International
Financial System
The Gold Standard
Gold Standard
1880-1914
 Currencies valued in terms of their gold
equivalent
 Mid 1870’s most major economies
pegged to gold
 All currencies linked together in a system
of fixed exchange rates
Gold Standard
Example
 Currency A worth 0.10 ounce gold
 Currency B worth 0.20 ounce gold
 1 unit of B worth twice as much as 1 unit
of A.
Gold Standard
pros and cons
 To achieve long run price stability
 Prices may rise and fall with swings in gold
output
 National money supplies constrained by growth
of stock of gold
 As long as gold stock steady prices steady
 Countries with balance of payments deficits
outflows of gold , msreduce.
The Interwar Period
1918-1939
 WW 1 ended the gold standard
 Europe experienced rapid inflation
 USA little inflation so returned to gold
standard in 1919.
 War ended Britain’s financial
preeminicence
 USA World’s dominent banker country
Interwar Period
 1930’s depression years.
 Trying to stimulate domestic economies
by increasing exports country after
country had to devalue.
 Period of competitive devaluations.
 Run on US gold holdings at the end of
1931.
 USA abandoned the gold standard.
The Gold Exchange Standard
1944-1970
 Desire to reform the international
monetary system led to an international
conference at Bretton Woods , New
Hampshire.
 US dollar key currency in the system.
 1$= 1/35 ounce gold.
 Primary architects Harry White of US and
Keynes of UK.
Bretton Woods
 For countries experiencing difficulty
maintaining their parity value new
institution created.
 The International Monetary Fund
International Monetary
Fund
 Headquartered in Washington D.C
 Had 30 original member now 180.
 Given the task of promoting the growth of world
trade, setting rules for maintenance of fixed
exchange rates.making loans to countries
facing balance of payments difficulties.
 Collecting and standardizing int economic data.
IMF
 oversees the international monetary system
 promotes exchange stability and orderly
exchange relations among its member
countries
 assists all members--both industrial and
developing countries--that find themselves in
temporary balance of payments difficulties by
providing short- to medium-term credits
IMF
 supplements the currency reserves of its
members through the allocation of SDRs
(special drawing rights); to date SDR 21.4
billion has been issued to member countries in
proportion to their quotas
 draws its financial resources principally from
the quota subscriptions of its member countries
 has at its disposal fully paid-in quotas now
totaling SDR 145 billion (about $215 billion)
 has a staff of 2,300 drawn from 182 member
countries
World Bank
 seeks to promote the economic development
of the world's poorer countries
 assists developing countries through long-term
financing of development projects and
programs
 provides to the poorest developing countries
whose per capita GNP is less than $865 a year
special financial assistance through the
International Development Association (IDA)
World Bank
 encourages private enterprises in developing
countries through its affiliate, the International
Finance Corporation (IFC)
 acquires most of its financial resources by
borrowing on the international bond market
 has an authorized capital of $184 billion, of
which members pay in about 10 percent
 has a staff of 7,000 drawn from 180 member
countries

1960’s
 In 1960 USA ; dollar crises due to run large
balance of payments deficits
 By the late 1960’s foreign dollar liabilities of
USA much larger than the US gold stock.
 Pressures of this dollar glut terminated Nixon
declared 1971 dollar incovertible
 Close to the Bretton Woods era fixed exchange
rates and convertible currencies.
Transition Years
1971-73
 Dec 1971 Smithsonian agreement dollar
devalued by about 8% , surplus
countrie’s curriencies revalued upward.
 June 1972 countries like Germany and
Switzerland experiencing large inflows of
speculative capital.
 They applied legal control to slow further
movements of money.
Transition Years
 Dollar still inconvertible.
 Speculative capital flows of 1972 further
devaluation of dollar.
 An ounce of gold rose from $38 to $42.2
still speculative capital flows from weak
to strong curr persisted.
 March 1973 major currencies began to
float.
Floating Exchange Rates
1973-to the Present
 System best described as managed float.
 Exchange rate systems; Flexible
(floating),Managed Floating, Fixed
Exchange Rate Systems.
Exchange Rate Systems
Floating -Flexible
 Flexible (floating) ; Value of the currency
determined by the market.
 By the interactions of banks , firms other
institutions.Seeking to buy , sell currency for
purposes of transactions clearing, hedging,
arbitrage and speculation
 Most OECD countries , US, Canada, Britain ,
Australia , European Monetary Union.
Managed Float
 Hybrid of fixed exchange rate and flexible
exchange rate system.
 Central Bank holds stocks of foreign
currency.
 Intervenes in forex market by buying and
selling foreign currency to keep exch rate
at desired implicit target values.
Fixed (Pegged) Exchange
Rates
 Prior to 1970’s most countries operated
under fixed exchange rate system.
 Exchange Rate of member countries
fixed against US dollar , with the dollar in
turn worth a fixed amount of gold.
 Why exch rates kept fixed??????
Fixed Exch Rates
 To facilitate trade
 Reducing fluctuations in relative prices.
 Reducing uncertainty
Adjustable Pegged Exchange
Rate
Crawling Peg
 Central Bank fixes the value of the
currency when it desires
 Crawling peg ; Fixed exchange rate
system where fixed rate changes in a
pre-determined manner .
Floating Exchange Rates
SDR
 SDR’s are special international reserve
assets created by IMF.
 If trade is not heavily concentrated with
USA diversified across several countries.
 More sensible to alter the currency value
to a weighted average of foreign
currencies.
SDR
 Some countries choose to peg to the
SDR (special drawing rights)
 A basket peg is choosen.
 Basket of currencies consisting of yen,
euro , sterling , dollar.(today)
The Choice Of an
Exchange Rate System
 Country size in terms of economic activity
or GDP important for choosing floating or
pegging exchange rates.
 Large countries more independent ,
foreign trade constitutes smaller part of
GDP..
Choice Of Exchange Rate
System
 Openess of economy ;
 the degree to which country depends on
international trade.
 The greater the fraction of tradable goods
in GDP the more open the economy will
be.
 The more open economy tends to follow
a pegged exchange rate.
Choice of Exc Rate
 Inflation rates ; Countries inflation experience
above average tend to choose floating exch
rates.
 Where exch rate is adjusted at short intervals
to compensate for inflation differentials.
 Countries that trade with one single currency
pegs their exchange rate to that currency.
Conclusion
 Peggers ; small size , open
economy,Harmonious inflation rate,
concentrated trade.
 Floaters; Large Size , Closed economy ,
Divergent inflation rate , diversified trade.