The way that the foreign-exchange market is organized; The types of assets used for financing or settling payments imbalances among countries; The mechanism of adjustment to trade deficits and surpluses.
With international transactions expanded greatly in the 19th century, an international monetary arrangement emerged in response to the demand for a better means of payments. This system was called the gold standard. It was an arrangement that evolved naturally. A key aspect of the gold standard was that central banks hold a large part of their international reserve assets in the form of gold. London was then the worlds major financial center, and the British pound was extensively accepted as the international reserve currency. Under the gold standard, national currencies were linked to gold at a fixed parity (, that is, each nation defined its currency unit as equal to the value of a specified amount of pure gold. From the common gold denominator, the value of any currency in units of any other was easily determined. During this period of the gold standard, a strict fixed exchange-rate system was adopted. For instance, 1 = 1 oz of gold $ 1 = 0.5 oz of gold So, 1= 2 $ (That is fixed.)
International payments imbalances give rise to gold movements that in turn were supposed to trigger an automatic adjustment process. A continuing surplus in one country would increase that countrys gold stock, hence, money supply, thus provoking a general price rise. The price rise would result in falling exports and rising imports until the surpluses disappeared. In the case of a persistent deficits, the money supply would diminish, causing the opposite direction. The gold standard proved attractive because of its autocratic, self-correcting properties and its promise of long- run price-level stability. However, in World War I, governments imposed currency controls and abandoned the commitment to convert their paper currencies into gold. Most currencies were allowed to fluctuate freely as the war ended.
On 20 July, 1944 in Bretton Woods (New Hampshire), delegates from 44 countries signed agreements that created the gold exchange standard, making the US dollar the only reserve currency convertible into gold.
The Bretton Woods agreement adopted a fixed exchange- rate system. Member governments agreed to fix the value of their currencies in terms of gold, but were not required to exchange their currencies for gold. Only the US dollar remained convertible into gold at the fixed rate of $ 35 per ounce. The special status of the US dollar within the system made it a universally accepted international reserve currency, and it was freely convertible into gold upon request from foreign official agencies. Under the system, a member country could borrow from the pool of national currencies held by IMF, or use SDRs to meet payment imbalance. For instance, other currencies US dollars gold
The Bretton Woods System worked well during its first 20 years. When national incomes and international trade grew rapidly, and the problem occurred, that is the Triffin Paradox. As the US inflation rate increased and payments deficits became larger in the late 1960s, US dollars depreciated against gold relatively. (More and more countries got dollars and exchanged those dollars into gold, and the American gold reserve can not meet such huge demands.) So this system can not be sustainable for a long time. ( ) Moreover, the rigidity of the exchange rate arrangements accelerated the transmission of inflation among countries.
It was not until 1976, at a meeting in Jamaica that the system of flexible exchange rates, already extensively used, were deemed to be acceptable to the IMF members, and central banks were permitted to intervene and manage their floats to prevent undue volatility. Gold was officially demonetized. Under the Jamaica System, SDRs position as an international reserve asset was strengthened, which to some extent improved the ability of the IMF in solving payments imbalances. With the economic development of Germany and Japan, the reserve assets tend to be diversified. The flexibility in exchange rates, as a main feature under the system, enabled nations to have their own arrangements in foreign exchanges and more freedom in national policies. (In practice, most of the currencies of the smaller economies were pegged to another currency, often that of their major trading partner. The currencies of the bigger economies were floating against each other, and most of the trade and investment flows were conducted based on floating exchanges.)
The exchange-rate flexibility, on on hand, added a new way for countries to meet their BOP deficits, while on the other hand, increased risks in international transactions and cause financial instability.
Today, we are facing economic globalization. There is a trend of increasing financial and economic interdependence among countries. Financial instability, which is spawned by financial deregulation ( and the growth in trade, is a more and more important issue for the financial market. In order to combat financial risks, many countries cooperate in interventions in foreign exchange market (managed float system), which came in conjunction with an agreement for greater coordination of monetary and fiscal policies among nations. It is hoped that IMS will evolve smoothly and become even better adapted to the more complex financial market.