Brief History of Financial System

Topics: Bretton Woods system, Foreign exchange market, Monetary policy Pages: 7 (1939 words) Published: April 5, 2011

The international financial system provides the framework enabling residents of one country to make payments to residents of other countries. Over the past centuries world trade was characterised by great changes in the international financial system, beginning with the use for gold and silver in the bimetallism era, through the gold standard the gold exchange standard , the Bretton Woods system and the current floating exchange rates. Arguably gold id the oldest metal used both as store of value and as a medium of exchange as realised in the early Egyptian Pharaohs’’ (3000 B.C), who stored wealth in gold and traded with other likewise, according to Prayer (1982).


According to Arthers and Sheffrins (2003) a financial system is a system that allows the transfer of money between savers and borrowers, comprising of a set of complex and closely interconnected financial institutions, market instruments, and transactions. This system in this regard allows the exchange of money/value among trading parties.

The international financial system is a financial system consisting of institutions that act on the international level. They operate under sets of internationally agreed rules and supporting institutions which facilitate international trade , cross border investment and the reallocation of capital between nation states.

General overview:

The international monetary system consists of:

i) exchange rate arrangements;

ii) (ii) capital flows; and

(iii) a collection of institutions, rules, and conventions that govern its operation. Domestic monetary policy frameworks dovetail, and are essential to the global system. A well-functioning system promotes economic growth and prosperity through the efficient allocation of resources, increased specialization in production based on comparative advantage, and the diversification of risk hence resulting in the continued stability of the international financial system.

In an attempt to answer the question, the writer gives a rundown of the background of the growth and development of the financial system, starting with the bimetallism era, through to the gold standard, the Bretton Woods system to the current floating exchange rate system.

The Bimetallism Era

This was a “Double Standard”, because both gold and silver were used used as money and were as well international means of exchange. This era was basically used in the pre-1875 period. The central bank of a country would agree at some exchange between gold and silver, say 16 ounces for silver equate to 1 ounce gold. Consequently a currency would be valued according to various standards, depending on the various countries. As a result of changes in the relative supplies and demands for the two metals there were fluctuations in the foreign exchange rates between two countries. With the opening up of the world supplies of gold and silver started varying supplies of both metals, as some countries could easily have access to gold and others silver. Out of consenting the countries agreed to make use of silver and try to preserve the scarce gold adopted in the Gresham’s Law.

Classical gold standard

This was used in the period 1875-1913 in which a monometallic standard was adapted in the form of gold. This was a commitment by participating countries to fix the prices of their domestic currencies in terms of gold. This was a traditional and orthodox way of pegging a currency is to adopt the gold standard according to Morgan (1990). The arrangement was such that each nation would define its currency in terms of a quantity of gold, maintain fixed relationship between its gold stock and money supply, and allow gold to be freely exported and imported.

Consequently countries pegged their currencies in price of gold, like the “Act of Parliament of 1876, obliged the Bank of England to buy gold at 3 pound, 17 shillings, 10.5 pence per ounce”...
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