fluctuations & determine the rate that is why it is called
Managed/ dirty float

 Crawling peg – unofficial pegging

International Monetary System
Target zone arrangement

 Under this system, countries adjust their national economic

policies to maintain there exchange rates within a specific margin

 Members of the arrangement adjust their national economic

policies to maintain the target range
International Monetary System
Fixed rate
 Bretton wood was also a fixed rate mechanism, in this type of
regime, Governments are committed to maintain a target
exchange rate

 Central banks buy/ sell currency actively if the exchange rate is

threatened

 For this system to work, all member nations must accept the
groups joint inflation rate as its own.

 These controls are major source of imperfection for MNC’s which

provide both risk & opportunities to them
International Monetary System
The current hybrid system
 The currency system is the one where major currencies float on a
managed basis, some currencies are freely floating while other
currencies follow various types of pegged exchange rates

 Examples – another currency as legal tender – Equador, el Salvador

(US dollar) – pegged against a single currency, Malaysia, Maldives,
Nepal, Iraq, Jordan
International Monetary System
Brief history of International
monetary system
 Why Gold – Gold has a certain desirable properties like durability,
ease of storage, easy recognition, standardization

 Short term changes in its stock are limited by high production cost,
making it expensive to manipulate

 It ensures price stability in long run

 This is the reason why most currencies fairly recent recently

followed gold standard which defined their exchange rates
International Monetary System
The Gold standard
 The gold standard essentially involved a commitment by the
participating countries to fix the price of their currencies in terms
of a specific amount of gold

 The price was maintained by buying/ selling gold at that price

 The value of gold relative to other goods does not change much
over long period of time, that helps in maintaining monetary
discipline & ensures long run price stability

 Concept of fat money – gold standard

International Monetary System
The gold standard from 1925 - 1944
 The gold standard broke down during World War I, and was briefly
re-instated between 1925-31 as gold exchange standard

 Under this system, only US & Britain were allowed to hold gold
reserves while other could hold both gold, dollars &/ or pound
reserves

 1931 – Britain departed from Gold standard due to high influx of

gold & capital, this led to devaluation of many currencies which in
turn led to trade wars, some economists even blame the
protectionist regimes of triggering the great depression
International Monetary System
Bretton woods (1946 – 1971 )
 To avoid destructive monetary economic policies to be formulated
allied nations agreed to form a new postwar system

 The conference held in New hampshire also created institutions,

IMF & World Bank to promote international financial stability

 World bank had the primary function of lending to nations

devastated by the world war

 The IMF had agenda to foster global growth and economic stability
 International Monetary System
Bretton woods – The fine print
 USD became the key currency & each Government pledged to
maintain a fixed, or pegged exchange rate vis-à-vis the dollar or
gold

 1 ounce of gold = $ 35
1 ounce of gold = 140 mark (German)
so 4 mark = $ 1
Exchange rates were allowed to fluctuate by 1% above or below
initial base price.

 The fixed exchange rates were maintained by official intervention

by central banks in the form of sale & purchase of dollars with the
IMF providing the foreign exchange
International Monetary System
Bretton woods (continued)
 Technical aspects of the system had practical implications on the
participating countries

 Stability of exchange rates removed a great deal of uncertainty

from international trade & investment transactions

 It also imposed a great deal of discipline on the participating

nations economic policies
 International Monetary System
Fall of Bretton woods

 The Bretton wood system was fixed rate, only in name, out of 21
major industrialized countries Only the US & Japan held to their
par value during 1946-71. Out of 21, 12 devalued their currencies
more than 30% against the dollar

 The death blow for the system came from President Nixon, who
was alarmed at high inflation rate & he devalued the dollar to deal
with the emerging trade deficit
International Monetary System
Post Bretton woods

 Smithsonian agreement of 1971 – US devalued to 38 $ / Oz of gold

& other countries were revalued on agreed amounts vis-à-vis the
dollar

 By 1973 – The world officially turned to floating exchange rates

International
Role Monetary
of International System
Monetary Fund
The IMF works to foster global growth and economic stability. It provides
policy advice and financing to members in economic difficulties and also
works with developing nations to help them achieve macroeconomic
stability and reduce poverty.

Its main works are –

•policy advice to governments and central banks based on analysis of

economic trends and cross-country experiences

•research, statistics, forecasts, and analysis based on tracking of global,

regional, and individual economies and markets

•loans to help countries overcome economic difficulties

•concessional loans to help fight poverty in developing countries

 International Monetary System
It is having 188 member countries till date

Special Drawing Right (SDR)

The IMF supplemented its foreign exchange by creating a new
reserve asset, (named SDR).

It serves as the IMF’s unit of account

It is a weighted average of the currencies of five nations (US,

Germany, France, Japan & Great Britain)

The weights, which are based on the relative importance of each

country in international trade are updated periodically
 International Monetary System
Role of World bank
The world bank is an internationally supported bank that provides
financial and technical assistance to developing countries for
development programs (e.g. bridges, roads, schools)with the stated
goal of reducing poverty.

Role of Bank of International Settlements

•Acts as the “Central Bank“ for Industrial Countries’ Central Bank

•Helps in managing FOREIGN EXCHANGE RESERVES

•BIS also holds deposits of Central Banks

 International Monetary System
Floating Rate system - 1973
 Proponents of the new system said that this system would reduce
economic volatility & facilitate free trade, floating exchange rates
would offset the differences in inflation rate

 High inflation countries would have their currencies depreciate,

allowing their firms to stay competitive without having to act
wages & unemployment
International Monetary System
Assessment of Floating Rate system

 Currency volatility has increased – The experience till date from

the system has been disappointing. The dollars ups & down has
little to do with inflation & a lot to do with expectations of future
government policies & economic conditions

 The instability reflects the non monetary shocks to the world

economy, such as changing oil prices & competitiveness amongst
countries
 International Monetary System
Jamaica Agreement 1976
Floating rates declared acceptable

Gold abandoned as reserve asset;

I. IMF returned gold reserves to members at current prices
II. Proceeds placed in trust fund to help poor nations
III. IMF quotas – member country contributions – increased;
membership now 182 countries
IV. Less-develop, non-oil exporting countries given more
access to IMF
IMF continued its role of helping countries cope with
macroeconomic and exchange rate problems
International Monetary System
Major events after 1973
OPEC and the Oil Crisis (1973-74)

1. OPEC raised oil prices four fold

2. Exchange rate turmoil resulted
3. Caused OPEC nations to earn large surplus B-O-P.
Surpluses recycled to debtor nations which set up debt crisis of
1980’s.

Dollar Crisis (1977-78)

1. U.S. B-O-P difficulties

2. Result of inconsistent monetary policy in U.S.
3. Dollar value falls as confidence shrinks.
 International
The Rising Dollar (1980-85)
Monetary System
1. U.S. inflation subsides as the Fed raises interest rates
2. Rising rates attracts global capital to U.S.
3. Result: Dollar value rises.

The Sinking Dollar:(1985-87)

1. Dollar revaluated slowly downward;

2. Plaza Agreement (1985) G-5 agree to depress US $ further.
3. Louvre Agreement (1987) G-7 agree to support the falling US $

Recent History (1988-2005)

I. 1988 US$ stabilized

II. Post-1991 Confidence resulted in stronger dollar
III. 1993-1995 Dollar value falls
.
 International Monetary
Financial Crisis 2007-12 System
Global Financial crisis: Worst Financial Crisis since the Great
Depression (1930)
EVENTS
• Subprime lending
• Growth of the housing bubble
• Easy credit conditions
• Weak and fraudulent underwriting practices
• Deregulation
• Increased debt burden or over-leveraging
• Incorrect pricing of risk
• Boom and collapse of the shadow banking system
• EURO Zone crisis
• Commodities boom
•Currency volatility
International Monetary System

Thank You