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Assignment on--
Prepared ForMd. Shariat Ullah Lecturer, Dept. Management Studies Faculty of Business Studies University of Dhaka
Prepared ByMd. Azim Ferdous Roll No: 121, Section: B, Batch: 11th Dept. of Management Studies University of Dhaka
Page | 2 The international monetary system establishes the rules by which countries value and exchange their currencies. It also provides a mechanism for correcting imbalances between a countrys international payments and its receipts. Further, the cost of converting foreign money into firms home currency-a variable critical to the profitability of international operations depends on the smooth functioning of the international monetary system. The history of monetary system started when in ancient time (seventh century B.C.1) tribes & city-states of India, Babylon & Phoenicia used gold & silver as media of exchange in trade. The total history of international monetary system is discussed below in a chronological order.
Del Mar, A History of Money in Ancient Countries (New York: Burt Franklin, 1968), p.71. I. Drummond, The Gold Standard and the International Monetary System 1900-1939 (London: McMillan Education Group, 1987), pp.10-11. 3 http://en.wikipedia.org/wiki/Gold_standard 4 In which paper notes are backed only by the traders' "full faith and credit" in the government, in particular by its acceptability for payments of debts to the government (usually taxes).
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Page | 3 The Gold Standard variously specified how the gold backing would be implemented, including the amount of specie per currency unit. The currency itself is just paper and so has no innate value, but is accepted by traders because it can be redeemed any time for the equivalent specie. A US silver certificate, for example, could be redeemed for an actual piece of silver5. Difficulty: Transacting in gold was expensive. For example, suppose Jardine Matheson, a Hong Kong trading company, sold 100,000 worth of tea to Twining & Company, a London distributor of fine teas. If it wanted to be paid in gold by Twining & Company upon delivery of the tea, Jardine Matheson had to bear the costs of loading the gold into the cargo hold of a ship, guarding it against theft, transporting it, and insuring it against possible disasters. Moreover, because of the slowness of sailing ships, Jardine Matheson would be unable to earn interest on the 100,000 payment while the gold was in transit from London to Hong-Kong. On the other hand, if Jardine Matheson was willing to he paid in British pounds, Twining could draft a check to Jardine Matheson and give it to the firms London agent. The London agent could then either immediately deposit the check in Jardine Matheson's interest-bearing London bank account or transfer the funds telegraph of the firm's account at its Hong Kong bank. Starling-Based Gold Standard: From 1821 until the end of 1918, the most important currency in international commerce was the British pound sterling because of the United Kingdoms large territory6 due to dominant economic and military power. So, most of the people relayed on pound that time. As a result international monetary system during this period is also called starling-based gold standard7. Because of the international trust London became a dominant international center in the 19 th century, a position it still holds8.
United Kingdoms territory that time was consisted of Canada, Australia, New Zealand, Hong Kong, Singapore, India, Pakistan, Bangladesh, Kenya, Zimbabwe, South Africa, Gibraltar, Bermuda, and Belize. 7 At the turn of the century, the French franc & the German mark were used in addition to sterling for setting private international transactions. 8 B. Cohen, The Future of Sterling as an international Currency (London: McMillan, 1971), pp.6061.
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Page | 4 despite the high levels of inflation, unemployment, and political instability that were wracking Europe.9 Implementation of Floating Rate System By Bank of England: The standard of gold standard was doomed by economic stresses triggered by the worldwide Great Depression. The Bank of England, the United Kingdom's central bank, was unable to maintain its new pledges under the gold standard. On September 21, 1931, it allowed the pound to float, meaning that the pound's value would be determined by the forces of supply and demand and the Bank of England would no longer guarantee to redeem British paper currency for gold at par value10. Competitive Devaluation of Currencies & Increased Tariff Rate: After the United Kingdom abandoned the gold standard, a "sterling area emerged as some countries, primarily members of the British Commonwealth, pegged their currencies to the pound and relied on sterling balances held in London as their international reserves.11 Other countries tied the value of their currencies to the U.S. dollar or the French franc. Some countries (United States, France, United Kingdom, Belgium, Latvia, the Netherlands, Switzerland & Italy) were deliberately & artificially devaluating their official value of currencies to make their goods cheaper in the international markets, which is stimulating its exports and reducing its imports. But, none were getting the benefit due to competitive devaluation at almost same percentage that is each currency's value relative to the other remains the same. Most countries also raised the tariffs they imposed on imported goods in the hope of protecting domestic jobs in import-competing industries. Nations adversely affected by trade barriers of any kind are quite likely to impose retaliatory or reciprocal tariffs12. Effect of beggar-thy-neighbor policies (World War II): As more and more countries adopted beggar-thy-neighbor policies like devaluation of currencies and increasing the tariff rate on imported goods, international trade contracted that hurt employment in each country's export industries. More ominously, this international economic conflict was soon replaced by international military conflict that was the outbreak of World War II in 1939.
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Decisions & Outcome of the Bretton Woods Conference: The Bretton Woods Conference has presented the world two historic agreements. These are as follows: A. Agreement of conferees to renew the gold standard on a modified basis. B. Agreement to create two new international organizations to assist the rebuilding of the world economy and the international monetary system. These area. International Bank for Reconstruction and Development (IBRD) b. International Monetary Fund (IMF) a. The International Bank for Reconstruction and Development (IBRD) The International Bank for Reconstruction and Development (IBRD) is the official name of the World Bank. Established in 1945, the World Bank's initial goal was to help finance reconstruction of the war-torn European economics. With the assistance of the Marshall Plan, the World Bank accomplished this task by the mid-1950s. The Bank then adopted a new missionto build the economies of the world's developing countries. As its mission has expanded over time, the World Bank created three affiliated organizations: a. International Development Association (IDA) b. International Finance Corporation (IFC) c. Multilateral Investment Guarantee Agency (MIGA)
Together with the World Bank, these constitute the World Bank Group. The World Bank is currently owned by the 185 member countries. The World Banks activities are focused on the reduction of global poverty, focusing on the achievement of the Millennium Development Goals (MDGs), goals calling for the elimination of poverty and the implementation of sustainable development. United States is the banks largest shareholder.
Page | 6 b. International Monetary Fund (IMF) International Monetary Fund (IMF) was created to monitor and control the functioning of the international monetary system. It is an international organization that oversees the global financial system by observing exchange rates and balance of payments, as well as offering financial and technical assistance. Its objectives are as follows: i. To promote international monetary cooperation. ii. To facilitate the expansion and balanced growth of international trade. iii. To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation. iv. To assist in the establishment of a multilateral system of payments. v. To give confidence to members by making the general resources of the Fund temporarily available to them and to correct maladjustments in their balances of payments. vi. To shorten the duration and lessen the degree of disequilibrium in the interactional balances of payments of members. At first 29 countries signed its Articles of Agreement of IMF. But now it has 186 Members. Its Headquarters are at Washington, D.C., USA. Current Managing Director is Dominique Strauss-Kahn. Its Central Bank of Base borrowing rate 5.50%. A Dollar-Based Gold Standard: The IMF and the World Bank provided the institutional framework for the postwar international monetary system. All countries agreed to peg the value of their currencies to gold. However, only the United States pledged to redeem its currency for gold at the request of a foreign central bank. Thus the U.S. dollar became the key-stone of the Bretton Woods system. In the early postwar years, only the U.S. and Canadian dollars were convertible currencies, that is, ones that could be freely exchanged for other currencies without legal restrictions. Countries had faith in the U.S. economy and so were willing to accept U.S. dollars to settle their transactions. As the British pound sterling had been in the nineteenth century, the U.S. dollar became the preferred vehicle for settling most international transactions. The effect of the Bretton Woods conference was thus to establish a U.S. dollar-based gold standard. Under the Bretton Woods Agreement each country pledged to maintain the value of its currency within 1% of its par value. If the market value of its currency fell outside that range, a country was obligated to intervene in the foreign-exchange market to bring the value back within 1% of par value. This stability in exchange rates benefited international businesses, since the Bretton Woods system generally provided an assurance that the value of each currency would remain stable. Bretton Woods System as Adjustable Peg : The Bretton Woods system is often described as using an adjustable peg because currencies were pegged to gold but the pegs themselves could be altered under certain conditions. The arrangement of Bretton Woods System worked well as long as pessimism about a countrys economy was
Page | 7 temporary. But, if a country suffered from structural macroeconomic problems, major difficulties could arise.
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Page | 8 pound sterling) with the weights revised every five years14. As of May 1995, the SDR was worth $1.54 in U.S. dollars. Outcome of Creating SDRs: SDRs solved the liquidity problem for the international monetary system, but if failed to solve the problem related to the glut of dollars held by foreigners & faith. By mid 1971, the Bretton Woods system was tottering, the victim of fears about the dollar's instability. In the first seven months of 1971, the United States sold one third of its gold reserves15. It became clear to the marketplace that the United States did not have sufficient gold on hand to meet the demands of those who still wanted to exchange their dollars for gold. Official Ending of Bretton Woods System: The Bretton Woods system officially ended when in a dramatic address on August 15, 1971, President Richard M. Nixon announced that the United States would no longer redeem gold at $35 per ounce.
International Monetary Fund, 1990 Annual Report, p.133. The European Financial Common Market (Luxembourg: Office for Official Publications of the European Communities, 1989), pp. 43ff.; The European Community in the nineties (Washington, D.C.: EC Delegation to the United States, 1992), pp.12ff.; Directorate-General for Economic and Financial Affairs, European Economy, No. 44 (October 1990), p. 42. 16 Group of Ten means the group consists of following countries who have worlds top most GDP shares: United States, Japan, Germany, France, Italy, United Kingdom, Canada, Netherlands, Belgium & Sweden. 17 http://www.gold-eagle.com
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