CHAPTER

21 International Economics

The International Monetary

System: Past, Present, and Future
LEARNING GOALS
After studying this chapter, you should be able to:
 Understand how the gold standard operated
 Describe how the postwar Bretton Woods System
operated and why it collapsed
 Know how the present international monetary system
works
 Identify the major international economic problems
facing the world today
Content
 Introduction
 The Gold Standard and the Interwar Experience
 The Bretton Woods System
 Operation and Evolution of the Bretton Woods System
 U.S BOP Deficits and Collapse of the Bretton Woods System
 The International Monetary System: Present and Future
 Group Discussion
1. What is meant by an international monetary system? How
many international monetary systems? How can international
monetary systems be classified and evaluated?
2. Describe the characteristics of the international monetary
system Bretton woods and explain why the Bretton Woods
System collapsed?.
3. Explain the role of gold and USD under the international
monetary systems and for Vietnam today?.
4. Explain briefly the operation of the Present International
Monetary System, and the main problems with Present
Exchange Rate Arrangements?.
Introduction
 An international monetary system refers to the rules,
customs, instruments, facilities and or organizations for
effecting international payments
 It can be classified according to the way in which:
 exchange rates are determined or
 according to the form that international reserve assets take.
Introduction
 The purpose of an international monetary system:
 To promote the international exchange of goods, services, and factors of
production
 A good international monetary system is one that:
 Maximizes the flow of international trade and investments
 Leads to “equitable” distribution of gains from trade among nations of
the world
 Introduction

 An international monetary system can be evaluated in terms of:

 Adjustment: process by which BOP disequilibria are corrected
 Liquidity: the amount of international reserve asset available to settle
temporary BOP disequilibria
 Confidence: the knowledge that the adjustment mechanism is
working adequately, and that international reserves will retain their
absolute and relative values
The Gold Standard and the Interwar
Experience
 The Gold Standard Period (1880-1914)
 The exchange rate between two currencies was determined by
their gold content.
 Exchange rates were fixed at mint parity (i.e within the gold points),
allowed to fluctuate by the cost of shipping:
 According to the mint parity theory, the exchange rate under gold standard is equivalent to
the gold content of one currency relative to that of another. This exchange rate is also
known as mint rate.
 The value of each coin (gold or silver) will depend upon the amount of metal (gold or silver)
contained in the coin, and it will freely circulate between the countries
 If USD contains 10 grams of gold and AUD contains 5 grams of
gold, then rate of exchange is: 1USD = 2AUD.
 The Gold Standard and the Interwar
Experience
 The Gold Standard Period (1880-1914)
 The exchange rate was determined within the gold points by the
forces of demand and supply and was prevented from moving
outside the gold points by gold shipments.
 The adjustment mechanism was Hume’s price –specie flow
mechanism:
 the increase in domestic prices due to the gold inflow would discourage exports and
encourage imports, thus automatically limiting the amount by which exports would
exceed imports
 Nations could not use monetary policy to achieve full employment
without inflation
The Gold Standard and the Interwar
Experience
 The Gold Standard Period (1880-1914):
 With each nation's currency fixed to gold, there is an implied
fixed exchange rate with each other nation's currency.
 For example:
 If the price of gold in the U.S. were to be set at $5 and the price of gold in
the U.K. were to be set at £1 then the implied fixed price of the pound is $5/
£1
 If the U.S were to run a deficit relative to the UK, then the price of the pound
would begin to increase on the foreign exchange market, say to $5.10/£1.
The Gold Standard and the Interwar
Experience
 The Gold Standard Period (1880-1914):
 In reality, adjustment process worked much too smoothly and
quickly, with few actual transfers of gold
 Adjustments occurred because of special conditions that existed
during this time:
 Great economic expansion and stability in most of the world
 Pound sterling was only important international currency
 Greater price flexibility than today
The Gold Standard and the Interwar
Experience
 The Interwar Experience
 Classical gold standard came to an end with outbreak of World
War I
 1919 -1924, exchange rates fluctuated wildly, and this led to a
desire to return to the stability of the gold standard.
 The gold-exchange standard allowed gold and currencies
convertible into gold to be used as international reserves
The Gold Standard and the Interwar
Experience
 The Interwar Experience
 Causes of gold-exchange standard collapse:
 the lack of an adequate adjustment mechanism as nations sterilized
the effect of BOP disequilibria on their money supplies in the face of
grossly inappropriate parities
 Huge destabilizing capital flows from Lodon to New York and
Paris’
 Outbreak of Great Depression 1931 – 1936 (a period of great instability
and competitive devaluations as nations tried to “export” their
unemployment)
Bretton Woods System
 Gold-Exchange Standard (1947-1971)
 In 1944, representatives of 44 nations met at Bretton
Woods, New Hampshire, and designed a new
postwar international monetary system for purposes of:
 Overseeing that nations followed rules of conduct in international
trade and finance
 Providing borrowing facilities for nations in temporary BOP
difficulties
The Bretton Woods System
 Gold-Exchange Standard (1947-1971)
 Bretton Woods was a gold-exchange standard
 The US was to maintain the price of gold fixed at $35 per
ounce and be ready to exchange on demand dollars for
gold at that price without restrictions or limitations.
 Each nation established a par value in relation to the
US dollar, which was pegged to gold at $35 per ounce
 Other nations fixed their exchange rates in terms of
dollars, maintaining rates within +-1% (above or below
par value)
 The Bretton Woods System
 In borrowing from the IMF, a nation receives convertible
currencies to fund BOP disequilibria
 Upon joining the IMF, a nation was to pay 25 percent of its quota
to the Fund in gold and the remainder in its own currency.
 A nation may borrow no more than 25 percent of its quota
during any given year with a maximum borrowing limit of 125
percent
 The first 25 percent borrowed, the gold trance, comes without restrictions
or conditions
 Subsequent tranches come with higher interest charges and stricter
conditions
Operation and Evolution of the Bretton
Woods System
 Bretton Woods system allowed changes in par values in
cases of fundamental disequilibria
 Deficit nations were reluctant to devalue their currencies
because they regarded this as a sign of national weakness
 Surplus nations resisted needed revaluations, preferring instead to
continue accumulating international reserves
 Since few nations changed par values, adjustment
mechanism was hindered
=> Resulted in destabilizing international capita flows
The United Nations BOP Deficit and
Collapse of the Bretton Woods System
 From 1958 onward, the United started facing BOP deficit problems
 With development of the euro markets, there was a huge outflow of
dollars (the period of the dollar shortage):
 These U.S. deficits allowed European nations and Japan to build up their
international reserves.
 Because dollar was an international currency, the US felt it could not
devalue to correct BOP
 Effects:
 Depletion of United States gold reserves (U.S. gold reserves declined
from $25 billion in 1949 to $11 billion in 1970).
 In 1971, declining gold reserves forced the US to suspend gold
convertibility
The United States BOP Deficit and
Collapse of the Bretton Woods System
 In late 1970 and early 1971, in the face of huge
balance-of-payments deficits
 Butthe US could not devalue its currency without bringing
down the Bretton Woods System
 Since the US could not use monetary policy, it had to
rely on fiscal policy to achieve domestic objectives
The United States BOP Deficit and
Collapse of the Bretton Woods System
 The unwillingness of Germany and Japan to
revalue their currency forced the U.S to devalue
the dollar, collapsing the Bretton Woods System
 This was a political decision to remove the US
from its position as the “world’s banker”
 However, the USD remained an international
currency even without the gold backing, WHY?
The United States BOP Deficit and
Collapse of the Bretton Woods System
 Smithsonian Agreement (December 1971)
 Dollar price of gold increased to $38/ounce
 Other major currencies revalued (German mark: 17%; JPY: 14%, etc.)
 Fluctuation bands increased from 1 percent to +-2.25 percent
 Since the dollar remained inconvertible into gold, the world was
now essentially on a dollar standard
 Continuing BOP deficits forced a subsequent devaluation of the
dollar in Feb. 1973 ($42.22 per ounce) and finally a suspension
of dollar convertibility to gold
The United States BOP Deficit and
Collapse of the Bretton Woods System
The International Monetary System:
Present and Future
 Following the collapse of the Bretton Woods System, the
monetary system moved to a system of managed floats
 formally recognized by the Jamaica Accords of 1976 (took effect in
April 1978)
 The nations are allowed to choice foreign exchange regimes
 In Mar. 1979, EMS and in Jan. 1999, Euro
 International reserve for currency intervention still provided
by the IMF
 The lending ability of the IMF was expanded in 1997 by the New
Arrangement to Borrow
The International Monetary System:
Present and Future
 The use of IMF conditionality has come to be a source of great
contention within the international monetary system
 IMF Conditions for Loans and Special Help:
 Reductions in government spending
 Growth of the money supply
 Wage increases to reduce imports, stimulate exports, and make country more
self-sustaining
The International Monetary System:
Present and Future
The International Monetary System:
Present and Future
 Problem with Present Exchange Rate Arrangements
 Large volatility and wide and persistent misalignments of
exchange rates
 Large quantities of dollar held by foreigners and ready to move from
monetary center to monetary center in response to fluctuations in exchange
rates
 Failure to promote greater coordination of economic policies
among leading industrial nations
 Inability to prevent international financial crisis
The International Monetary System:
Present and Future
 Current International Problems
 Financial crises in emerging market economies
 Slow growth and high unemployment in advanced
economies after the “great recession”
 Trade protectionism in advanced countries in a rapidly globalizing
world
 Large structural imbalances in the United States,
slow growth in Europe and Japan, and insufficient restructuring in
transition economies of Central and Eastern Europe;
 Deep poverty in many developing economies
 Resource scarcity, environmental degradation, and climate change that
endanger growth and sustainable world development
Global exchange rate arrangements and
monetary policy framework
 Vietnam (At the end of April 2019):
 Exchange rate arrangement:
 Stabilized arrangement (The country maintains a de facto
exchange rate anchor to the USD)

[Link]
 Vietnam: Financial Position in the IMF
(as of September 30, 2021)

 Membership Status: September 21, 1956

 Outstanding Purchases and Loans: None

Extended Credit Facility (ECF) provides financial assistance to countries with protracted balance of payments problems

[Link]
Q&A