1. The International
Monetary System

2. Introduction
 The international monetary system refers
to the institutional arrangements that
countries adopt to govern exchange rates

3. Introduction
International monetary systems are sets
of internationally agreed rules,
conventions and supporting institutions
that facilitate international trade, cross
border investment and generally the
reallocation of capital between nation
states

4. Introduction
 It addresses to solve the problems
relating to international trade:
a.
b.
c.
Liquidity
Adjustment
Stability

5. The problem of Liquidity
 The problem of liquidity existed even in
the domestic transactions through barter
system
 Barter system was replaced by precious
metals as a medium of exchange and store
of value
 Gold standard system of international
payments came into existence

6. The Gold Standard
The
first modern international monetary
system was the gold standard
Put in effect in 1850
Participants – UK, France, Germany &
USA

7. Gold Standard- I ( 1876-1913)
●In this system, each currency was linked to
a weight of gold
●Under gold standard, each country had to
establish the rate at which its currency
could be converted to a weight of gold.

8. Gold Standard- I ( 1876-1913)
●Most of the countries used to declare
par value of their currency in terms of
gold
●The problem was every country needed
to maintain adequate reserves of gold in
order to back its currency

9. The Gold Standard
●
After World War I, the exchange rates were
allowed to fluctuate
●
Since gold was convertible into currencies
of the major developed countries, central
banks of different countries either held gold
or currencies of these developed countries

10. The System of Bretton Woods
( 1944-71)
 In July, 1944, 44 countries met in Bretton
Woods, New Hampshire, USA – a new
International Monetary System was
created
 John Maynard Keynes of Britain and
Harry Dexter White of USA were the key
movers

11. The Bretton Woods Agreement
 Creation of International Monetary Fund
(IMF) to promote consultations and
collaboration on international monetary
problems and countries with deficit balance
of payments
 Establish a par value of currency with
approval of IMF
 Maintain exchange rate for its currency
within one percent of declared par value

12. The Bretton Woods Agreement
 Each member to pay a quota into IMF pool –
one quarter in gold and the rest in their own
currency
 The pool to be used for lending
 Dollar was to be convertible to gold till
international instrument was introduced
 International Bank for Reconstruction and
Development (IBRD) was created to
rehabilitate war-torn countries and help
developing countries

13. The System of Bretton Woods
( 1944-71)
 So in effect this was a gold – dollar exchange
standard ( $35/ounce)- known as fixed
exchange rate system or adjustable
peg
 Devaluation could not be resorted arbitrarily
When BOP problem became structural i.e.
repetitive, devaluation upto ten percent was
permitted by IMF
 Thus each currency was tied to dollar directly
or indirectly


14. Collapse of the
Fixed Exchange System
 The system of fixed exchange rates
established at Bretton Woods worked well
until the late 1960’s
 Any pressure to devalue the dollar would
cause problems throughout the world
 The trade balance of the USA became highly
negative and a very large amount of US
dollars was held outside the USA ; it was
more than the total gold holdings of the USA

15. Collapse of the
Fixed Exchange System
 During end of sixties, European
governments wanted gold in return for
the dollar reserves they held
 On 15th Aug. 1971, President Nixon
suspended the system of convertibility of
gold and dollar and decided for floating
exchange rate system

16. The end of the Bretton Woods System (1972–
81)
 The system dissolved between 1968 and
1973
 By March 1973, the major currencies
began to float against each other

17. The end of the Bretton Woods System (1972–
81)
IMF members have been free to choose any
form of exchange arrangement they wish
(except pegging their currency to gold):
 Allowing the currency to float freely
 Pegging it to another currency or a basket
of currencies
 Forming part of a monetary union

18. Exchange Systems after 1973
Exchange Rate systems are classified on
the basis of the flexibility that the
monetary authorities show towards
fluctuations in the exchange rates and
are divided into two categories:
1. Systems with a fixed exchange rate
( “fixed peg” or “hard peg”) and
2. Systems with a flexible exchange
rate
( “Floating” systems)

19. Exchange Systems after 1973
But as usual, between these two extreme
positions there exists also an intermediate
range of different systems with limited
flexibility, usually referred to as “soft pegs”

20. A fixed peg regime
A fixed peg regime exists when the
exchange rate of the home currency is
fixed to an anchor currency
This is the case with economies having
currency boards or with no separate
national currency of their own
Countries do not have a separate national
currency, either when they have formally
dollarized, or when the country is a
member of a currency union, for example
Euro

21. Floating Exchange Rate System
● The collapse of Bretton Woods and
Smithsonian Agreements coupled with oil
crisis of 1970, the floating exchange rate
system was adopted by leading
industrialised countries
● Officially approved in April 1978
● Under the system, the exchange rate would
be determined by market forces without the
intervention of government

22. Floating Exchange Rate System
●No country in the world has adopted
freely floating exchange rate system
●Floating exchange rate regimes consist of
independent floating and managed
floating systems

23. Independent Floating systems
In Independent Floating systems the
exchange rate is market determined
and monetary policy usually functions
without exchange rate considerations
Foreign exchange interventions are
rare and meant to prevent undue
fluctuations
But no attempt is undertaken to
achieve/maintain a particular rate

24. Managed Floating systems
 Managed Floating systems usually let the
market take its own course but the monetary
authorities intervene in the market to “manage”
the exchange rate, if needed, to prevent high
volatilities and to stimulate growth, without
committing to a particular exchange rate level
 The monetary authorities do not specify their
opinion on “suitable” exchange rate level
 The IMF calls this practice a “Managed Floating
With No Predetermined Path for the Exchange
Rate”

25. Intermediate Regimes ( Soft Pegs)
Intermediate exchange rate regimes
consist of an array of differing systems
allowing a varying degree of flexibility,
such as conventional fixed exchange rate
pegs, crawling pegs and exchange rate
bands

26. Conventional fixed exchange rate pegs
In a Conventional Fixed Peg arrangement
a currency is pegged at a fixed rate to a
major currency or a basket of currencies,
allowing the exchange rate to fluctuate
within a narrow margin of ±1 percent
around a formal central rate
The monetary authority intervenes in the
market, if the fluctuation is outside these
limits

27. Crawling Peg ( The Dirty Float)
●In this system an attempt is made to
combine the advantages of fixed exchange
rate with flexibility of floating exchange
rate
●It fixes the exchange rate at a given level
which is responsive to changes in market
conditions i.e. it is allowed to crawl

28. Crawling Peg ( The Dirty Float)
In a Crawling Peg arrangement the
currency is adjusted periodically “in
small amounts at a fixed rate or in
response to changes in selective
quantitative indicators (past inflation
differentials vis-à-vis major trading
partners…)
A Crawling Band allows a periodic
adjustment of the exchange rate band
itself

29. Crawling Peg ( The Dirty Float)
● The upper and lower limits are decided for
exchange rate depending demand and supply of
foreign exchange
● As the exchange rate crosses these limits, fiscal
and monetary policies come into play to push
the exchange rate within the target zone
● But in this case, these limits are sustained for
some time and if it is felt that economic
indicators are being disturbed, the monetary
authorities let the exchange rate depreciate or
appreciate as the case may be

30. Exchange Rates Since 1973
●
The merits of each continue to be debated
●
There is no agreement as to which system
is better
●
Many countries today are disappointed
with the floating exchange rate system

31. Implications For Managers
For managers, understanding the
international monetary system is important
for:
 Currency management
 Business strategy
 Corporate-government relations

32. Currency Management
Managers must recognize that the current
international monetary system is a managed
float system in which government
intervention can help drive the foreign
exchange market
Under the present system, speculative
buying and selling of currencies can create
volatile movements in exchange rates

33. Business Strategy
Managers need to recognize that while
exchange rate movements are difficult to
predict, their movement can have a major
impact on the competitive position of
businesses
To contend with this situation, managers
need strategic flexibility e.g. dispersing
production to different locations

34. Corporate-Government Relations
Managers need to recognize that
businesses can influence government
policy towards the international
monetary system
Companies should promote an
international monetary system that
facilitates international growth and
development