Gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold. Silver standard is a monetary system in.

INTERNATIONAL MONETARY SYSTEM

INTRODUCTION AND EVOLUTION

Gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold.

Silver standard is a monetary system in which the standard economic unit of account is a fixed weight of silver.

GOLD STANDARD

Gold specie standard is a system in which the monetary unit is associated with circulating gold coins, or with the unit of value defined in terms of one particular circulating gold coin in conjunction with subsidiary coinage made from a lesser valuable metal. (till late WW I – 1925 in Britain)

Gold exchange standard typically involves only the circulation of silver coins, or coins made of other metals(during the silver standard ie period from 1600 to 1800)

Gold bullion standard is a system in which gold coins do not actually circulate as such, but in which the authorities have agreed to sell gold bullion on demand at a fixed price in exchange for the circulating currency. (till 1931)

Byzantine Empire

Gold certificates were used as paper currency in the United States from 1882 to 1933. These certificates were freely convertible into gold coins.

ADVANTAGESThe gold standard limits the power of governments to inflate prices through

excessive issuance of paper currency;

The gold standard makes chronic deficit spending by governments more difficult; and

High levels of inflation are rare and hyperinflation is impossible as the money supply can only grow at the rate that the gold supply increases.

DIS-ADVANTAGES

A gold standard leads to deflation whenever an economy using the gold standard grows faster than the gold supply;

Deflation rewards savers and punishes debtors;

recessions can be largely mitigated by increasing money supply during economic downturns; and

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

INTER WAR PERIOD (1914 - 1944)

The gold standard broke down in country after country soon after its rehabilitation during the post-1914-18 war decade. There were several reasons for this development:

Gold was very unevenly distributed among the countries in the inter-war period. While the U.S.A. and France came to possess the bulk of it, other countries did not have enough to maintain a monetary system based in gold.

International trade was not free. Some countries often imposed stringent restrictions on imports, which created serious balance of payments problems for other countries. Not having enough gold to cover the gap, they threw the gold standard overboard.

PREDATORY DEPRECIATION A country can increase its money, supply which will cause the price of its currency to decrease. Goods manufactured in this country then become less expensive on the world market, which attracts foreign investment (Germany was hit hardest).

IMAGES OF POST WAR GERMANY

THE GREAT DEPRESSION

In 1929 after the stock market crash banks in Austria, England ,and The United States experienced large declines in portfolio values. This set off a series of bank runs.

Most countries focused on stabilizing their own national economies. They hoarded gold reserves which constrained monetary supply and hampered international trade.

Britain especially experience severe outflows of gold (why ?) The British Pound was still the dominant international currency and Britain had exploited that fact

incurring large trade deficits on currency backed by their own gold reserves.

British gold reserves were devastated causing a general loss in confidence in the pound, which ended its use as the dominant international currency

Hoarding of gold became such a problem in the U.S. that in 1933 Franklin D. Roosevelt made it illegal to own more that $100 worth of gold. The government could confiscate gold in exchange for paper money

Britain was forced off the gold standard in 1931 Canada, Sweden, Austria, Japan, the US, and finally France followed between

1933 - 1936

THE SYSTEM OF BRETTON WOODS

Held in 1944.

44 Countries participated.

Birth of IMF

Birth of International Bank for Reconstruction and Development (IBRD)

Implemented a system of fixed exchange rates with the $ as the key currency

Goal: Avoid a recurrence of the closed markets and economic warfare that had characterized the 1930s.

BRETTON WOODS CONTD.• Developed by

Harry Dexter White John Maynard Keynes

• US defined 1 ounce of Gold as $35

• All other nations had to define the value of their money according to “par value system” in terms of U.S. dollars or gold.

IMF

Officially established on December 27, 1945 Commenced its financial operations on

March 1, 1947

Purposeo Promote international monetary cooperation

o Facilitates world trade expansion

o Ensures exchange rate stability

o Provide funds to member countries to bring their BOP to equilibrium

IMF-Operations• Source of Money: Quota subscription

IMF- Organization• Highest authority is the Board of Governors

• Day-to-day work is managed by the Executive Board formed by 24 Executive Directors

INTERNATIONAL BANK FOR RECONSTRUCTION & DEVELOPMENT

Goal:• Original mission was to finance the reconstruction of nations devastated by WW-2

• Improve living standards and to eliminate the worst forms of poverty

• Supports the restructuring process of economies and provides capital for productive investments

• Encourages foreign direct investment by making guarantees or accepting partnerships with investors.

• Aims to keep payments in developing countries balanced and fosters international trade

WORLD BANK: ORGANIZATION

• The highest authority: Council of Governors

• Executive Board: five Directors to whom the Council of Governors transfers responsibility for nearly all issues.

ADJUSTMENTS AND REACTIONS TO THE

CHANGING ENVIRONMENT1. Integration of developing countriesAffiliated organizations of the World Bank:

i. International Finance Cooperation (IFC)-1956 Function: grant credits to private organizations that

lack capital for projects in the developing world

ii. International Development Association (IDA)- 1961Function: grant credits to especially poor countries at very favorable conditions.

2. Special Drawing Rights

In 1960s substantial economic expansion lead to weakening of the position of the USA and a devaluation of the U.S. dollar.

IMF reacted by issuing SDRs which member countries could add to their holdings of foreign currencies and gold.

SDRs were assigned with a value based on the average worth of the world’s major currencies.

These were the U.S. dollar, the French franc, the pound sterling, the Japanese yen, and the German mark.

FALL OF BRETTON WOOD SYSTEM

• One national currency (the U.S. dollar) had to be an international reserve currency at the same time.

• As a result US were free from external economic pressures, while heavily influencing those external economies.

• To ensure international liquidity USA were forced to run deficits in their balance of payments

• This, together with the emergence of a parallel market for gold where the price soared above the official US mandated price, led to speculators running down the US gold reserves.

• The system of Bretton Woods collapsed on 15 August 1971

FLOATING EXCHANGE RATE REGIME

•Collapse of Bretton Woods Agreement- Floating Exchange Rate Regime was formalized in 1976 in Jamaica.

•At the Jamaica meeting, the International Monetary Fund's (IMF) Articles of Agreement were revised to reflect reality of floating exchange rates.Under the Jamaican agreement

floating rates were declared acceptablegold was abandoned as a reserve assettotal annual IMF quotas - the amount member countries contribute to the IMF - were increased to $41 billion (today, this number is $311 billion)

•The rules for the International Monetary System that were agreed upon at the meeting are still in place today.

• Since 1973, exchange rates have become more volatile and less predictable because of

– the oil crisis in 1971 – the loss of confidence in the dollar after U.S. inflation jumped between 1977

and 1978 – the oil crisis of 1979– the rise in the dollar between 1980 and 1985– the partial collapse of the European Monetary System in 1992– the 1997 Asian currency crisis– the decline in the dollar in the mid to late 2000s

QUESTION ARISES

Which is better?

Fixed Exchange rate

or

Floating Exchange rate

ADVANTAGES OF FLOATING EXCHANGE RATE

• Automatic Balance of Payments Adjustment: Any BOP disequilibrium will be rectified by a change in the exchange rates.

Eg: if a country’s BOP is deficit then its currency should depreciate because imports will be greater than exports.

• Absence of Crisis: No pressure on the currency to revalue or devalue as the changes are automatic.

• Reduced need for holding currency reserves for use in intervention in the currency market. These reserves have opportunity costs.

• Freedom for domestic monetary policy- eg freedom to set interest rates to control inflation rather than exchange rate.

ADVANTAGES OF FIXED EXCHANGE RATE

• Limits Speculation: A vital risk in running a stable market.

• Helps in future planning of amount of investments and the amount of business a company can undertake.

• Fixed Rates provides a discipline on the domestic producers to keep their prices and costs down.

• Reinforces gains in comparative advantage

- if one country has a fixed rate with another, then differences in relative costs will quite easily be reflected in changes in the rate of growth of exports and imports.

NEW BRETTON WOODS SYSTEM

2003 - Michael P. Dooley, Peter M. Garber, and David Folkerts-Landau

“the emergence of a new international system involving an interdependency between states with generally high savings in Asia lending and exporting to western states with generally high spending”

NEW BRETTON WOODS SYSTEM

• Asian currencies were being pegged to the dollar

• Result - Unilateral intervention of Asian governments in the currency market to stop their currencies appreciating

• Led to the developing world as a whole preventing current account deficits in 1999

• It was in response to unsympathetic treatment following the 1997 Asian Financial Crisis.

US CURRENT ACCOUNT BALANCE

CHINA CURRENT ACCOUNT BALANCE

POST 2008 CRISIS

• The call for the a New Bretton Woods System was strengthened post the 2008 crisis.

• Brown and Sarkozy have been pushing for a New Bretton Woods System for a significant time now

• But they differ for a fact that – Brown – favors free trade and globalization– Sarkozy – Argues that unrestricted has failed

POST 2008 CRISIS

• But the European Leaders were unanimous in calling for a the development of a New International Financial Order that succeeds the one present now.

• Probably here the dollar will be superseded as a base currency and may be replaced by probably a pool of currencies or pool of commodities.

• Triffin dilemma - conflicts of interest between short-term domestic and long-term international economic objectives

• Bancor – John Maynard Keynes – Bretton Woods I

POST 2008 CRISIS

• This has gained significance as it started gaining support from the economic giant China.

• Chinese Proposal – Based on SDR• The call for a New Order has been gaining

momentum starting from the 2008 G 20 Washington Summit, 2009 G 20 London summit and the 2010 World Economic Forum Davos Summit.

• ASEAN, NAFTA – have their own cusotmized Bancor’s.

CONTEMPORARY CURRENCY REGIMES

IMF Exchange Rate Regime Classifications

Exchange Arrangements with No Separate Legal Tender: Currency of another country circulates as sole legal tender or member belongs to a monetary or currency union in which same legal tender is shared by members of the union eg. Euro

Currency Board Arrangements: Monetary regime based on implicit national commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate.ie. Pegging.

– Other Conventional Fixed Peg Arrangements: Country pegs its currency (formal or de facto) at a fixed rate to a major currency or a basket of currencies where exchange rate fluctuates within a narrow margin or at most ± 1% around central rate

– Pegged Exchange Rates w/in Horizontal Bands: Value of the currency is maintained within margins of fluctuation around a formal or de facto fixed peg that are wider than ± 1% around central rate

– Crawling Peg: Currency is adjusted periodically in small amounts at a fixed, preannounced rate in response to changes in certain quantitative measures

– Exchange Rates w/in Crawling Peg: Currency is maintained within certain fluctuation margins around a central rate that is adjusted periodically

– Managed Floating w/ No Preannounced Path for Exchange Rate: Monetary authority influences the movements of the exchange rate through active intervention in foreign exchange markets without specifying a pre-announced path for the exchange rate

– Independent Floating: Exchange rate is market determined, with any foreign exchange intervention aimed at moderating the rate of change and preventing undue fluctuations in the exchange rate, rather than at establishing a level for it

DOLLARIZATION

• Dollarization refers to the replacement of a foreign currency with U.S. dollars.

• Dollarization goes beyond a currency board, as the country no longer has a local currency.

• For example, Ecuador implemented dollarization in 2000.

IDEAL CURRENCY

ATTRIBUTES OF THE “IDEAL” CURRENCY• Exchange rate stability – the value of the currency would be fixed in

relationship to other currencies so traders and investors could be relatively certain of the foreign exchange value of each currency in the present and near future

• Full financial integration – complete freedom of monetary flows would be allowed, so traders and investors could willingly and easily move funds from one country to another in response to perceived economic opportunities or risk

• Monetary independence – domestic monetary and interest rate policies would be set by each individual country to pursue desired national economic policies, especially as they might relate to limiting inflation, combating recessions and fostering prosperity and full employment

THE IMPOSSIBLE TRINITY

EMERGING MARKETS & REGIME CHOICES

CURRENCIES AT A GLANCECountry Currency

Bahrain Bahrain Dinar

Egypt Egyptian Pound

Irag Iraqi Dinar

Iran Iranian Rial

Israel New Shekel

Jordan Jordanian Dinar

Kuwait Kuwaiti Dinar

Lebanon Lebanese Pound

Oman Rial Omani

Palestinian West Bank-Gaza

New Israeli Shekel/ Jordanian Dinar

Qatar Qatar Riyal

Saudi Arabia Saudi Riyal

Syria Syrian Pound

Turkey Turkish Lira

United Arab Emirates UAE Dirham

Yemen Yemeni Rial

HOW IT ALL BEGAN

• The British were in the Middle East by 1838• At first, the Indian Rupee was introduced in the Gulf

States• After the first World War:

• British East Africa – Florin and then a Shilling• TransJordan and Palestine- Palestinian Pound at par with pound

sterling• East African Shilling - Arabian Dinar in 1965

• The system gradually gave away to a systems based on units of the sterling system, but without ever involving the introduction of the full sterling coinage

• 1951 : East African Shilling replaced the Rupee in Aden

• 1961 : Dinar was adopted in Aden and Kuwait– 1 Dinar = 20 Shillings

• 1966 : Bahrain and Abu Dhabi adopted Dinar• 1966 : Qatar, Dubai and other States adopted Saudi

Riyal• 1970 : Oman adopted the Rial• Difference arose due to the Maria Theresa Thaler

Coinage System

DIFFERENCES IN VALUATION

• Sterling Devaluation in 1970• Value of other Dinars rose, Omani rial was less

in value

Pound Sterling Unit Maria Theresa Thaler

Israel, Jordan, Iraq, Kuwait, Bahrain, Oman, and the Yemen

Saudi Arabia, UAE and Qatar

• After World War II, Sterling Area was formed • All the Middle East Territories were pegged at a

fixed value to the pound sterling• After the devaluation in 1967, and other issues,

none of the currencies retained any fixed parity

CURRENT CURRENCY CONVERSIONSCurrency Pegged/ Current Conversion

Bahrain Dinar (second highest valued) 1 USD = 0.376

Egyptian Pound Not Pegged ( 1USD = 5.7009)

Iraqi Dinar Not Pegged ( 1 USD = 1168)

Iranian Rial Not Pegged (1 USD = 10000)

New Shekel Not Pegged ( 1USD = 3.791)

Jordanian Dinar 1 USD = 0.7078

Kuwaiti Dinar ( Highest Valued currency unit) 1 USD = 0.2285 (Basket of Currencies)

Lebanese Pound 1 USD = 1501

Rial Omani (third highest valued) 1 USD = 0.385

Qatar Riyal 1 USD = 3.64

Saudi Riyal 1 USD = 3.75

Syrian Pound 1 USD = 46.95 ( Not Pegged)

Turkish Lira 1 USD = 1.506 (Not Pegged)

UAE Dirham 1 USD = 3.67

Yemeni Rial 1 USD = 236.8 ( Not Pegged)

LATEST BUZZ

• Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.

• A new concept of financing- Gulf Clearing Union functioning on the lines of Swiss WIR

• creating - within a suitable legal framework - a "petro" unit redeemable in a constant amount of energy value

• provides a straightforward benchmark for both domestic and international buyers of oil, gas, petroleum products, and even electricity, to use petros - as well as, or instead of, US dollars - in settlement for purchases of GCC production.

EURO

The Path to a Flexible Economy

NEED FOR A STABLE CURRENCY WORLDWIDE

• As early as World War - II• The Bretton Woods System - Fixed

exchange rates

• Collapse of BWS in 1970s• The US moved towards Floating

Exchange Rates• The Europe held to its path of

Stable Exchange Rates

EUROPEAN MONETARY SYSTEM (1979)

• 15 members of European Union• Used Exchange Rate Mechanism (ERM)

• Helped to create Stable Exchange Rates

• Member Govts. commitment• Exchange Rate Fluctuation < 2.25% from central point

• Created European Currency Unit (ECU)– An unit of Account– Weighted average of EMS Countries– Not a real currency – A basis for the idea though– Idea – Realized with launching of Euro (1999)– Designed to create stable commerce & encourage trade

between member states– Unprecedented co-ordination of monetary policies

between member states– Operated successfully over a decade – Provided impetus

for more

DELORS REPORT

• The European Commission President, Jacques Delors, and The Central Bank Governors of the EU Member states commitment towards EMU

• Stage – I (1990-1994)• Completing Internal Market

» Free Movement of Capital

• Stage – II (1994-1999)• The ECB, ESCB & Economic Convergence

• Stage – III (1999 onwards)• Fixing Exchange Rates & Launching of Euro

MAASTRICHT TREATY (DEC, 1991)

• Acceptance of the Delors report• Replace all individual ECU

Currencies with a single currency called Euro

• Laid down the steps for a complete European Economic Monetary Union(EMU)

THE MAASTRICHT CONVERGENCE CRITERION

• Nominal Inflation <1.5% above the average for the three members of the EU with the lowest inflation rates

• Long term interest rate <2% above the average of the for the three members with the lowest interest rate

• The fiscal deficit <3% of the GDP

• Government debt <60% of GDP

EURO –JOURNEY & GOVERNING BODIES

• 1999 – Virtual Currency• Official currency of 11 member

states• For cashless payments &

accounting purposes

• 2002 – Physical form• As bank notes & coins

• Monetary policy• Independent European Central

Bank (ECB)• National Central Banks of the

Member States

• Fiscal policy• Stability & Growth Pact• Full responsibility for Structural

Policies• Common goals - Stability, Growth &

Employment

Year Countries Involved/ Milestone

1999

Belgium, Germany, Ireland, Spain, France, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland

2001 Greece

2002 Introduction of euro banknotes and coins

2007 Slovenia

2008 Cyprus, Malta

2009 Slovakia

EURO BENEFITS

• Stable Prices• Inflation rate fallen from

20% (1980s) to 2%– Better purchasing power

& value of savings– Future more certain

• Easier, Safer & Cheaper Borrowing– As inflation is low,

interest rates are low too– Cheaper consumer loans– Mortgage rates fallen

from 8-14%(1980s) to 5%