1 The International Monetary System Budirman Bin Daud (805014) Noorina Binti Abd Hamid (805015) Dayang Halimah Binti Mahali ( ) Datu Zakariah Bin Datu Bistari (808744)

2Outline 1.Introduction 2.The Gold Standard 3.The Bretton Woods System 4.The Collapse of the Fixed Exchange Rate System 5.The Floating Exchange Rate Regime 6.The Fixed Versus Floating Exchange Rates 7.Exchange Rate Regimes in Practice 8.IMF Crisis Management

3Introduction International Monetary System is the institutional arrangements that countries adopt to govern exchange rate or we can say is the rules and procedures by which different national currencies are exchange for each other in world trade. Such a system is necessary to define a common standard of value for the world’s currencies.

4 Terms of Exchange Rate 1.Floating exchange rate : When a country allow the foreign exchange market to determine the relative value of a currency. 2.Pegged exchange rate : When a country fixes the value of its currency relative to a reference currency. 3.Dirty float : When a country tries to hold the value of its currency within some range against an important reference currency. 4.Fixed exchange rate : The values of a set of currencies are fixed against each other at some mutually agreed-on exchange rate.

5 The Gold Standard The gold standard dates back to ancient times when gold coins were a medium of exchange, unit of account, and store of value. Some country pegging currencies to gold and guaranteeing convertibility. In the 1880s, most of the world’s trading nations followed the gold standard which the payment for imports was made in gold or silver. Later, as trade grew, payment was made in paper currency which was linked to gold at a fixed rate.

6 The Gold Standard The Gold par value: U.S dollar $1.00 = grains of pure gold $20.67 = 1 ounce of gold (480 grains = 1 ounce) British pound £1.00 = 113 grains of pure gold £4.25 = 1 ounce of gold From the gold par value of pounds and dollars, we can calculate the exchange rate for exchanging pounds in dollars: i.e £1.00 = $4.87 (*Currently £1.00 = $1.62) The great strength of the gold standard was that it contained a powerful mechanism for achieving balance-of- trade equilibrium (when the income a country’s residents earn from its exports is equal to the money its residents pay for imports) by all countries.

7 The Period Between The Wars: The gold standard worked fairly well from the 1870s until the start of World War I in During the war, many governments financed their war expenditures by printing money, and in doing so, created inflation. People lost confidence in the system and started to demand gold for their currency putting pressure on countries' gold reserves, and forcing them to suspend gold convertibility. By 1939, the gold standard was dead.

8 The Bretton Woods System In 1944, 44 countries met in New Hampshire Countries agreed to peg their currencies to US$ which was convertible to gold at $35/oz Agreed not to engage in competitive devaluations for trade purposes and defend their currencies Weak currencies could be devalued up to 10% w/o approval Created the IMF and World Bank

9 The Role of the IMF  IMF maintained exchange rate –discipline National governments had to manage inflation through their money supply –flexibility Provides loans to help members states with temporary balance-of-payment deficit; –Allows time to bring down inflation –Relieves pressures to devalue Excessive drawing from IMF funds came with IMF supervision of monetary and fiscal policies –Allowed to 10% devaluations and more with IMF approval

10 The Role of the World Bank  World Bank (IBRD) role (International Bank for Reconstruction & Development) –Refinanced post-WWII reconstruction and development –Provides low-interest long term loans to developing economies  The International Development Agency (IDA), an arm of the bank created in 1960 –Raises funds from member states –Loans only to poorest countries –50 year repayment at 1% per year interest

11 The Collapse of the Fixed Exchange Rate System The system of fixed exchange rates established at Bretton Woods worked well until the late 1960’s The US dollar was only currency that could be converted into gold The US dollar served as the reference point for all other currencies Any pressure to devalue the dollar would cause problems through out the world

12 Factors that led to the collapse of the fixed exchange system include President Johnson financed both the Great Society and Vietnam by Printing money High inflation and high spending on imports On 8 August 1971, President Nixon announces dollar no longer convertible into gold Countries agreed to revalue their currencies against the dollar On 19 March 1972, Japan and most of Europe floated their currencies In 1973, Bretton Woods fails because the key currency (dollar) is under speculative attack

13 The Floating Exchange Rate Regime In 1976, following the collapse of Bretton Woods, IMF members formalized a new exchange rate system at a meeting in Jamaica. The rules that were agreed on then, are still in place today. The Jamaica Agreement revised the IMF’s Articles of Agreement to reflect the new reality of floating exchange rates.

14 The Jamaica Agreement Under the Jamaican agreement: floating rates were declared acceptable gold was abandoned as a reserve asset total annual IMF quotas - the amount member countries contribute to the IMF - were increased to $41 billion

15 Exchange Rates Since 1973 Since 1973, exchange rates have become more volatile and less predictable than they were between 1945 and 1973 Volatility has increased because of: The 1971 oil crisis The loss of confidence in the dollar that followed the rise of U.S. inflation in 1977 and 1978 The 1979 oil crisis The unexpected rise in the dollar between 1980 and 1985 The partial collapse of the European Monetary System in 1992 The 1997 Asian currency crisis

16 FIXED VERSUS FLOATING EXCHANGE RATES Disappointment with floating rates in recent years has led to renewed debate about the merits of a fixed exchange rate system. The Case for Floating Exchange Rates The case for floating exchange rates has two main elements: monetary policy autonomy automatic trade balance adjustments

17 Monetary Policy Autonomy Advocates of a floating exchange rate regime argue that removal of the obligation to maintain exchange rate parity restores monetary control to a government Under a fixed system, a country's ability to expand or contract its money supply as it sees fit is limited by the need to maintain exchange rate parity

18 Trade Balance Adjustments Under the Bretton Woods system, if a country developed a permanent deficit in its balance of trade that could not be corrected by domestic policy, the IMF would agree to a currency devaluation Critics of this system argue that the adjustment mechanism works much more smoothly under a floating exchange rate regime

19 The Case for Fixed Exchange Rate The case for fixed exchange rates rests on arguments about monetary discipline, uncertainty, and the lack of connection between the trade balance and exchange rates. Monetary Discipline The need to maintain a fixed exchange rate parity ensures that governments do not expand their money supplies at inflationary rates

20 Speculation Critics of a floating exchange rate regime also argue that speculation can cause exchange rate fluctuations Uncertainty Speculation adds to the uncertainty surrounding future currency movements that characterizes floating exchange rate regimes Trade Balance Adjustments Advocates of floating exchange rates argue that floating rates help adjust trade imbalances The Case for Fixed Exchange Rate

21 Who is Right? There is no real agreement as to which system is better We know that a fixed exchange rate regime modeled along the lines of the Bretton Woods system will not work A different kind of fixed exchange rate system might be more enduring and might foster the kind of stability that would facilitate more rapid growth in international trade and investment

22 EXCHANGE RATE REGIMES IN PRACTICE 19% of IMF members follow a free float policy 26% of IMF members follow a managed float system 22% of IMF members have no legal tender of their own The remaining countries use less flexible systems such as pegged arrangements, or adjustable pegs

23 The Exchange Rate Policies of IMF Members, 2006

24 Pegged Exchange Rates Under a pegged exchange rate regime a country will peg the value of its currency to that of another major currency. Pegged exchange rates are popular among the world’s smaller nations. There is some evidence that adopting a pegged exchange rate regime does moderate inflationary pressures in a country. Currency Boards A country that introduces a currency board commits itself to converting its domestic currency on demand into another currency at a fixed exchange rate. To make this commitment credible, the currency board holds reserves of foreign currency equal at the fixed exchange rate to at least 100% of the domestic currency issued.

25 IMF ORIGINAL FUNCTIONS WAS TO PROVIDE A POOL OF MONEY, WHICH MEMBER CAN BORROW, SHORT TERM TO ADJUST THEIR BALANCE OF PAYMENTS AND EXCHANGE RATE IMF Crisis Management

26  Currency Crisis - when a speculative attack on the exchange rate  Banking Crisis - Loss of confidence in the banking system  Foreign debt crisis – When a country cannot service its foreign debt obligations 3 Types of Crisis

27 1. High relatives price inflations rates 2. Widening Current Account Deficit 3. Excessive Expansion of Domestic Borrowing 4. Asset Price inflation ( sharp rise in stock & property prices) Effect of These Crisis

28 All IMF loan packages attached with conditions, including 1.Tighter Macroeconomic policies, which include cut in pubic spending 2.Higher interest rate 3.Tight monetary control 4.Deregulation of protected industries from competitions 5.Privatization of stated owned assets 6.Better financial reporting from banking sectors. Evaluation the IMF’s Policy Prescriptions

29 “one-size-fits-all” refers to one rescue package that applied to all countries, inappropriate. “Moral Hazard” refers to borrower behaving recklessly because they know that they will be saved if things goes wrong. IMF have become too powerful for an institution that lacks accountability. Inappropriate Policies

30 IMF were able to contains economic meltdown in several crisis for example The Asian economic crisis in But in several cases also the policies implemented seem to fail, e.g Turkey have received 18 aids since 1958 Conclusions

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