Development of the International Monetary System (2023)

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Title: Evolution of the International Monetary System

Evolution of the International Monetary System

(Video) The International Monetary System

  • Bimetallism before 1875
  • Classic gold standard 1875-1914
  • interwar period 1915-1944
  • Sistema de Bretton Woods 1945-1972
  • The 1973-Present Flexible Exchange Rate Regime

Bimetallism before 1875

  • A double standard in the sense that so much gold
    and silver were used as money.
  • Some countries were on the gold standard, others on the
    the standard silver, some in both.
  • Both gold and silver were used as internationals.
    means of payment and exchange rates between
    coins were determined by their gold
    or silver content.
  • Gresham's Law implied that it would be the minimum
    valuable metal that would tend to circulate. Bad
    money drives out good.

Classic gold standard 1875-1914

  • During this period, in most major countries
  • Only gold was guaranteed mintage without restrictions.
  • There was a two-way convertibility between gold and
    national currencies in a stable proportion.
  • Gold could be freely exported or imported.
  • The exchange rate between two countries
    the currencies would be determined by their relationship
    gold content.

Classic gold standard 1875-1914

  • For example, if the dollar is linked to gold in
    US30 1 ounce of gold and the pound sterling
    is pegged to gold in 6 1 ounce of gold,
    It must be the case that the exchange rate is
    determined by the relative gold content

30 6 5 1
Classic gold standard 1875-1914

  • Highly stable exchange rates under the classical regime
    the gold standard provided an environment that was
    favorable to international trade and investment.
  • Misalignment of exchange rates and
    payment imbalances were automatically
    corrected by the price-species-flow mechanism.

price-species-flow mechanism

  • Suppose Britain exports more to France
    that France imported from Great Britain.
  • This cannot persist under a gold standard.
  • Net export of goods from Great Britain to France
    will be accompanied by a net flow of gold from
    France to Great Britain.
  • This flow of gold will lead to a lower price.
    level in France and, at the same time, a greater
    price level in Great Britain.
  • The resulting change in relative price levels
    will slow down exports from Great Britain and
    encourage exports from France.

Classic gold standard 1875-1914

  • there are deficiencies
  • The supply of newly minted gold is so restricted
    that growth in world trade and investment can
    be harmed by not having enough money
  • Even if the world went back to the gold standard,
    any national government could abandon the

The relationship between money and growth

  • Money is needed to facilitate the economy.
  • MVPY ?The trading equation.
  • Assuming that the velocity (V) is relatively stable, the
    amount of money determines the level of
  • If there are not enough monetary instruments
    available, you can restrict the level of
  • If income (Y) grows but money (M) is constant,
    prices (P) must fall. This creates a deflation
  • Deflationary episodes were common in the US.
    during the gold standard.

interwar period 1915-1944

  • Exchange rates fluctuated across countries
    used predatory deprecations of their
    coins as a means of gaining an advantage in
    world export market.
  • Attempts were made to restore the gold standard,
    but participants lacked the political will to
    follow the rules of the game.
  • The result for international trade and investment
    it was deeply harmful.
  • Tarifas Smoot-Hawley
  • Great Depression

Sistema de Bretton Woods 1945-1972

  • Named for a 1944 meeting of 44 nations in Bretton
    Woods, Nuevo Hampshire.
  • The objective was to project an international post-war.
    Monetary system.
  • The objective was exchange rate stability without
    Golden pattern.
  • The result was the creation of the IMF and the
    World Bank.

Sistema de Bretton Woods 1945-1972

  • Under the Bretton Woods system, the US dollar
    was pegged to gold at 35 per ounce and others
    Currencies were pegged to the US dollar.
  • Each country was responsible for maintaining its
    exchange rate within 1 of the adopted face value
    purchase or sale of foreign reserves as
  • The United States was only responsible for maintaining the
    gold par.
  • This created a strong demand for reserves and
    allowed the United States to run trade deficits.
  • The Bretton Woods system was a dollar-based gold system.
    exchange pattern.

Sistema de Bretton Woods 1945-1972
Set in 35/oz.
Bretton Woods collapse

  • The global demand for the Triffin paradox requires
    The US will maintain a persistent balance of payments
    deficits that ultimately lead to loss of
    trust him.
  • The SDR was created to alleviate shortages.
  • Throughout the 1960s, countries with large
    reserves started buying US gold in
    increasing amounts threatening gold
    US reservations
  • Large US budget deficits and high monetary growth
    created imbalances in the exchange rate that could not
    sustained, that is, it was overvalued and the
    DM and they were underestimated.
  • Several realignment attempts were made, but
    Finally, the US gold supply run caused
    the suspension of convertibility in September
  • Smithsonian Agreement of December 1971

Composition of SDRs
The Flexible Exchange Rate Regime 1973-Present.

  • Declared flexible exchange rates acceptable
    to IMF members in Jamaica, January 1976.
  • Central banks were allowed to intervene in the
    exchange rate markets to solve unwarranted problems
  • Gold was abandoned as an international reserve.
  • Non-oil exporting and less developed countries
    Countries had greater access to IMF funds.

Value since 1965
current exchange rate

  • free floating
  • The largest number of countries, around 48, allows
    market forces to determine your currencies
  • float managed
  • About 25 countries combine governments
    intervention with market forces to establish exchanges
  • Linked to another currency
  • Like the US dollar or the euro (via the franc or
  • no national currency
  • Some countries don't bother to print their own,
    they use US dollar only. For example,
    Ecuador, Panama and El Salvador were dollarized.

European Monetary System

  • Eleven European countries maintain exchange rates
    between its currencies within narrow bands, and
    they float together against foreign currencies.
  • Goals
  • Establish a zone of monetary stability in
  • Coordinate exchange rate policies against
    non-European currencies.
  • Pave the way for the European Monetary Union.

What is the euro?

  • The euro is the single currency of the European Union
    Monetary union that has been adopted by 11 countries
    United States on January 1, 1999.
  • These original member states were Belgium,
    Germany, Spain, France, Ireland, Italy,
    Luxembourg, Finland, Austria, Portugal and


About the euro

(Video) The Bretton Woods Monetary System (1944 - 1971) Explained in One Minute

  • The sign of the new single currency appears
    an E with two clearly marked, horizontal
    parallel lines through it.
  • It was inspired by the Greek letter epsilon, in
    reference to the cradle of European civilization
    and even the first letter of the word 'Europe'.
  • All insurance and other legal contracts continued
    into force with the substitution of quantities
    denominated in national currencies with their respective
    euro equivalents.

Euro value in US dollars

  • January 1999 to July 2004

Theory of optimal currency areas

  • Cost and benefits depend on how well integrated
    your economy is with those of your potential
  • Fixed exchange rates are most appropriate for
    areas strongly integrated through
    trade and mobility of factors of production

Benefits of the ideal currency area
Monetary Efficiency Gain

  • Monetary Efficiency Gain
  • Savings from floating rates
  • Uncertainty
  • Confusion
  • Calculation
  • transaction costs

Tight economic integration leads to interconnection
price stability
Degree of Economic Integration
Costs of optimal currency areas
Loss of Economic Stability

  • Loss of Economic Stability
  • Abandoning the ability to use the exchange rate and
    monetary policy stability of production and
  • With fixed exchange rates, monetary policy has no
    power to affect domestic production
  • Reduce the loss of economic stability due to production
    market disturbances

Degree of Economic Integration
Optimum Currency Area Decisions

  • The variability in your product markets makes
    countries least willing to enter the fixed exchange rate
    area fee
  • After the 1973 oil crisis, countries
    reluctant to revive the Bretton Woods system of
    fixed exchange rates
  • Fixed exchange rate better serves the economy
    interests of each of its members when the degree
    of economic integration is high

profit or loss
The loss outweighs the gain
The gain outweighs the loss
Degree of Economic Integration
Ideal currency areas

  • Degree of Economic Integration
  • They trade a lot with each other.
  • There is a high degree of labor mobility among them.
  • The economic shocks they face are highly correlated
    (systematic shocks)
  • There is a federal tax system to transfer
    funds for regions experiencing adverse shocks

The European Union

  • Replacement
  • EU members export 10 to 20 of their production
    to other EU members
  • The US exports about 2% of its GDP to EU members
  • labor mobility
  • The United States has only minor differences in
    unemployment rate across regions due to
    almost complete mobility
  • Europe has certain impediments to mobility
  • Language
  • Culture
  • Regulation

The long-term impact of the euro

  • If the euro triumphs, it will advance
    the political integration of Europe into an important
    way, eventually making a United States of
    viable Europe.
  • The US dollar is likely to lose its
    place as the dominant world currency.
  • The euro and the US dollar will both be
    major currencies.

(No transcript)
The Mexican Peso Crisis

  • On December 20, 1994, the Mexican government
    announced a plan to devalue the peso against the
    dollar by 14 percent.
  • This decision changed forex traders
    expectations about the future value of the peso.
  • They ran towards the exits.
  • In her rush to get out, the weight dropped as much as
    like 40 percent.

(No transcript)
How does a devaluation affect foreign investors?

  • If a US investor buys a Mexican asset,
    they must buy pesos first.
  • When the asset is sold, the proceeds must be
    exchanged before being repatriated, the
    The profitability of US investors is affected by the
    exchange rate at that time.
  • If it is greater (weight appreciation), the return to
    The American investor is bigger in terms.
  • If the peso has depreciated, the returns will be

The Mexican Peso Crisis

  • The Mexican peso crisis is unique because
    represents the first serious international
    financial crisis triggered by cross-border
    portfolio capital flight.
  • two lessons emerge
  • It is essential to have multinational security
    net to protect the financial world
    system of such crises.
  • An influx of foreign capital can lead to a
    overvaluation in the first place.

The Asian Currency Crisis

  • The Asian currency crisis turned out to be far away
    more serious than the Mexican peso crisis in
    terms of the extent of contagion and the
    the severity of the economic and social consequences resulting
  • Many companies with securities in foreign currency were
    forced into bankruptcy.
  • The region has experienced a profound and widespread

(No transcript)
Explanations of the currency crisis

  • In theory, the value of a currency reflects the
    fundamental strength of its underlying economy,
    relative to other economies. Ultimately.
  • In the short term, foreign exchange traders' expectations
    they play a much more important role.
  • In today's environment, merchants and lenders,
    using the most modern communications, act for
    fight or flight instincts. For example, if they
    expect others to be about to sell reais
    for dollars they want to get to the exits
  • Thus, fears of depreciation become
    self-fulfilling prophecies.

(No transcript)
Fixed vs flexible exchange rate regimes

  • Arguments in favor of flexible exchange rates
  • Easier external adjustments.
  • National political autonomy.
  • Arguments against flexible exchange rates
  • Exchange rate uncertainty can make it difficult
    international trade.
  • There are no guarantees to avoid crises.

Fixed vs flexible exchange rate regimes

  • Suppose the exchange rate is 1.40/today.
  • On the next slide, we see that the demand for British
    Pounds are outnumbered at this exchange rate.
  • The United States runs trade deficits.

Fixed vs flexible exchange rate regimes
Price in dollars per (exchange rate)
Q of
Flexible exchange rate regimes

(Video) Evolution of international Monetary System- Explained by Prof.Mihir Shah

  • Under a flexible exchange rate regime, the dollar
    will simply depreciate to 1.60/, the price in
    that supply equals demand and the trade deficit
    fades away

Fixed vs flexible exchange rate regimes
Supply (S)
Price in dollars per (exchange rate)
Demand (D)
Demand (D)
Q of
Fixed vs flexible exchange rate regimes

  • Instead, assume that the exchange rate is fixed at
    1.40/, therefore the imbalance between supply
    and demand cannot be removed for a price
    to change.
  • The government would have to change the demand
    curve from D to D
  • In this example, this corresponds to
    contractionary monetary and fiscal policies.

Fixed vs flexible exchange rate regimes
Supply (S)
contractionary policies
Price in dollars per (exchange rate)
(fixed regime)
Demand (D)
Demand (D)
Q of
(No transcript)

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