The International Monetary System:
History and Where we are Today
Recall the Definition of an Exchange Rate
Regime
• Defined: The way in which a country manages
its currency and thus the arrangement by the
price of that country’s currency is determined
on foreign exchange markets.
• Arrangements ranging from:
– Floating Rate
– Managed Rate (AKA “Dirty Float”)
– Pegged Rate
• Arrangement is determining by governments.
History of Exchange Rate Regimes
• Over the past 200+ years, the world has gone
though major changes its global exchange rate
environment.
• Starting with the gold standard regime of the
latter part of the 19th century to today’s
somewhat “mixed system” we can identify there
3 distinct periods:
– Gold Standard: 1816 - 1914
– Bretton Woods: 1945 - 1973
– Mixed System: 1973 – the present
Gold Standard: 1816 - 1914
• During the 1800s the industrial revolution brought about
a vast increase in the production of goods and widened
the basis of world trade.
• At that time, trading countries believed that a necessary
condition to facilitate world trade was a stable exchange
rate system.
– Stable exchange rates were seen as necessary for encouraging
and settling commercial transactions across borders (both by
companies and by governments).
– So by the second half of the 19th century, most countries had
adopted the gold standard exchange rate regime.
Basics of the Gold Standard
• The gold standard regime required
that domestic currencies (national
money) be defined in terms of a
specific weight of gold.
• For example:
– The British pound was fixed at
.23546% of an ounce of pure gold
(in 1816).
– The U.S. dollar was fixed at
0.048379% of an ounce of pure gold
(in 1879).
– Thus, the dollar pound “parity” (i.e.,
the exchange rate) was set at
$4.867
– .23546/.048379 = 4.867
• The Gold Standard also required
that each country adjust its
domestic money supply in direct
relation to the amount of gold it
held.
– Increase in gold would increase the
domestic money and a reduction in
its gold supply would reduce the
money supply.
• How it worked:
• Assume the United Kingdom
ran a trade deficit with the
United States.
• As a result, gold would flow
from the UK to the US (gold
financed trade imbalances).
• Each country’s domestic money
supply was tied into the
amount of gold it held, thus the
U.S. money supply would rise.
• The increase money supply
would increase prices in the
United States, which in turn
would make U.S. goods less
attractive to the UK.
• The net result was that the
trade surplus of the US would
decrease and the trade deficit
of the UK would decrease.
World War I (1914) Through World
War II (1944)
• World War I marks the beginning of the end of the Gold Standard .
• During the war, countries suspended the convertibility of their currencies
into gold.
• After WW I, various attempts were made to restore the “classical” gold
standard.
– 1919: United States returned to a gold standard.
– 1925: Great Britain joined, followed by France and Switzerland.
• These attempts proved unsuccessful.
– Why: During this time, most countries were more concerned with
their national economies than exchange rate stability.
• Especially during the Great Depression (1929 – 1930s)
– As a result, countries abandoned their attempts to return to an
interwar gold standard.
• Britain and Japan dropped it in 1931, the U.S. in 1933.
Bretton Woods: A Pegged Regime
• 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.
The Yen During Bretton Woods
JPY Exchange Rate: 1950 - 1970
361.5
Exchange Rate
361
360.5
360
359.5
359
1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970
Sterling During Bretton Woods
GBP Exchange Rate: 1950 - 1970
2.9
2.8
Exchange Rate
2.7
2.6
2.5
2.4
2.3
2.2
2.1
1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970
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 higher).
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.
Yen Immediately After the Collapse
of Bretton Woods
1971 - 1980
•
•
•
•
•
•
•
•
•
•
400
350
300
Exchange Rate
Annual Data: % in USD
250
200
150
100
50
0
1971 1972 1973 1974 1975 1976 1977 1978 1979 1980
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
349.33
303.17
271.70
292.08
296.79
296.55
268.51
210.44
219.14
226.74
-2.96%
-13.21%
-10.38%
7.50%
1.61%
-0.08%
-9.46%
-21.63%
4.13%
3.47%
Sterling Immediately After the
Collapse of Bretton Woods
1971 - 1980
•
•
•
•
•
•
•
•
•
•
3
2.5
Exchange Rate
Annual Data: % in GBP
2
1.5
1
0.5
0
1971 1972 1973 1974 1975 1976 1977 1978 1979 1980
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
2.4336
2.4975
2.4497
2.3375
2.2124
1.7969
1.7443
1.9176
2.1177
2.3239
1.41%
2.62%
-1.91%
-4.58%
-5.35%
-18.78%
-2.93%
9.93%
10.44%
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 currency’s
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 currency’s 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
Useful Web Sites
• Link to the history of foreign exchange regime
changes of many countries.
– http://intl.econ.cuhk.edu.hk/exchange_rate_regime/i
ndex.php?cid=8
• Quarterly report on U.S. Intervention in foreign
exchange markets
– http://www.ny.frb.org/markets/foreignex.html
Go to archives, July 30, 1998 to view intervention
activity.