International Monetary System Content •A. Bimetallism •B. The gold standard •C. Modified gold standard •D. The Bretton-Woods monetary system •E. Post Bretton-Woods monetary system Starting points •All previous lectures BUT we have to predominantly consider: •Development of WE – period of ups and downs •Gresham´s law •Equation of exchange P*Q = M*V •Theory of balance of payment (BofP) •Exchange rate regimes – fixed, floating, pegging Function of international currency in WE •A. International trade currency •evaluate and mediate international trade •price (exchange rate) is formed on foreign currencies markets •B. International reserve currency •foreign currency hold as reserve = consequence of BofP disequilibrium Bimetallism A. BIMETALLISM •simultaneous circulation of coins from at least 2 different metals •conditions for the functioning: a)legally determined exchange ratio between the metals b)existence of authorized mint prepared to exchange the metals •more favourable to purchase goods with different prices •X ê prices – if only one metal - é AD è é production + if insufficient é Ms (gold) è ê prices = deflation •instability - good functioning as long as the difference between official and market EX rate is small è otherwise è ….of metal with higher values = monometallism • abandoned mainly in order to follow GB The gold standard B. Gold Standard (GS) •practically a single currency – (period from 1870s to WWI) •uncertain starting point – dates ranged from1880 to 1897 •before WWI – 59 countries (except China) •system with automatically reached equilibrium •remember: •successful stable period - é trade, production, INV- é interdependence of WE •relative balance among powers •GB superpower prepared to take responsibility for the development of WE •difference between theory and practice •at the beginnig of the 1970s •gold (AU): GB (already since 1717) •Interuption during the Nepolenic Wars •silver (AG): DE, NL, Scandinavia, Lat. America and Orient •bimetallis: USA and FR •banknotes: Russia, AUS-HUN, IT and GR •Prussia – Frace War 1871 •DE – Goldmark + Reichsbank •ðòprices of AG ð FR forced to adopt GS •rich deposits of AG (e.g. Nevada) ðò prices of AG ð threat of P ð NL, NO, SE, DK to Au •until 1878 GS: GB, BE, NL, FR, DE, Skandinavia + paper money ð silver out of use •1879 USA (formally 1900); AUS-HUN 1892; Russia nad JP 1897 ð break of the new century – GS in almost all countries •later AR, MX, PE, UY • Recall Conditions for the functioning of GS 1.each currency had a fixed volume of AU – gold par value 2.obligation of the monetariry authority to exchange any amount of domestic currency (at a given rate) for AU 3.unlimited EX and IM of AU 4.ban on gold inflow sterilizing •any violation è disfunction of the system Self-balancing mechanism – closed economy • (e.g.) technological progress in mining ò MC on mining below the real price of AU ñ mining = ñ Ms = ñprice level BUT fixed nominal price of AU ò real price of AU ò profits in mining industry+ ñ use for nonmonetary purposes ð avoid toñ Ms –LR stable Mechanism of BofP balancing = Hume´s Law •BofP DEFICIT outflow of AU from the country = ò money in circulation = ò price level (P*Q = M*V) ñ EX and ò IM BofP improvement Mechanism of BofP balancing based on interest rates •BofP DEFICIT •ò •outflow of AU from the country •ò •ñ interest rates •ò •ñ foreign INV •ò •BofP improvement GS in practice •diversions between theory and practice •impact on the amount of money in circulation (r) •capital flows (sterilizing) • WHY did it function? a. willingness of GB to lend •policy of Bank of England b. use of pound instead of AU •stability of the pound •London – financial center c. cooperation of CBs SUCCESSFUL PERIOD To sum up •https://www.youtube.com/watch?v=LdyHso5iSZI Modified gold standard C. Modified gold standard •after WWI •attempt to return to GS •BUT problems: •countries seriously weakened •unstable currencies •lack of understanding of the functioning of GS •nobody shielded the system •when and how to anchor the currencies to AU •majority of countries in the system at the end of 1920s Two forms of modified GS •A. Gold bullion standard •limited exchange of money for AU – minimum amount •practically Ricardo´s ingot plan •B. Gold exchange standard •no direct convertibility for gold •stable exchange rates to currencies convertible into gold Problems with modified GS •1. instability of the system •problems with anchor = overvalued… undervalued •in 1920s FR and USA accumulated AU + sterilizing ð deflation •2. Bank of England •outflow of AU- ò reserves •need to hold big reserves for foreign creditors •ðpound under continuous pressure •GB the weakest constituent of the system •3. modifications ð ñ foreign currencies as reserves • ð pyramidal effect = fin. crisis ð shift to other countries – devaluation ð ò reserves Great Depression and fin. crisis collapse in the 930s •running away from all forms X convertibility of currencies for AU - majority of countries – floating with CB interventions •already in 1929 certain countries (e.g. Latin America) •1931 GB ceased to exchange pound for AU •followed by countries with closed commercial relations Influence of USA •crisis in USA ð GS would serve as tool for recovery •ò economy ð ò IM ð ñ BofP surplusð ñ inflow of AU ð ñ Ms ð ñ economy X FED concerns about inflation and sterilization of AU inflows •ð outflow of AU in the world ð ò Ms ð ò AD ð governments´ attempt to reduce IM •1933 USA abandoned AU convertibility • •London Conference in 1932 to solve problems of IMS BUT dissension •Gold Bloc •countries with AU •FR, BE, NL + other Eur states (Czechoslovakia included) •deflationary policy – attempt to maintain parity BUT devaluation ð 1936 end of convertibility •Sterling bloc •GB, colonies, … •X deflation + for ñ price level •better results than the Gold Bloc •Dollar bloc •USA + most countries on the am. continent •devaluation and later $ pegged to AU, but bound on EX of AU The Bretton–Woods system The beginning… • •https://www.youtube.com/watch?v=GVytOtfPZe8 • D. Bretton-Woods system •1944 – Conference in Bretton-Woods • •motivation: mainly to avoid repeating of the pre-WWII development • •B-W coincide with a succesfull period in WE, but it has not be the cause of prosperity •Content: 1.Establishment 2.Institutions •International Monetary Fund •International Bank for Reconstruction and Development 3.Functioning D1. Establishment •debates already during WWI •White plan (USA) •emphasis on free trade •+ creation of Stabilization Fund of United and Associated Nations = loans to countries which want to protect their currencies •+ creation of bank for reconstruction and development •after-war reconstruction •help to DC •Keynes plan (GB) •International compensatory chambre = supranational bank •multirateral compensations among CBs •loans to countries with deficits •deposits of surpluses •new currency – pegged to AU (inside the insitution) •in total higher authority + potential threat of pegging to dollar •similar aims (partial contradictions) −> compromise GB and USA (1943) but closer to the US plan The International Monetary Fund (IMF) •Washington – supreme organ = Board of Governors •tasks = to realise B-W agreements: •loans for covering BofP deficits •to everybody è repayments as soon as possible •before lending è proposals of solutions – payback period 3-5 years •implementation of mutual convertibility of national currencies •in addition •development of monetary cooperation •consulting services to member states •multilateral trading and payment system •contribution to ñ production and world trade •elimination of barriers in mutual trade D2. Institutions The International Bank for Reconstruction and Development (IBRD) •same membership as IMF •aim: to support econ. growth è long-term loans on projects (e.g, education, ecology, communication, …) different tasks of IMF and IBRD (even though) IMF = www.imf.org WB = www.worldbank.org D3. Functioning •The goal of the system: •replace scarce gold reserves with the dollar •stable environment for the international trade • •Conditions of functioning: •a. mutual convertibility •b. fixed exchange rates (CB´s obligation to intervene) •c. USA´s obligation to exchange $ for AU at any time •d. loans in the case of problems with BofP Convertibility •USA pressure on GB ð 1947 Ł convertible BUT outflow of $ ð the end of convertibility •majority of Eur currencies convertible after 1958 •ð real functioning of the system only after this date Exchange rates •after WWII – difficulties with setting parities (value, uncertainty, …) ðin 1946 Ex rates set BUT not realistically ð •1948 – 49 I. wave of devaluations b/c strong external imbalances = lack of $ •1. GB ð other developed countries ð until 1952 BofP improvement, ñ AU and $ reserves •1967 – II. wave - GB (large strike in GB docks + economic consequences of 6 days lasting war) - 7 developed and 17 DC •1969 – III. wave FR (students´ uprisings and strikes) - 16 DC •1969 autumn – revaluation of the mark •in total 280 devaluations and 10 revaluations • at least o devaluation – 96 (21 developed and 75 DC) from 109 countries, i.e. 88% •only 11 countries without changes of EX rate •need of adjustments, but unwillingness to devaluate – only under the pressure of markets (financial crisis) – politically unpopular • •ð relatively stable system – mainly during 1959 – 67 (no changes) •stable X preceding and followinf period Problems of the B-W system •different inflation rates •ð real appreciation (countries with higherP) and depreciation (countries with lower P) •ðEX of P to countries with lower ñ price level •ñ prices of imported goods •interventions (obligation to keep fixed EX rate) – countries with lower P had to purchase foreign currency and sell national currency = ñMs •government – limits on capital flows (gradual easing) ð no free movement as before WWI ð effectivity… Pressure on $ - (many dollars in circulation) •after WWII USA large reserves ð confidence in $ •other CB wanted $ ð USA possibility of having BofP deficit without loss of AU = national currencies used to pay foreign debts •but in 1960s worsening of the BofP deficit •aaccumulation of $ abroad •ò gold reserves •exchange of $ for AU •ñMs ð ñ inflation •expansive fiscal policy (social programs and Vietnam) •expansive monetary policy •ðð many $ in circulation X reserves of AU •ðð crisis of confidence in convertibility of $ for AU ð run to $ •at the beginning of the 1970s only 20% $ covered by AU Lack of dollars (X preceding) •in 1960s lack of $ •ñ foreign trade + $ as international reserve currency •ð USA had to have BofP deficit •ñ $ obligations > ñ AU reserves •Triffin dilemma: •a. USA not issue enough $ ð obstacle for the WE •b. issue enough SH ð threat of P + relation AU and $ •ð 1969 IMF introduction of Special Drawing Rights (SDR) – reserve currency- late Development of the US gold reserves (tons) and the US share in the world’s gold reserves (%), 1948-1980 Gold annual average USD price 1793-2005 Collapse of the B-W system •USA not able to keep fixed $/AU ratio •1971 serious worsening of the US BofP deficit = outflow of $ •CBs in a large scale exchange $ for AU •ð aug. 1971 devaluation + convertibility of $ for AU abandoned •ð gold ceased to function as monetary anchor – commodity •ðð after abandonement $ collapse of the system •the end in 1973 - IMF broadening of the currency fluctuation range to 2,25% …ð floating https://www.youtube.com/watch?v=3KHIpxU-t8U Post Bretton–Woods system E. Post Bretton-Woods system •detachment of currencies from comodities è one of the reasons of increasing inflation in the 1970s •è independent CBs •1976 IMF meeting in Kingston (Jamaica) è new system - managed floating • BUT attempt to fix è pegging Exchange rates in developing countries, 1976 - 1996 and world-wide in 2006 The European Monetary System •ñ imbalances and problems with BofP è 1979 EMS •3 pillars: •European Currency Unit ECU = currency basket •Exchange Rate Mechanism ERM = exchange rates of currencies to ECU (bands) •credit mechanism– to support stability of the system •problems of EMS at the beginning of the 1990s •GB, IT, … forced to abandon the system The present •euro – see lecture about EU •dollar still the most important reserve currency •disputes about international institutions •to dissolve them (e.g. Friedman) •to reform them •return to original ideas •ongoing reforms in WB Currency share in foreign reserves To sum up •monetary systems are important for smooth development of WE •performance of WE depends on the monetary systems •afer the fall of B-S system – at the first time the international monetary system is not pegged to any commodity Currency composition of globally disclosed foreign exchange reserves (1947-2013, in %) Source: ECB Working Paper 1715, August 2014 Thank you for attention The End!